Beruflich Dokumente
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NOTES RECEIVABLE
6. Explain accounting issues related to recognition and valuation of notes receivable. A note receivable is supported by a formal promissory note , a written promise to pay a certain sum of money at a specific future date. Such a note is a negotiable instrument that a maker signs in favor of a designated payee who may legally and readily sell or otherwise transfer the note to others. Although all notes contain an interest element because of the time value of money, companies classify them as interest-bearing or non-interest-bearing. Interestbearing notes have a stated rate of interest. Zero-interest-bearing notes (non-interest-bearing) include interest as part of their face amount. Notes receivable are considered fairly liquid, even if long-term, because companies may easily convert them to cash (although they might pay a fee to do so). Companies frequently accept notes receivable from customers who need to extend the payment period of an outstanding receivable. Or they require notes from high-risk or new customers. In addition, companies often use notes in loans to employees and subsidiaries, and in the sales of property, plant, and equipment. In some industries (e.g., the pleasure and sport boat industry), notes support all credit sales. The majority of notes, however, originate from lending transactions. The basic issues in accounting for notes receivable are the same as those for accounts receivable: recognition, valuation, and disposition.
Bigelow computes the present value or exchange price of the note as follows.
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ILLUSTRATION 7-10 Present Value of NoteStated and Market Rates the Same
In this case, the present value of the note equals its face value because the effective and stated rates of interest are also the same. Bigelow records the receipt of the note as follows. Notes Receivable 10,000 Cash 10,000 Bigelow recognizes the interest earned each year as follows. Cash 1,000 Interest Revenue 1,000
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show the time diagram depicting the one cash flow in Illustration 7-11.
Jeremiah records the transaction as follows. Notes Receivable Discount on Notes Receivable Cash 10,000.00 2,278.20 7,721.80
Discount on Notes Receivable is a valuation account. Companies report it on the balance sheet as a contra asset account to notes receivable. They then amortize the discount, and recognize interest revenue annually using the effective-interest method. Illustration 7-12 shows the three-year discount amortization and interest revenue schedule.
Jeremiah records interest revenue at the end of the first year using the effective-interest method as follows. Discount on Notes Receivable Interest Revenue 694.96 694.96
The amount of the discount, $2,278.20 in this case, represents the interest revenue Jeremiah will receive from the note over the three years.
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Interest-Bearing Notes. Often the stated rate and the effective rate differ. The zero-interest-bearing note is one example. To illustrate a more common situation, assume that Morgan Corp. makes a loan to Marie Co. and receives in exchange a three-year, $10,000 note bearing interest at 10 percent annually. The market rate of interest for a note of similar risk is 12 percent. We show the time diagram depicting both cash flows in Illustration 7-13.
Morgan computes the present value of the two cash flows as follows.
ILLUSTRATION 7-14 Computation of Present ValueEffective Rate Different from Stated Rate
In this case, because the effective rate of interest (12 percent) exceeds the stated rate (10 percent), the present value of the note is less than the face value. That is, Morgan exchanged the note at a discount. Morgan records the receipt of the note at a discount as follows. Notes Receivable 10,000
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480 9,520
Morgan then amortizes the discount and recognizes interest revenue annually using the effective-interest method. Illustration 7-15 shows the three-year discount amortization and interest revenue schedule.
On the date of issue, the note has a present value of $9,520. Its unamortized discountadditional interest revenue spread over the three-year life of the noteis $480. At the end of year 1, Morgan receives $1,000 in cash. But its interest revenue is . The difference between $1,000 and $1,142 is the amortized discount, $142. Morgan records receipt of the annual interest and amortization of the discount for the first year as follows (amounts per amortization schedule). Cash 1,000 Discount on Notes Receivable 142 Interest Revenue 1,142 The carrying amount of the note is now 3. . Morgan repeats this process until the end of year
When the present value exceeds the face value, the note is exchanged at a premium. Companies record the premium on a note receivable as a debit and amortize it using the effective-interest method over the life of the note as annual reductions in the amount of interest revenue recognized. Notes Received for Property, Goods, or Services. When a note is received in exchange for property, goods , or services in a bargained transaction entered into at arm's length, the stated interest rate is presumed to be fair unless: 1. No interest rate is stated, or 2. The stated interest rate is unreasonable, or 3. The face amount of the note is materially different from the current cash sales price for the same or similar items or from the current fair value of the debt instrument. [4] In these circumstances, the company measures the present value of the note by the fair value of the property, goods, or services or by an amount that reasonably approximates the fair value of the note. To illustrate, Oasis Development Co. sold a corner lot to Rusty Pelican as a restaurant site. Oasis accepted in exchange a five-year note having a maturity value of $35,247 and no stated interest rate. The land originally cost Oasis $14,000. At the date of sale, the land had a fair value of $20,000. Given the criterion above, Oasis uses the fair value of the land, $20,000, as the present value of the note. Oasis therefore records the sale as:
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Oasis amortizes the discount to interest revenue over the five-year life of the note using the effective-interest method.
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Impairments. A note receivable may become impaired. A note receivable is considered impaired when it is probable that the creditor will be unable to collect all amounts due (both principal and interest) according to the contractual terms of the receivable. In this case, a loss is recorded for the amount of the impairment. Appendix 7B further discusses impairments of receivables.
The massive write-downs that financial firms are posting have begun to spur a backlash among some investors and executives, who are blaming accounting rules for exaggerating the losses and are seeking new, more forgiving ways to value investments. The ruleswhich last made headlines back in the Enron erarequire companies to value many of the securities they hold at whatever price prevails in the market, no matter how sharply those prices swing. Some analysts and executives argue this triggers a domino effect. The market falls, forcing banks to take writeoffs, pushing the market lower, causing more write-offs. Companies like AIG and Citicorp argue that their writedowns may never actually result in a true charge to the company. It's a sore point because companies feel they are being forced to take big financial hits on holdings that they have no intention of actually selling at current prices. Companies believe they are strong enough to simply keep the holdings in their portfolios until the crisis passes. Forcing companies to value securities based on what they would fetch if sold today is an attempt to apply liquidation accounting to a going concern, says one analyst. Bob Herz, former FASB chairperson, acknowledges the difficulty but notes, you tell me what a better answer is. Is just pretending that things aren't decreasing in value a better answer? Should you just let everybody say they think it's going to recover? Others who favor the use of market values say that for all its imperfections, market value also imposes discipline on companies. It forces you to realistically confront what's happening to you much quicker, so it plays a useful purpose, said Sen. Jack Reed (D., R.I.), a member of the Senate banking committee. Japan stands out as an example of how ignoring Problems can lead to years-long stagnation. Look at Japan, where they ignored write-downs at all their financial institutions when loans went bad, said Jeff Mahoney, general counsel at the Council for Institutional Investors. In addition, companies don't always have the luxury of waiting out a storm until assets recover the long-term value that executives believe exists. A classic example relates to many European banks that hold loans to countries like Greece, Spain, Ireland, and Portugal. Although these loans are clearly toxic (values overstated), some banks still contend that they should not be written down (partly because they can be held to maturity). However, this contention is suspect, and impairment losses are rising. For example, Bankia Group, Spain's third largest bank, recently restated its 2011 results to show a 3.3 billion ($4.2 billion) loss rather than the previously reported 40.9 billion profit.
Sources: Adapte d from David R e illy, Wave of Write-Offs Rattles Market: Accounting Rules Blasted as Dow Falls; A $600 Billion Toll? Wall Street Journal (March 1, 2008), p. Al; and J. W e il, The E4 Smiled While Spain's Banks Cooked the Books , Bloomberg (June 14, 2012).
Copyright 2012 John Wiley & Sons, Inc. All rights reserved.
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