Question

On July 1, 2017, Moresan Company sold special-order merchandise on credit and received in return an interest-bearing note receivable from the customer. Moresan will receive interest at the prevailing rate for a note of this type. Both the principal and interest are due in one lump sum on June 30, 2018.

On September 1, 2017, Moresan sold special-order merchandise on credit and received in return a zero-interest-bearing note receivable from the customer. The prevailing rate of interest for a note of this type is determinable. The note receivable is due in one lump sum on August 31, 2019.

Moresan also has significant amounts of trade accounts receivable as a result of credit sales to its customers. On October 1, 2017, some trade accounts receivable were assigned to Indigo Finance Company on a non-notification (Moresan handles collections) basis for an advance of 75% of their amount at an interest charge of 8% on the balance outstanding.

On November 1, 2017, other trade accounts receivable were sold without recourse. The factor withheld 5% of the trade accounts receivable factored as protection against sales returns and allowances and charged a finance charge of 3%.

Instructions

(a) How should Moresan determine the interest revenue for 2017 on the:

(1) Interest-bearing note receivable? Why?

(2) Zero-interest-bearing note receivable? Why?

Short answer

Interest revenue for interest-bearing notes will becalculated using face value and interest rate for six months. Interest revenue for zero-interest bearing notes will be computed using discounted present value and market rate of interest for four months.

Step-by-step solution

Definition of Accrued Interest

Accrued interest is defined as the interest expenses due for any amount borrowed but is still unpaid. Such interest is reported as a current liability.

Interest Revenue

(1) Interest-bearing note: Interest revenue for interest-bearing notes will be calculated by multiplying the principal amount by the interest rate and 6/12. It is multiplied by 6/12 because the interest gets accrued for July to December.

(2) Zero-Interest bearing note: Interest revenue for non-interest-bearing notes is calculated by multiplying the carrying value of the note, market interest rate, and 4/12. The carrying value is calculated as the present value of the face amount on September 1 from the maturity date. The discounted value must be calculated at the market rate of interest.