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Guest2011
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Joined: 25 Mar 2011
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Posted: 30 Mar 2011 at 03:27 \| IP Logged

Garr Co. received a $60,000, 6-month, 10% interest-bearing note from a
customer. After holding the note
for two months, Garr was in need of cash and discounted the note at the
United Local Bank at 12%. The
amount of cash Garr received from the bank was:
a. $60,480
b. $60,630
c. $61,740
d. $62,520

Explanation
Choice "a" is correct. $60,480 cash proceeds received from bank.
Approach
I II
Net Net
Proceeds Interest
At Revenue
Discount (Expense)
Face of note 60,000 $60,000
Int Rt on note 10% × 1/2 yr x       5%
    3,000 $3,000
Maturity value of note 63,000 63,000
Disc by bank - 12% × 4/12 yr        4%
   (2,520) (2,520)
Proceeds from bank $60,480
A
Net interest income (expense) $   480

why is it 12% times 4/12 if it was held for 2 months? I guess it's because
the maturity was only 6months? maybe the explanation should say 2/6

Zeratul
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Joined: 11 Jun 2009
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Posts: 987

Posted: 30 Mar 2011 at 10:43 \| IP Logged

4 months represents the remaining life of the note at the time of acquisition by the bank.

mvn910
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Posted: 02 Apr 2011 at 03:08 \| IP Logged

I think this example can be understood as you are gonna get 63K in 4 months but you can not wait. So what you are going to do? Bring it to the bank and cash it. Here the issue, how much the bank would charge us? They are based on the rate 12%, an amount of 63K and a period of 4 months. In this case, service charge = 63K * 12% * 4/12 = 2520.

Hopefully this would give you an idea why we have 4/12 in this situation.

At another point, I personally do not think answer a. $60,480 is the correct answer if we apply the concept of discount fully to this example. The cash received from the bank should represent the present value discounted from the future value of 63k at the rate of 12 in a period of 4 months. So we have 63k = Present value (cash received) * (1+0.04). Then present value = 63k : 1.04= 60,576. It does not match any answer choices lolz. Probably the accounting rule make it simple in this case when discounting a future value to present value.

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TaxProfMom
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Posted: 02 Apr 2011 at 13:41 \| IP Logged

mvn910 wrote:

I think this example can be understood as you are
gonna get 63K in 4 months but you can not wait. So what you are going
to do? Bring it to the bank and cash it. Here the issue, how much the bank
would charge us? They are based on the rate 12%, an amount of 63K and
a period of 4 months. In this case, service charge = 63K * 12% * 4/12 =
2520.Hopefully this would give you an idea why we have 4/12 in this
situation.At another point, I personally do not think answer a. $60,480
is the correct answer if we apply the concept of discount fully to this
example. The cash received from the bank should represent the present
value discounted from the future value of 63k at the rate of 12 in a period
of 4 months. So we have 63k = Present value (cash received) * (1+0.04).
Then present value = 63k : 1.04= 60,576. It does not match any answer
choices lolz. Probably the accounting rule make it simple in this case
when discounting a future value to present value.

I believe (correct me if I'm wrong) that trade receivables that are short-
term are not discounted.

Either way, if they don't give you a discount rate, don't get fancy and think
you need to discount.

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Zeratul
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Posted: 05 Apr 2011 at 07:09 \| IP Logged

You don't generally apply time value when the life of the recievable/payable is less than a year.

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