Interest-bearing notes receivable

The financial statement of Rachel Corporation presented the following information in the 2010 balance sheet:



Footnote information:

The fair market value of the notes was estimated by discounting the future cash flows using current rates available to similar borrowers under similar circumstances.

All notes receivable bear interest at 5% to 12% and require future principal payments of approximately $683,750 in 2011, $4,677,500 in 2012, $1,268,750 in 2013, $853,750 in 2014, $826,250 in 2015, and $31,691,250 thereafter. The current portion of these long-term notes is included in other receivables in the consolidated balance sheets.

Required:
1. Estimate the average term of the notes and the interest rates at which these notes were issued by customers of Rawlins.
2. Why would the interest rates vary so much?
3. Are the stated rate and the prevailing market rate of interest similar or quite different at the date of issue?

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Recording credit sales involving long term notes

A specialized equipment were sold by Shanty Co. on January 1, 2010. The original cost of the equipment was $50,000 and, at the time of disposition, the book value was $40,000. By nature, the market value of the equipment was dificult to determine.

At the time of transaction, Shanty Co. received a $12,500 downpayment and a note, $25,000 face value, 5% interest, in four equal annual installments starting December 31, 2010. The market interest rate on notes on January 1, 2010 for a similar nature and risk was 10%.

Required

Prepare journal entries to record the disposal of the equipment on January 1, 2010, and the first interest received on December 31, 2010.

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Recording long term notes receivable

Caren Company sells specialized machinery and equipment. On January 1, 2008, the company sold equipment and received a two-year, $10,000 note with a 3 percent stated interest rate. Interest is payable each December 31, and the entire principal is payable December 31, 2009.

The equipment does not have a readily established market value. The market rate of interest for notes of this type and level of risk is 10 percent.

Required

Prepare the entries on Caren Company’s books to record the sale of the equipment.

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Amortization of discount on note

On December 31, 2010, Green Company finished consultation services and accepted in exchange a promissory note with a face value of $500,000, a due date of December 31, 2013, and a stated rate of 5%, with interest receivable at the end of each year. The fair value of the services is not readily determinable and the note is not readily marketable. Under the circumstances, the note is considered to have an appropriate imputed rate of interest of 10%.

The following interest factors are provided:



Instuctions
(a) Determine the present value of the note.
(b) Prepare a Schedule of Note Discount Amortization for Green Company under the effective interest method. (Round to whole dollars.)

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