[nicole_123]

Hi all,

I feel like this question should be super obvious but I’ve been spinning my wheels on this for longer than I care to admit so here it goes: On August 1, year 1, Vann Corp’s $500,000, one year, non interest-bearing note due July 31, year 2, was discounted at Homestead Bank at 10.8%. Vann uses the straight-line method of amortizing bond discount, What amount should Vann report for notes payable in it December 31, Year 1, balance sheet?

My understanding is that with non interest-bearing notes you must use an imputed interest rate. According to what I’ve read in Becker to do this, you record the payable at its face amount (in this case, $500,000), record what was received for the note at the present value and the difference is the discount. So my JE’s are as follows:
August Year 1:
Cash 451,263*
Discount on NP 48,737**
Note Payable 500,000
* To get the PV of the cash proceeds I used the PV of $1 formula → future value / (1+r)^n → 500,000 / (1+.108) = 451,263
** Discount = 500,000-451,263

December 31, Year 1:
Note Payable 22,500 ***
Discount on NP 22,500
*** Interest calculated as: (500,000*.108) X 5/12 = 22,500

Then to get the carrying amount of the note on the BS: 500,000 – 22,500 = $477,500

Basically, I must be calculating the present value of the cash proceeds incorrectly but I cannot for the life of me figure out what I’m doing wrong. Someone, please help before I jump out a window!

Edited to add: Becker says the carrying value is $468,500 and the cash proceeds are $446,000.

[chandler]

No need to use PV here.
First figure out the discount: $500,000*10.8%= $54,000 discount.
Second, calculate net proceeds: $500,000 face- $54,000 discount= $446,000 cash proceeds
Third, figure out amortization. In this case it is (5/12)* 54,000= $22,500. (5 months out of 12 to the b/s date.
Finally figure out the carrying value by adding proceeds to discount amortized: $446,000+$22,500= $468,500.

Let me know if this makes sense.

[f]

How are we supposed to know NOT to calc. the PV in this question though?? Basically having the same problem as OP. You would think you would get the correct answer regardless of the method you used to solve the problem…

I guess the logic behind the question is since Vann uses SL method for amortizing the discount, simply calc. the discount amount and subtract it from the face amount to get your “present value”

[DocJ]

PV is NOT for 1 year or less. It's long-term, it's to figure out the value of a thing in X years. But 1 year is too short, there's no big difference between what a thing is worth now versus next year. Hence the name, PRESENT Value, if it's in a year, it's already present. Never PV the short term.

Chandler nails it. I see this confusion on “non-interest bearing” all the time. It just means the thing doesn't bear a specific interest rate. Normally, if you see “non-interest bearing,” then the TOTAL dollar you got is principle AND interest combined. Rule 34a-EVERYTHING has interest. No exceptions…least that's how I think it :p

Put it this way: You get $500K and 10.8% and asked for total interest and principle, you'd multiply and add them. Well, discounting is just the reverse. Multiply for interest and SUBTRACT. So principle = $446,000 and discount/interest = $54,000. “Discount” is like “what part of this $500K is interest?”

Now, payment on the note isn't due til next year, so that $446K principle is still owed. Interest though is nonstop. Just figure out how much has accrued. Aug-Dec = 5 months. $54,000 total interest / 12 months = $4500 per month. $4500 * 5 months = $22,500. So you owe $446,000 principle plus $22,500 interest from 5 months = $468,500.

Just remember the basics: A payable is something you owe. What principle do you gotta pay, and what interest is attached to it so far?

[f]

100% agree, Chandler's explanation makes sense! My thought process was that we must calc. the pv of a note if it is at least 1 year. That's wrong.

Pv calculation is not required for payables that do not exceed approximately 1 year.

[DocJ]

See, with all the explanations and minutiae that goes into Becker and Wiley and so on, they constantly gloss over the basics like “PV is long-term only.” It's prob why a lot of people fail, this sort of stuff is just assumed that everyone knows it. But we DON'T, you guys! And even if we did, it's very easy to forget when you got 10 million other things to remember (facepalm)

Ninja, take note here…

[Author]

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