[jessanqi]

I’m just wondering, in calculating the interest expense, why don’t use the amortization amount $65,000 divide by the life of this note which is 3 years???

Anyone can help?? thank you in advance!!!!

On January 1, 20X5, Dorr Company borrowed $200,000 from its major customer, Pine Corporation, evidenced by a note payable in three years. The promissory note did not bear interest. Dorr agreed to supply Pine’s inventory needs for the loan period at favorable prices. The going rate of interest for this type of loan is 14%. Assume that the present value (at the going rate of interest) of the $200,000 note is $135,000 at January 1, 20X5. What amount of interest expense should be included in Dorris 20X5 income statement?

A. $0
B. $18,900
C. $21,667
D. $28,000

Explanation
The correct answer is B. Per U.S. GAAP, when a corporation lends a supplier cash which is to be repaid with no interest, “such a non-interest bearing loan may be partial consideration under a purchase contract for supplier products at lower than the prevailing market prices. In this circumstance, the difference between the present value of the receivable and the cash loaned to the supplier is appropriately regarded as an addition to the cost of products purchased during the contract term. The note discount is amortized as interest over the … life of the note.”

Applying the above to our situation, we have a cash loan of $200,000, with a present value of this amount being $135,000 using an assumed rate of interest of 14%. Thus, the interest for 20X5 would be 14% × $135,000, or $18,900.

[mccarta7]

Hi @Jjessanqi, When you are calculating interest expense on a note payable that bears no interest for a period of time the calculation is: carrying amount x implied interest rate x portion of period note is outstanding. So for this example, you want to take $135,000 x .14 x (12/12) = $18,900. The interest expense is then added to the old carrying amount of the note to find the new carrying amount. Thus, the new carrying amount in 20X6 is 153,900. In 20×6, the interest expense would be 153,900 x .14 x (12/12) = $21,546. And by the end of the note term the carrying value should equal the face value of the note.

I made the same mistake of thinking you would just divide the excess by 3 as well when I first began studying for FAR. I hope this helps a little!

[jessanqi]

Thank you so much @mccarta7@ 🙂

Good luck on you exam!!

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