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Chapter 13: Question 7Q (page 691)

What is the nature of a 鈥渄iscount: on notes payable?

Short Answer

Expert verified

Note Payableis a current liability whose payment is due within one year. Notes payable discount occurs when the carrying value is less than the face value.

Step by step solution

01

Meaning of Discount

A discount is a difference between the face value and the carrying value. The concept of discounted notes is that the short-term obligations are issued at a discount from face value, and they don鈥檛 have interest since they receive the face value at maturity

02

Discount on Notes Payable

A discount on notes payable occurs when the note`s face value is greater than its carrying value. It represents the added interest that must be paid over the life of the note.

A contra liability account for notes payable would be called the discount on notes payable. The difference is gradually amortized over the remaining life of the note so that the difference is eliminated as of the maturity date.

For example, a 1-year discount note of face value of $1,000 purchased at the price of $950 would yield $50.

Discount on notes payable = Difference of Face value & Carrying value

Hence, the discount would be $50.

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Most popular questions from this chapter

(Refinancing of Short-Term Debt) On December 31, 2017, Hattie McDaniel Company had \(1,200,000 of short-term debt in the form of notes payable due February 2, 2018. On January 21, 2018, the company issued 25,000 shares of its common stock for \)38 per share, receiving \(950,000 proceeds after brokerage fees and other costs of issuance. On February 2, 2018, the proceeds from the stock sale, supplemented by an additional \)250,000 cash, are used to liquidate the \(1,200,000 debt. The December 31, 2017, balance sheet is issued on February 23, 2018.

Instructions

Show how the \)1,200,000 of short-term debt should be presented on the December 31, 2017, balance sheet, including note disclosure

Distinguish between a current liability, such as accounts payable, and a provision.

You are the independent auditor engaged to audit Millay Corporation鈥檚 December 31, 2017, financial statements. Millay manufactures household appliances. During the course of your audit, you discovered the following contingent liabilities.

  1. Millay began production of a new dishwasher in June 2017 and, by December 31, 2017, sold 120,000 to various retailers for \(500 each. Each dishwasher is under a 1-year warranty. The company estimates that its warranty expense per dishwasher will amount to \)25. At year-end, the company had already paid out \(1,000,000 in warranty expenses. Millay鈥檚 income statement shows warranty expenses of \)1,000,000 for 2017. Millay accounts for warranty costs on the accrual basis.
  2. In response to your attorney鈥檚 letter, Morgan Sondgeroth, Esq., has informed you that Millay has been cited for dumping toxic waste into the Kishwaukee River. Clean-up costs and fines amount to \(2,750,000. Although the case is still being contested, Sondgeroth is certain that Millay will most probably have to pay the fine and clean-up costs. No disclosure of this situation was found in the financial statements.
  3. Millay is the defendant in a patent infringement lawsuit by Megan Drabek over Millay鈥檚 use of a hydraulic compressor in several of its products. Sondgeroth claims that, if the suit goes against Millay, the loss may be as much as \)5,000,000. However, Sondgeroth believes the loss of this suit to be only reasonably possible. Again, no mention of this suit is made in the financial statements.

As presented, these contingencies are not reported in accordance with GAAP, which may create problems in issuing a favorable audit report. You feel the need to note these problems in the work papers.

Instructions

Heading each page with the name of the company, balance sheet date, and a brief description of the problem, write a brief narrative for each of the above issues in the form of a memorandum to be incorporated in the audit work papers. Explain what led to the discovery of each problem, what the problem really is, and what you advised your client to do (along with any appropriate journal entries) in order to bring these contingencies in accordance with GAAP.

Grant Company has had a record-breaking year in terms of growth in sales and profitability. However, market research indicates that it will experience operating losses in two of its major businesses next year. The controller has proposed that the company record a provision for these future losses this year, since it can afford to take the charge and still show good results. Advise the controller on the appropriateness of this charge

Why is the liabilities section of the balance sheet of primary significance to bankers?
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