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AG_CPA
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Joined: 19 Jun 2009
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Posted: 14 Oct 2009 at 05:31 \| IP Logged

I am unable to comprehend this question/answer
explanation, appreciate if someone could explain?

Thanks in advance

Becker CPA-00337
Ace Co. sold to King Co. a $20,000, 8%, 5-year note that
required five equal annual year-end payments. This note
was discounted to yield a 9 % rate to King. The present
value factors of an ordinary annuity of $1 for five
periods
are as follows:
8% 3.992
9% 3.890

What should be the total interest revenue earned by King
on this note?
a. $9,000
b. $8,000
c. $5,560
d. $5,050

Explanation
Choice "c" is correct. $5,560 total interest revenue.
Annual payments = $20,000 ÷ 3.992 = $ 5,010
Five equal payments of principal and interest. × 5
Total payments 25,050
Discounted note = $5,010 × 3.890 = (19,490)
Total interest over five years $ 5,560

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abood
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Posted: 14 Oct 2009 at 09:22 \| IP Logged

Think of it as lease...
Total interest revenue with a lease=gross investment-net investment.
this question is the same...

BJordan85
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Posted: 14 Oct 2009 at 14:41 \| IP Logged

abood wrote:

Think of it as lease...
Total interest revenue with a lease=gross investment-net investment.
this question is the same...

I had actually run into this question a few weeks ago and struggled with it. Your explanation would have saved me quite some time. Thanks!

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AG_CPA
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Posted: 14 Oct 2009 at 22:15 \| IP Logged

Sorry, I am unable to first establish who is the maker
and who is the payee. With which party has this been
discounted with. I read this Q repeatedly but my
understanding points to as follows:

If note is NOT discounted, the Total payments received
25,050 LESS Principle of 20,000 = 5,050 Revenue.

If discounted, it will be 25,050 LESS 19,040 = 5,560
Revenue.

This is not making sense to me as your earnings should be
lesser (not more) if discounted...

Any thoughts would be appreciated...

Thanks

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lovethepirk
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Joined: 10 Jul 2009
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Posts: 295

Posted: 23 Oct 2009 at 09:50 \| IP Logged

Ag,

I am the process of hashing out the details on these problems.

If someone would post the two journal entries for the loans inception
and the amortization of the discount that would help.

Anyway, i am pretty sure this has to do with cash outflow by King(the
lender). Had the lender given the loan at face value 20,000 they are
writing a check for 20,000. When they get 25,050 back, the diffence in
cash paid 20,000 and received is 5050 interest revenue.

When they "discount" the loan it means at the inception the loan will
transact lower than facevalue. That means the lenders writes a check
at inception for 19490. Since they still receive 25050 the differnce is
more than before.

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