[MShanafelt]

I was hoping somebody could help me with this one: The question reads as follows: “On August 1, 20X1, Vann Corp.’s $500,000, 1-year, noninterest-bearing note due July 31, 20X2, was discounted at Homestead Bank at 10.8%. Vann uses the straight-line method of amortizing discount. What amount should Vann report for notes payable in its December 31, 20X1, balance sheet?”

And the first part of the answer states: Discount on note = 10.8% x $500,000 = $54,000

Monthly amortization = $54,000 / 12 months = $ 4,500/month

Face amount of note $500,000

Less discount at issuance 54,000

---

Carrying value of note at issuance $446,000

My question is this: I thought the initial discount was calculated by using the following equation: 1.108x=$500,000, and x therefore equals $451,264. Thusly, If someone were to pay $451,264 for this note and then receive $500,000 12 months later; their rate of return would be 10.8 percent. If an investor purchased this note for $446,000 as the answer per the MCQ states, aren’t they getting a 12.1 percent rate of return? ($54,000 / $446,000 = .121). I am terribly confused by this answer and would appreciate some guidance. Thanks!

[monikernc]

To solve for the discount you set it up as: (500,000-x)/500,000=.108 to get $54,000. The discount is not compounded as you attempted to do with the 1.108.

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[MShanafelt]

Hi monikernc
If a note, bond. etc. is discounted at 10.8%, doesn't that by definition mean that whoever purchases the discounted instrument is getting a 10.8% return on their investment? In this example isn't the bank getting a 12.1 percent return?

[monikernc]

i could be wrong but i think you are overthinking this particular problem which simply states the discount is amortized on a straight line basis and i set that up correctly for you above. fasb requires the effective interest rate method (in all but special cases where effect of both methods are essentially the same usually very short term). a study problem asking for that will give you either the cash proceeds or equivalent cash value (goods purchased) or a prevailing rate and/or the discount rate.

FAR 7/25/15 76!
AUD 10/30/15 93
BEC 2/27/16 82
REG 5/23/16 88!
Ninja Book and MCQ and the forum - all the way!!!
and a little thing i like to call, time and effort!
if you want things to change, you have to do something different

[Author]

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