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Chapter 6: Q1AAP. (page 312)

Johnson Co. accepts a note receivable from a customer in exchange for some damaged inventory. The note requires the customer make semiannual installments of \(50,000 each for 10 years. The first installment begins six months from the date the customer takes delivery of the damaged inventory. Johnson鈥檚 management estimates that the fair value of the damaged inventory is \)679,517.

Accounting

(a) What interest rate is Johnson implicitly charging the customer? Express the rate as an annual rate but assume semiannual compounding.

(b) At what dollar amount do you think Johnson should record the note receivable on the day the customer takes delivery of the damaged inventory?

Analysis

Assume the note receivable for damaged inventory makes up a significant portion of Johnson鈥檚 assets. If interest rates increase, what happens to the fair value of the receivable? Briefly explain why.

Principles

The Financial Accounting Standards Board has issued an accounting standard that allows companies to report assets such as notes receivable at fair value. Discuss how fair value versus historical cost potentially involves a trade-off of one desired quality of accounting information against another.

Short Answer

Expert verified

The interest rate is 4% Semi-annually, notes receivables should be recorded at $679,517. The fair value of receivables will decrease. The fair value and historical cost involves a trade-off.

Step by step solution

01

Accounting

a)PVF-OA=PresentValueofNoteSemiannualPayment=679,51750,000=13.59034

So, using the table we find that rate is 4% semi-annually or 8% pa

b) Receivable should be recorded at the amount of $679,517 because the other part represents only the interest amount

02

Analysis

When cash flow is discounted at higher interest, then the present value decreases.Similarly, if the rates are increased then the fair value of receivables will decrease

03

Principles

The fair value and historical cost usually involve trade-offs. This is because fair value is more relevant but has subjective nature. On the other hand, historical cost is more reliable and fixed. Fair value represents the present scenario which is very useful for the users of financial statements.

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Most popular questions from this chapter

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