[Anonymous]

I have completed reviewing all the financial statement accounts for FAR and the one area I am having issues grasping conceptually are notes and bonds. I do not understand the whole notion of a discount/premium. Once calculations get involved, I also cannot figure what rates are applicable; I get particularly confused when questions ask for proceeds to a bank if they buy a note receivable and interest bearing vs noninterest bearing.

Take this question below for example. I understand that you use the stated rate to calculate the payment amount, but why do we suddenly use the market rate to calculate interest revenue?

Ace Co. sold King Co. a $20,000, 8%, 5-year note that required five equal annual year-end payments. This note was discounted to yield a 9% rate to King. The present value factors of an ordinary annuity of $1 for five periods are as follows:

8% 3.992

9% 3.890

What should be the total interest revenue earned by King on this note?

A. $9,000

B. $8,000

C. $5,560

D. $5,050

I would really appreciate it if someone can give me a conceptual overview of notes/bonds and what a discount/premium really means. I know we discount if stated rate>market rate, but conceptually what does that really mean? I think once I grasp the concept, I will be able to breeze through MCQs.

[titine]

Ok let me try. If stated rate > market rate, we have premium, not discount. Premium means people pay more money to us because higher stated rate attracts them more. Vice versa, if stated rate < market rate, people wouldn't be interested in buying it if we don't give them discount. Make sense?

About interest, here is my attempt to make it more understandable: Stated rate is what on the agreement, it's the cash we take out of our pocket. But we need to adjust it to the market (just think like we want it to reflect the market since it's the true value) so the expense will be calculated using the market rate instead.

Hope it helps 🙂

[Topsya]

I think this might help you. Check it out:

https://www.cpanet.com/cpa_forum/forum_posts.asp?TID=38562

AUD - 90
FAR - 83
BEC - 81
REG - 80
ETHICS - 100

[Anonymous]

thanks all, explanations were helpful. One more question I have though is regarding the market rate. Who uses the market rate to show the expense/payment, the bond issuer or holder? My understanding is that the bond issuer uses the stated rate to calculate the amount of interest payable, while the bond holder uses the market rate to calculate present value of the bond and to recognize interest income. Can someone please clarify?

[Author]

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