Lesson 22 Flashcards
What is the difference between current notes payable and long term notes payable?
The maturity date
Define long term notes payable
notes payable expected to be paid off longer than a year from issue date
A note is similar to a bond in what way?
A note is valued at the present value of its future interest and principal cash flows. And the company amortizes any discount or premium over the life of the note.
What is implicit interest rate?
it is the rate that equates the cash received with the amounts to be paid in the future.
What is the difference between the face amount and the present value of a zero interest bearing note?
It is called a discount and it is amortized to interest expense over the life of the note.
If there is no stated rate of interest, how do you determine the amount of interest?
The amount of interest is the difference between the face amount of the note and the fair value of the property
Define imputation
the process of interest rate approximation
Define imputed interest rate
the resulting interest rate for an approximation
define mortgage note payable
is a promissory note secured by a document called a mortgage that pledges title to property as security for the loan
On January 1, 2017, Trinity Company loaned $901,560 to Litton Industries in exchange for a 3 year, zero-interest-bearing note with a face amount, $1,200,000. The prevailing rate of interest for a loan of this type is 10%.
What is included in the adjusting journal entry made by Litton on December 31, 2017 with regard to the note?
A credit to Discount on Notes Payable for $90,156
When a note is issued at zero percent, the discount is amortized using the implicit interest rate calculated by evaluating the present value of future cash flows. In this case, the implicit interest rate is given as 10%. Similar to bonds, the difference of a note’s face value and the present value is booked as a discount and amortized to interest expense over the life of the note. The book value of the bond is the face value less any unamortized discount. In this case, the book value is given as $901,560. Interest expense for 2017 is $90,156 ($901,560 x .10). The December 31, 2017 journal entry will be: Debit Interest Expense $90,156, Credit Discount on Notes Payable $90,156.
A debt instrument with no ready market is exchanged for property whose fair market value is currently indeterminable.
When such a transaction takes place, what is true?
The present value of the debt instrument must be approximated using an imputed interest rate.
When a note is issued at zero percent, the discount is amortized using the implicit interest rate calculated by evaluating the present value of future cash flows.
A corporation borrowed money from a bank to build a building. The long-term note signed by the corporation is secured by a mortgage that pledges title to the building as security for the loan. The corporation is to pay the bank $80,000 each year for 10 years to repay the loan.
What relationship can you expect to apply to the situation?
The amount of interest expense will decrease each period the loan is outstanding.
Since the amount of principal due decreases as each payment is made, the amount of interest expense will decrease each period the loan is outstanding, while the portion of the annual payment applied to the loan principal will increase each period.
