Walk Through Balance Sheet. Chapter 7. Learning Objectives. Learning Objectives 1, 2. Learning Objectives 1, 2. Cash and Receivables.

(1)

Chapter 7

Cash and Receivables

1

Walk Through Balance Sheet

§  Chapters 1 – 6

§  Accounting cycle: JE, AJE, financial stmts

§  Conceptual framework, GAAP, revenue

§  Time value of money concepts

§  Remaining chapters (ACTG 161, 162)

§  Start at top of balance sheet (Cash)

§  Finish at bottom (Stockholders’ equity)

§  Look at each balance sheet account

§  Related income statement accounts ₂

Learning Objectives

1.  Identify items considered cash

2.  Indicate how to report cash and related items 3.  Define receivables, identify types of receivables 4.  Recognition of accounts receivable

5.  Valuation of accounts receivable

6.  Recognition and valuation of notes receivable 7.  Fair value option

8.  Disposition of accounts and notes receivable 9.  Reporting and analyzing receivables

3

" What is cash?

" Reporting cash

" Summary of

cash-related items

Cash Special

Issues

" Recognition of

notes receivable

" Valuation of

notes receivable

Cash and Receivables

Accounts

Receivable Notes Receivable

" Recognition of

accounts receivable

" Valuation of

accounts receivable

" Fair value option

" Disposition of

accounts and notes receivable

" Presentation and

analysis

4

Learning Objectives 1, 2

§  Identify items considered cash

§  Indicate how to report cash

Dr. Pepper, AMR, Blockbuster, SAP, Peet’s, Whole Foods (restricted cash) A/R:Apple,Dominos, Office Depot (n), Tiffany (n)

5

Learning Objectives 1, 2

§  Identify items considered cash

§  Indicate how to report cash

6

(2)

Cash

§  Accepted deposit at financial institutions

§  Coins and currency

§  Checks from customers and money orders

§  Certified checks and cashier’s checks

§  Savings accounts

§  Petty cash

§  Amounts ready to deposit counted as cash, even though not deposited

7

Cash Equivalents

§  Earn interest on unneeded cash

§  Readily convertible to cash

§  Highly liquid debt securities

§  Maturities of 90 days or less at purchase

§  Highest rating, AAA; little interest rate risk

§  Similar to money market fund Interest = Principal × Rate × Time Interest = $10,000,000,000 × 3% × 30/360

Interest = $25,000,000

8

Cash Equivalents

§  Debt securities

§  Treasury notes, other government debt

§  Corporate debt (commercial paper, notes)

§  Money market funds

§  Managed by third party (Fidelity, Schwab)

9

Cash and Cash Equivalents

§  Readily available to

§  Pay off debt

§  Use in operations

§  No legal or contractual restrictions

§  No distinction between

§  Cash

§  Cash equivalents

§  Restricted cash NOT cash or equivalent

10

Restricted Cash

§  Cash not available for current use reported as

§  Restricted cash

§  Investments

§  Other assets

§  Can be current or non-current asset

§  Disclosure required

11

Restricted Cash

§  Restrictions on cash can be

§  Informal

§  Contractually imposed

§  Informal (management intent)

§  Management sets aside cash for purpose

§  Plant expansion or payment of debt

§  Can be used for other purposed if needed

§  Contractually imposed (legally binding)

§  Vendor or lender requirement in writing ₁₂

(3)

Not Cash

§  If not readily convertible to cash with no penalties or restrictions, not cash

§  Must look at nature of asset

§  Example: Certificate of deposit (CD)

§  Penalty to convert to cash before due date

§  Classify as Short-term investment

13

Compensating Balance

§  Restricts use of cash borrowed

§  Minimum balance required in bank account to reduce risk to bank

§  Can be current of noncurrent

§  Disclosure required

§  If contractual requirement “not cash”

§  If informal may be cash

14

Compensating Balance

Amount borrowed $10,000,000

Compensating balance 2,000,000

Available for use $8,000,000

Interest rate 12%

Interest per year 10,000,000 × 12% = 1,200,000 Effective interest rate 1,200,000 / 8,000,000 = 15%

Compensating balance increases effective interest rate

15

When a company writes a check for more than the amount in its cash account.

Bank Overdrafts

§  Generally reported as a current liability

§  May net against other cash accounts at same bank, but not at other banks

16

Codification: 305 Cash and Cash Equivalents,10 Overall ¹⁷

Learning Objectives 3, 4, 5

§  Define receivables, identify types of receivables

§  Recognition of accounts receivable

§  Valuation of accounts receivable

18

(4)

Receivables

§  Claims held against customers and others for money, goods, or services

§  Accounts receivable

§  Notes receivable

19

Accounts Receivable

§  We are seller

§  Goods are delivered, service provided

§  Promise of purchaser to pay

§  Open account (no contract signed)

§  Short-term extension of credit

§  Usually 30 to 60 days

§  No interest if paid on time

20

Notes receivable

§  We are lender

§  Use note receivable when

§  Larger amount

§  Repayment longer term

§  Contract signed by borrower stating

§  Principal

§  Interest (stated interest rate)

§  Due date

21

Non-trade Receivables

§  Advances or loans to employees

§  Advances or loans to subsidiaries

§  Deposits for potential damages / losses

§  Deposits as a guarantee of performance or payment

§  Dividends and interest receivable

22

Accounts Receivable

§  Trade receivables: Receivables from sale of goods or services on account

§  Deliver merchandise or service today, customer pays later

§  Current asset: Converted to cash within normal operating cycle

Date Description Debit Credit

Accounts receivable 5,000

Sales 5,000 23

Accounts Receivable

§  Record receivable at amount of sale

§  Do not use present value

§  Time less than one year

§  Difference between PV and FV small

§  APB Opinion 21 excludes accounts receivable from PV valuation

24

(5)

Subsidiary Ledgers

§  General ledger account shows total receivable from all customers

§  Subsidiary ledgers show amount due from each customer

25

Accounts receivable 5,000

A/R: Smith 5,000 General

ledger

Accounts receivable subsidiary ledgers

26

Description Debit Credit

Service revenue 5,000

Performed service on account for customer Smith

A/R: Smith 5,000

A/R: Chi 1,000

A/R: Marx 3,000 General

ledger Accounts receivable subsidiary ledgers

27

Accounts Receivable 5,000

1,000 3,000

9,000

Trade Discounts

§  Seller publishes price list

§  Buyers given discount off list price

§  Trade discount reduces selling price

§  Record sale net of discount

§  List price – trade discount = sell price

§  No entry made for discount amount

If more than one trade discount, apply in chain;

second discount applied to net amount after first disc.

28

Trade Discount

Description Item Number Price

Bookcase NCK749 $1,200

Chair JRK483 $1,000

Table TLW497 $800

Account receivable 800

Sales 800

Sold one chair, 20% trade discount: $1,000 × (1 – 0.20) = $800 Seller offers trade discount of 20%

29

Trade Discount

Account receivable 612

Sales 612

Sold one chair with trade discounts: $1,000 × 0.80 × 0.85 × 0.90 = $612 Seller offers trade discounts of 20%, 15%, 10%

Description Item Number Price

Bookcase NCK749 $1,200

Chair JRK483 $1,000

Table TLW497 $800

30

(6)

2/10,n/30

Number of Days Discount is

Available

Otherwise, Net (or All) is Due

Credit Period Discount

Percent

Cash Discounts (Sales Disc.)

31

Cash Discounts

§  Also called early payment discount

§  Sales discount / Purchase discount

§  Reduces amount buyer pays if payment made within a specified period of time

§  Increase sales

§  Encourage early payment

§  Increase likelihood of collections Not the same as trade discount – be careful

32

Cash Discounts: Gross Method

§  Sales are recorded at invoice amounts

§  Sales discounts recorded if payment received within discount period

§  Discount not taken is sales revenue

33

Cash Discounts: Net Method

§  Sales recorded at invoice less discount

§  Sales discounts forfeited if payment received after discount period

§  Discount not taken is interest revenue

34

Cash Discounts

§  Net method preferred by GAAP

§  Difference between the gross and net methods usually not material

§  Most companies use gross method

35

On May 10 sold $5,000 of merchandise, cash discount of 1/10, n/30.

Gross Method

May 10 Accounts receivable 5,000

Sales 5,000

Net Method

May 10 Accounts receivable 4,950

Sales 4,950

36

(7)

On May 19 received payment in full payment for the sale made on May 10

Gross Method

May 19 Cash 4,950

Sales discounts 50

Net Method

May 19 Cash 4,950

37

Financial Statements

Income Statement (Gross method)

Sales $5,000

Sales discounts 50

Net sales 4,950

Income Statement (Net method)

Sales $4,950

Other income:

Financing revenue 0

38

If payment in full received on May 31 (not within discount period)

Gross Method

May 31 Cash 5,000

Net Method

May 31 Cash 5,000

Financing revenue 50

39

Financial Statements

Income Statement (Gross method)

Sales $5,000

Sales discounts 0

Net sales 5,000

Income Statement (Net method)

Sales $4,950

Other income:

Financing revenue 50

40

Returns and Allowances

§  Accounts receivable decreased

§  Return: Merchandise returned

§  Allowance: Buyer keeps merchandise

Sales returns and allowances ?,???

Accounts receivable ?,???

41 42

(8)

Adjusting Journal Entries

§  AJE required if returns or cash discounts in future periods are material

§  Estimate future returns and discounts

§  Amount material

§  Record in same period as related sale

43

ACCOUNT ACTIVITY

Sales

Sales discounts Sales returns

Sales

Returns Discounts

44

Net Sales

Sales (after trade discounts) Sales returns and allowances Sales discounts (cash discounts) Net sales

Revenue Contra-revenue

45

Accounts Receivable

§  Will all receivable be collected? No!

§  Balance sheet must show amount expected to be collected

§  Net realizable value

§  Bad debt expense is operating expense

§  Match to revenue in period of sale

46

Direct Write-off Method

§  Not permitted by GAAP

§  Only use direct write-off when uncollectible accounts immaterial

§  Write-off account when identified

§  No allowance account

Bad debt expense ?,???

Accounts receivable ?,???

47

ALLOWANCE METHOD

§  If uncollectible accounts material

§  Allowance method required by GAAP

§  Do not wait for specific accounts to become uncollectible

§  Estimate future uncollectible accounts

§  Match expense with related sales revenue

§  Balance sheet shows net collectible

48

(9)

Matching

Principle

Bad Debt

Expense

Sales

Revenue

Record in same period

Matching Principle

49

Accounts Receivable

Accounts receivable

Allowance for uncollectible accounts Net accounts receivable

Asset Contra-asset

50

ACCOUNT ACTIVITY

Allow Uncollectible Sales Returns

Collections Write-offs

Write-offs AJE Est.

Asset

Contra asset

51

Estimate Bad Debt Expense

§  Estimate bad debt expense with AJE

Allowance for uncoll. acc. ?,???

Assets = Liabilities + Equity

È È

52

Estimating Expense

§  Two methods to estimate

Percent of Sales

A/R Aging

53

Balance Sheet Approach Emphasis on Realizable Value Accts.

Rec. All. for Uncoll.

Accts.

Percentage of Sales

Accounts receivable aging Income

Statement Approach Emphasis on

Matching Sales

Bad Debts

Exp.

Methods to Estimate

54

(10)

Percentage-of-Sales

§  Estimate bad debt expense associated with credit sales in current period

§  Income statement approach

§  Match expense to revenue

§  Income statement fairly stated

§  Balance sheet (net A/R) not fairly stated

55

Percent-of-sales

§  Balances before year-end adjustments

Contra asset account

Accounts Receivable 100,000

Allow Uncollectible 5,000

Percent-of-sales method ignores these two values ₅₆

Percent-of-Sales

§  Sales $500,000

§  Uncollectible estimated 1.5% of sales

§  Bad debt expense = $500,000 × 0.015

§  Bad debt expense = $7,500

Bad debt expense 7,500

Allowance for uncoll. acc. 7,500

57

Percent-of-Sales

Allow Uncollectible 5,000 7,500 12,500

Balance Sheet

Less allowance 12,500

Net accounts receivable 87,500 ₅₈

Percent-of-Sales

§  Matched expense to revenue

§  Income statement fairly stated

§  Ignored values on balance sheet

§  Balance sheet may not be fairly valued

§  Changes in estimate prospective

§  Less accurate estimates from previous periods never corrected

59

Aging Of Receivables

§  Age invoices, predict % not collected

§  Estimate receivables not collectible

60

(11)

Aging Of Receivables

§  Balance sheet approach

§  Balance sheet fairly stated

§  Income stmt may not be fairly stated (no matching)

61 62

Balance Sheet

Net accounts receivable 509,350

63

Aging Of Receivables

§  Balances before year-end adjustments

Aging method uses these two values

64

Invoice 1 – 30 31 – 60 61 – 90 90 + Total

5367 3,000 3,000

5953 15,000 15,000

6107 12,000 12,000

6153 13,000 13,000

6244 30,000 30,000

6287 27,000 27,000

Total 57,000 25,000 15,000 3,000 100,000

Est % 2% 5% 10% 60%

Allow. 1,140 1,250 1,500 1,800 5,690 Days from invoice date

Invoice number

Invoice amount

65

Invoice 1 – 30 31 – 60 61 – 90 90 + Total

5367 3,000 3,000

5953 15,000 15,000

6107 12,000 12,000

6153 13,000 13,000

6244 30,000 30,000

6287 27,000 27,000

Total 57,000 25,000 15,000 3,000 100,000

Est % 2% 5% 10% 60%

Allow. 1,140 1,250 1,500 1,800 5,690 Days from invoice date

Invoice number

Invoice amount

Balance Sheet

Net accounts receivable 94,310

66

(12)

Aging Of Receivables

§  Aging estimates $5,690 not collectible

690 5,690

67

Aging Of Receivables

§  Aging estimates $5,690 not collectible

690 5,690 Balance Sheet

Net accounts receivable 94,310 ⁶⁸

Aging Of Receivables

§  Adjusting journal entry $690

Bad debt expense 690

Allowance for uncoll. acc. 690

690 5,690

69

Aging Of Receivables

§  What if Allowance balance was $500?

Allow Uncollectible

??? 500 5,690

70

Aging Of Receivables

§  Adjusting journal entry $5,190

Bad debt expense 5,190

Allowance for uncoll. acc. 5,190

Allow Uncollectible 5,190 500 5,690

71

Aging Of Receivables

§  What if Allowance balance was $6,000?

???

5,690

72

(13)

Aging Of Receivables

§  Adjusting journal entry $310

Allowance for uncoll. acc. 310

Bad debt expense 310

Allow Uncollectible 6,000 310

5,690

73

Aging Of Receivables

§  Balance sheet fairly valued

§  Net A/R fairly estimated

§  Income statement not fairly stated

§  Expenses not matched to revenue

§  Estimates from previous periods that were too high (too low) are reversed

74

Estimate Bad Debt Expense

§  Estimate doubtful accounts expense with an adjusting journal entry

Allowance for uncoll. acc. ?,???

Assets = Liabilities + Equity

È È

75

Writing Off Accounts

§  Write-off $1,000

Allowance for uncollectible acc. 1,000

Assets = Liabilities + Equity ÇÈ

76

Writing Off Accounts

Before Write-off

After Write-off Accounts receivable $100,000 - 1,000 $99,000

Less allowance 5,000 - 1,000 4,000

Accounts receivable, net $95,000 $95,000

77

Estimates And Actual

AJE Doubtful Acc. Exp. (Estimated)

Allowance for Uncoll Acc Estimated Actual

Write-off account receivable (Actual)

78

(14)

Collect Account Written-Off

§  Reverse write-off

Allowance for uncollect. acc. 1,000

Record collection of receivable

Cash 1,000

Accounts receivable 1,000 ⁷⁹

Sale On Account

A L SE Accounts receivable Ç

Sales Ç

80

Collect Cash On Account

Sales Ç

Cash Ç

Accounts receivable È

81

AJE Estimate Doubtful

Accounts Expense

Sales Ç

Cash Ç

Doubtful accounts expense È

Allowance for doubtful acc. È

82

Write-off Account

Sales Ç

Cash Ç

Doubtful accounts expense È

Allowance for doubtful acc. È

Allowance for doubtful acc. Ç

Accounts receivable È ⁸³

Account Activity

Allow Uncollectible Sales Returns

Collections Write-offs

Write-offs AJE Est.

Asset

Contra asset

84

(15)

Learning Objectives 6

§  Recognition of notes receivable

§  Valuation of notes receivable

85

Notes Receivable

§  Written contract

§  From borrower to lender

§  Negotiable (may be sold)

§  Promise to pay

§  From borrower (maker) to lender (payee)

§  Principal (amount borrowed)

§  Plus interest (stated or unstated)

§  On date

86

Notes Receivable vs. A/R

§  Compared to accounts receivable

§  Dollar amount higher

§  Payment terms longer

§  Higher risk of default

§  Earn interest on outstanding balance

§  Legal contract

§  Easier to enforce in court

87

Why Notes Receivable?

§  Customers extend payment period

§  High-risk or new customers

§  Sales of property, plant, and equipment

§  Lending transactions (majority of notes)

§  Loans to employees, subsidiaries, vendors

88

PROMISSORY NOTE

Face Value Date

after date I promise to pay to the order of

Westward, Inc.

Dollars plus interest at the annual rate of .

$25,000 Nov. 1, 2011

One year

12%

Twenty-five thousand and no/100---

Janet Lee , Winn,Co.

Maker Payee

Principal

Interest Rate

Date of Note Term

Notes Receivable

89

Interest Computation

Principal × Interest rate × Time = Interest Rate is rate per year

Time is years or fractions of years If time ≤ one year, simple interest If time > one year, compound interest (TVM)

Home / Broad Transactions / 835 Interest / 30 Imputation of Interest 90

(16)

November 1, 2011: Loan $25,000, 12%, one year Journal entries November 1, December 31, 2011

Entry to record receivable

Nov 1 Note receivable 25,000

Cash 25,000

Adjusting journal entry to accrue interest: $25,000 × 12% × 2/12

Dec 31 Interest receivable 500

Interest revenue 500

91

November 1, 2011: Loan $25,000, 12%, one year Journal entry on due date, November 1, 2012

Entry to record collection of receivable

Nov 1 Cash 28,000

Note receivable 25,000

Interest receivable 500

Interest revenue 2,500

$25,000 × 12% × 10/12 = $2,500

92

§ 

Non-Interest-Bearing Notes

§  Actually do bear interest

§  Interest is deducted (discounted) from the face value of the note

§  Use market rate of interest

§  Face value = Principal + interest

§  Cash received = Face value − interest

93

Non-Interest-Bearing Notes

§  Discount is future interest revenue

§  Discount is contra account to notes receivable

94

December 31, 2011, accepted $25,000, one-year non-interest-bearing, note discounted at 12%

Entry to record acceptance of note receivable Discount = $25,000 × 0.12 × 1 = $3,000

Date Description Debit Credit

Dec 31 Note receivable 25,000

2011 Discount on note receivable 3,000

Cash 22,000

95

Note Receivable 25,000

Discount on N/R 3,000 Balance Sheet

December 31, 2011

Note receivable $25,000

Discount on note receivable 3,000

Net note receivable $22,000

Discount is revenue to be recognized in future periods

96

(17)

December 31, 2011, accepted $25,000, one-year non-interest-bearing, note discounted at 12%

Entry to record collection of note receivable

Dec 31 Cash 25,000

Entry to record acceptance of note receivable Discount = $25,000 × 0.12 × 1 = $3,000

Cash 22,000

97

Notes Received in Exchange

for Property, Goods, Services

§  In arm’s length bargained transaction stated rate is presumed fair unless

§  No interest rate is stated

§  Stated interest rate is unreasonable

§  Face amount of the note is materially different from the current cash sales price

98

Notes Received in Exchange

for Property, Goods, Services

§  Stated rate not fair, use better known of

§  FMV of goods, services

§  FMV of note

§  Interest rate (estimate market rate)

§  Given all numbers except one

§  Work backwards to plug for unknown

99

Notes Receivable for Land: 1

Sold land, received five year, non-interest bearing N/R Face value note $35,000 Fair value land $20,000 Interest rate Unknown Cost of land $14,000

PV of note = Cash value of asset today

= Fair value of land

= $20,000

Calculation of Discount on Note Receivable Future value (face value of note) $35,000

− Present value (fair value of land) 20,000 Discount (future interest revenue) 15,000 100

Land 14,000

Gain on sale of land 6,000

Sold land, received five year, non-interest bearing N/R Face value note $35,000 Fair value land $20,000 Interest rate Unknown Cost of land $14,000

Plug

− Present value (fair value of land) 20,000 Discount (future interest revenue) 15,000

101

Notes Receivable for Land: 2

Sold land, received five year, non-interest bearing N/R Face value note Unknown Fair value land $30,000 Interest rate 8% Cost of land $10,000

102

− Present value (fair value of land) 30,000 Discount (future interest revenue) $14,080 Present value × FV$1 factor = Future value

$30,000 × 1.46933 (8%, 5) = $44,080

(18)

103

Land 10,000

Sold land, received five year, non-interest bearing N/R Face value note Unknown Fair value land $30,000 Interest rate 8% Cost of land $10,000

Plug

− Present value (fair value of land) 30,000 Discount (future interest revenue) $14,080

Notes Receivable for Land: 3

Sold land, received five year, non-interest bearing N/R Face value note $40,000 Fair value land Unknown Interest rate 10% Cost of land $14,000

104

Future value × PV$1 factor = Present value

$40,000 × 0.62093 (10%, 5) = $24,837

− Present value (fair value of land) 24,837 Discount (future interest revenue) $15,163

Notes Receivable for Land: 3

Sold land, received five year, non-interest bearing N/R Face value note $40,000 Fair value land Unknown Interest rate 10% Cost of land $14,000

Fair value of land = $24,837

105

Discount on N/R 15,163

Land 14,000

Plug

Notes Receivable

§  Short-Term

§  Record at face value, less allowance

§  Long-Term

§  Record at present value of cash expected to be collected

106

Non-Interest-Bearing Note

0 1 3 3

$0 $0 Annuity

$0

$10,000 Future value

n = 3 4

Discount at market rate of interest, 9%

Face value $10,000 Term Three years Stated rate 0% Interest paid At maturity Market rate 9% Compounding Annually

107

Non-Interest-Bearing Note

PV of $1

Future value PV$1 Present value

$10,000 × 0.77218 = $7,722 108

(19)

Non-Interest-Bearing Note

Year Beg bal Interest 9% End bal

0 7,722

1 7,722 695 8,417

2 8,417 758 9,174

3 9,174 826 10,000

Total 2,278

109

Non-Interest-Bearing Note

0 7,722

1 7,722 695 8,417

2 8,417 758 9,174

3 9,174 826 10,000

Total 2,278

Entry to record creation of note receivable

Cash 7,722 110

Discount on N/R 2,278 Balance Sheet

December 31, 2011

Note receivable $10,000

Net note receivable $7,722

Discount is revenue to be recognized in future periods

111

Non-Interest-Bearing Note

0 7,722

1 7,722 695 8,417

2 8,417 758 9,174

3 9,174 826 10,000

Total 2,278

Entry to record annual interest revenue earned during first year

Dec 31 Discount on note receivable 695

112

Non-Interest-Bearing Note

0 7,722

1 7,722 695 8,417

2 8,417 758 9,174

3 9,174 826 10,000

Total 2,278

Entry to record annual interest revenue earned during second year

113

Non-Interest-Bearing Note

0 7,722

1 7,722 695 8,417

2 8,417 758 9,174

3 9,174 826 10,000

Total 2,278

Entry to record annual interest revenue earned during third year

114

(20)

Non-Interest-Bearing Note

0 7,722

1 7,722 695 8,417

2 8,417 758 9,174

3 9,174 826 10,000

Total 2,278

Entry to record collection of note receivable on due date

Dec 31 Cash 10,000

115

Discount on N/R 480 142

0 159 179 10,000

0 Cash 10,000

Interest revenue 695

2,278 7,722

2,278

758 826

0 7,722

1 7,722 695 8,417

2 8,417 758 9,174

3 9,174 826 10,000

Total 2,278 ₁₁₆

Discount on N/R 2,278 695

0 758 826 10,000

0 Cash 10,000

2,278 7,722

2,278

758 826 Year Beg bal Interest 9% End bal

0 7,722

1 7,722 695 8,417

2 8,417 758 9,174

3 9,174 826 10,000

Total 2,278

117

Discount on N/R 2,278 695

0 758 826 10,000

0 Cash 10,000

2,278 7,722

2,278

758 826

118

Two interest rates

Interest rate Note issued at Stated rate = Market rate Face value (par) Stated rate < Market rate Discount (less than par) Stated rate > Market rate Premium (more than par)

119

Note Issued at Par (Face Value)

Interest paid (annuity) = Face value × stated rate × time

$1,000 = $10,000 × 10% × 1

0 1 2 3

1,000 1,000 Annuity

$1,000

4 Discount at market rate of interest, 10%

Face value $10,000 Term Three years Stated rate 10% Interest paid Annually Market rate 10% Compounding Annually

120

(21)

Note Issued at Face Value

PV of annuity $1

Annuity PV$1 Ord Ann Present value

$1,000 × 2.48685 = $2,487 121

Note Issued at Face Value

PV of $1

$10,000 × 0.75132 = $7,513 122

Note Issued at Face Value

Creation of note receivable at par (face value), interest rate 10%

Jan 1 Note receivable 10,000

Cash 10,000

Annual interest revenue earned and cash collected, interest rate 10%

Dec 31 Cash (10,000 × 10% × 1) 1,000

Calculation of present value of note receivable Present value of face value of note (FV) $ 7,513 Present value of interest payments (annuity) 2,487 Present value of note receivable $ 10,000

123

Beginning

Balance Interest

Revenue Cash

Received Ending Balance

0 10,000

1 10,000 1,000 1,000 10,000

2 10,000 1,000 1,000 10,000

3 10,000 1,000 1,000 10,000

3,000 3,000

Cash received (annuity) = Face value × stated rate × time Interest revenue = Beginning balance × market rate × time

Note Issued at Face Value

124

Two interest rates

Interest rate Note issued at Stated rate = Market rate Face value (par) Stated rate < Market rate Discount (less than par) Stated rate > Market rate Premium (more than par)

125

Note Issued at Discount

Interest paid (annuity) = Face value × stated rate × time

$1,000 = $10,000 × 10% × 1

0 1 2 3

1,000 1,000 Annuity

$1,000

n = 3 4

Face value $10,000 Term Three years Stated rate 10% Interest paid Annually Market rate 12% Compounding Annually

Discount at market rate of interest, 12%

126

(22)

Note Issued at Discount

PV of annuity $1

Annuity PV$1 Ord Ann Present value

$1,000 × 2.40183 = $2,402 ₁₂₇

Note Issued at Discount

PV of $1

$10,000 × 0.71178 = $7,118 128

Note Issued at Discount

Calculation of discount on note receivable

Face value of note $ 10,000

Present value of note ($7,118 + $2,402) 9,520

Discount $ 480

Creation of note receivable; stated rate 10%, market rate 12%

Jan 1 Note receivable 10,000

Discount on note receivable 480

Cash 9,520

129

Note Issued at Discount

Calculation of discount on note receivable

Face value of note $ 10,000

Present value of note ($7,118 + $2,402) 9,520

Discount $ 480

Balance sheet

Note receivable $ 10,000

Less discount on note receivable 480

Net note receivable $ 9,520

130

Beginning Balance Interest

Received Discount Amortized Discount

Remaining Ending Balance

0 480 9,520

1 9,520 1,142 1,000 142 338 9,662

2 9,662 1,159 1,000 159 179 9,821

3 9,821 1,179 1,000 179 0 10,000

3,480 3,000 480

Cash received (annuity) = Face value × stated rate × time Interest revenue = Beginning balance × market rate × time

Discount amortized = Interest revenue − cash received Discount remaining = Previous discount − discount amortized

Ending balance = Face value − discount remaining OR Ending balance = Previous balance + discount amortized 131

Note Issued at Discount

First period: Annuity, interest revenue; stated rate 10%, market rate 12%

Dec 31 Cash 1,000

Discount on note receivable 142

Beginning Balance Interest

Received Discount Amortized Discount

Remaining Ending Balance

0 480 9,520

1 9,520 1,142 1,000 142 338 9,662

2 9,662 1,159 1,000 159 179 9,821

3 9,821 1,179 1,000 179 0 10,000

3,480 3,000 480

132