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Intermediate Accounting (Kieso)
Found in: Page 377

Short Answer

On September 30, 2016, Rolen Machinery Co. sold a machine and accepted the customer’s zero-interest-bearing note. Rolen normally makes sales on a cash basis. Since the machine was unique, its sales price was not determinable using Rolen’s normal pricing practices.

After receiving the first of two equal annual installments on September 30, 2017, Rolen immediately sold the note with recourse. On October 9, 2018, Rolen received notice that the note was dishonored, and it paid all amounts due. At all times prior to default, the note was reasonably expected to be paid in full.

Instructions

(1) How should Rolen determine the sales price of the machine?

(2) How should Rolen report the effects of the zero-interest-bearing note on its income statement for the year ended December 31, 2016? Why is this accounting presentation appropriate?

The sales price of the machine will be equal to the fair value of the note calculated using the discounted rate. The income statement of 2016 will include the interest revenue for three months of 2016 October, November, and December.

See the step by step solution

Step by Step Solution

Definition of Note Dishonored

A note is said to be dishonored when the issuing business entity or individual does not pay the due amount on maturity.

Determination of Sales Price of Machine and Effect of Zero Interest Bearing Bonds

(1) The sales price of the machine will be reported as the fair value of the note receivable on 30 September 2016. The fair value of the note receivable will be calculated as the discounted fair value of the two installments’ at the market interest rate of the customer.

(2) The interest revenue for 2016 will be calculated as the multiplication of carrying amount, market interest rate, and 3/2. Interest revenue for 2016 will include interest for October, November, and December. Therefore, it is multiplied by 3/12.

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