Chapter 7, Problem 7.6P

(1)

To determine

Note receivable:

Note receivable refers to a written promise for the amounts to be received within a stipulated period of time. This written promise is issued by a debtor or borrower to lender or creditor. Notes receivable is an asset of a business.

To determine: The rate of interest of the noninterest-bearing note.

Answer to Problem 7.6P

The rate of interest of the noninterest-bearing note is determined as follows:

Compute the amount of remaining discount of note 3:

Face Value of Note 1	$300,000
Face Value of Note 2	150,000
Face Value of Note 3	200,000
Total Face value of Notes	$650,000
Less: Carrying Value of Notes as Per Balance Sheet	(645,000)
Remaining Discount on note 3	$5,000

Table (1)

Compute the discount rate for 6 months:

$\begin{array}{c}\text{Discount Rate for 6 Months = }\frac{\text{Discount Amount for 6 Months}}{\text{Face Value}}\\ =\frac{\$10,000}{\$200,000}\\ =5\%\end{array}$ (1)

Explanation of Solution

Note 3 is a 6-month noninterest bearing note, with three months remaining. Hence, $5,000 represents the discount for three months. Therefore, the total amount of discount for 6 months is $10,000.

Annualize the discount rate:

$\begin{array}{c}\text{Annual Discount Rate = Rate for 6 Months (1) }\times \frac{12}{6}\\ =5\%\times \frac{12}{6}\\ =10\%\end{array}$

Conclusion

Therefore, the discount rate is 10%.

(2)

To determine

The accrued interest on note 2.

Explanation of Solution

The accrued interest on note 2 is determined as follows:

Total Accrued interest Receivable	$16,000
Less: Interest Accrued on Note 1	(10,000) (2)
Accrued Interest on Note 2	$6,000

Table (2)

Working note:

$\begin{array}{l}\text{Interest = Principal }\times \text{ Rate }\times \text{ Period}\\ \text{=}\text{\$300,000 }\times \frac{10}{100}\times \frac{4\left(\text{August 31 to December 31}\right)}{12}\end{array}$ (2)

Compute the explicit interest rate of note 2:

$\begin{array}{c}\begin{array}{l}\text{Interest Rate for 4 Months }\\ \left(\text{August 31 to December 31}\right)\end{array}]\text{ = }\frac{\text{Interest Amount for 4 Months}}{\text{Face Value}}\\ =\frac{\$6,000}{\$150,000}\\ =4\%\end{array}$ (3)

Annualize the discount rate:

$\begin{array}{c}\text{Annual Interest Rate = Rate for 6 Months }\times \frac{12}{6}\\ =4\%\times \frac{12}{6}\\ =8\%\end{array}$

Conclusion

Therefore, the Interest rate is 8%.

(3)

To determine

The amount of interest revenue to be reported on the income statement of 2016.

Explanation of Solution

Interest on Notes Receivable:

The amount of interest on notes receivables is calculated as follows:

$\text{Interest = Principal }\times \text{ Rate of interest }\times \text{ Interest period}$

Compute the amount of interest for the following notes receivable.

Computation of Interest on Notes receivable
Note Number	Principal ($)	Interest Rate (%)	Period (Days/Months	Interest ($)
1	300,000	10	4 Months (August 31 to December 31)	10,000 (1)
2	150,000	8	6 Months (June 30 to December 31)	6,000 (2)
3	200,000	10	3 Months (September 30 to December 31)	5,000 (3)
Total Interest to be Reported in the Income Statement of 2016				21,000

Table (3)

Working Notes:

Note 1:

$\begin{array}{c}\text{Interest = Principal }\times \text{ Rate of interest }\times \text{ Interest period}\\ \text{ = \$300,000 }\times \frac{10}{100}\times \frac{4}{12}\\ =\$10,000\end{array}$                       (4)

Note 2:

$\begin{array}{c}\text{Interest = Principal }\times \text{ Rate of interest }\times \text{ Interest period}\\ \text{ = \$150,000 }\times \frac{8}{100}\times \frac{6}{360}\\ =\$6,000\end{array}$                        (5)

Note 3:

$\begin{array}{c}\text{Interest = Principal }\times \text{ Rate of interest }\times \text{ Interest period}\\ \text{ = \$200,000 }\times \frac{10}{100}\times \frac{3}{12}\\ =\$5,000\end{array}$ (6)

Conclusion

Therefore, the amount of interest revenue to be reported on the income statement of 2016 is $21,000.