300459 Flashcards
Amortization
Amortization is an accounting process for reducing an asset or liability by periodic payments or writedowns that are distributed across the time the organization gains a value from or has obligation for the item. Specifically, it is the process of reducing a liability recorded as a result of a cash receipt (e.g., unearned revenue) by recognizing revenues or reducing an asset recorded as a result of a cash payment (e.g., prepaid expenses) by recognizing expenses or costs of production.
SFAC 6.142
Amortization is an allocation process to orderly reduce bond premium, bond discount, and bond issue costs by allocating the cost of an intangible asset to expense over time.
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 the discount. What amount should Vann report for notes payable in its December 31, 20X1, balance sheet?
$500,000
$477,501
$471,571
$446,000
$471,571
Carrying Amount (Book Value)
The carrying amount or book value is the net amount at which an item is reported in the financial statements of the enterprise. For a receivable, the FASB ASC Glossary indicates the carrying amount is the “face amount increased or decreased by applicable accrued interest and applicable unamortized premium, discount, finance charges, or issues costs and also an allowance for uncollectible amounts and other valuation accounts.”
For a payable, the FASB ASC Glossary indicates the carrying amount is the “face amount increased or decreased by applicable accrued interest and applicable unamortized premium, discount, finance charges, or issue costs.”
Discount
A discount is the excess of face value over the proceeds (cash paid) for a bond (i.e., the borrower receives proceeds less than the face value), which is contrasted to a premium. A discount results when the stated interest rate is less than the effective (market) rate. It is amortized over the life of the bond with the amount of amortization reported as interest and is the difference between the present value of the bond and its face value (where the face value is higher). The discount is recorded on the balance sheet as a contra account inseparable from the bond which gives rise to it. It must be disclosed as a direct deduction from the face amount of the bond.
Example: A bond at face value is a $1,000, 20-year bond bearing interest at 10% annually, where the stated interest rate is 10% and cash interest paid is $100 per year. (FASB ASC 835-30-55-5)
If the prevailing market rate is 12%, the bond will “sell” for less than $1,000 (proceeds received will equal $851), because the lender could earn 12% on any other investment (so this bond’s market value is less than its face value). The bond sells at a discount.
i=.12, n=20, PVA(100) = (PVA × 100) + (PV × 1,000)
= (7.47 × 100) + (.104 × 1,000)
Selling price = $747 + $104 = $851
Discount = $1,000 − $851 = $149
The measure of the time value of money (present value), the amount deducted in advance of a payment due (as a cash discount on a receivable for early payment) or an amount charged in advance and deducted from the amount due (as a discounted or noninterest-bearing bond), and the process of decreasing a future amount back to the present at a specific discount rate (i) are all examples of ways in which the term “discount” is used.
Discount Rate
A discount rate is the rate of interest used to compute the present value of future cash flow(s). FASB ASC 835-30 requires that the interest rate be the borrower’s rate for an arm’s-length transaction in which you have a willing buyer and a willing seller and neither is compelled to buy or sell. In other cases, the rate of interest used is the prime rate, an opportunity cost rate, an investment rate of return, a weighted average cost-of-capital rate, etc.
Non-interest Bearing
A non-interest-bearing note includes the interest in the face amount of the note, i.e., the face value equals the principal plus interest as a single amount to be paid back at maturity. It is a discounted (present value) note, i.e., interest is charged in advance and deducted from the amount of the loan. The borrower receives some amount (the principal) less than the face amount (principal plus interest) that will be repaid at maturity. (Contrast to interest-bearing.)
2281.01
Notes payable are liabilities that are formally recognized by a written promissory note. These notes most often occur when the company cannot pay short-term accounts payable or obligations for items that have entered into the operating cycle. In those instances, the company may sign an interest-bearing note to defer payment for a short time. These notes payable are usually short-term liabilities.
2281.02
Short-term bank loan: A common way for a company to acquire temporary financing is to arrange a short-term bank loan. The company signs an interest-bearing promissory note.
Example: On February 1, 20X1, ABC Corp. borrows $500,000 for United Bank by signing a six-month 8% promissory note. Interest is due upon maturity of the note.
February 1, 20X1:
Cash 500,000
Notes payable 500,000
August 1, 20X1:
Interest expense ($500,000 x 8% x 6/12) 20,000
Notes payable 500,000
Cash 520,000
2281.03
Credit line: A common method of acquiring short-term notes payable is a credit line. A credit line allows a company to borrow up to an arranged limit without using formal loan paperwork.
2281.04
Commercial paper: Another type of note payable is commercial paper. Commercial paper is an unsecured note generally sold in minimum amounts of $25,000 with maturities of 30 to 270 days. Commercial paper is issued directly to the buyer.
2281.05
Exchanges: When a note payable is exchanged for property, goods, or services, and the interest rate is not stated or is unreasonable, record the note at the fair value of the property, goods, or services exchanged OR at the amount that approximates the market value of the note, whichever is more clearly determinable. In the absence of said information, the note is recorded at its present value by discounting all future payments on the note using an imputed interest rate. The imputed interest rate is determined by considering the debtor’s credit standing, prevailing rates for similar debt, and rates at which the debtor can obtain funds. The note payable should be presented in the statement of financial position at its face amount minus the discount calculated at the imputed interest rate.
FASB ASC 835-30-25-3
