A two-year note was issued in an arm's-length transaction at face value solely for cash at the beginning of the year. There were no other rights or privileges exchanged. The interest rate is specified at 10 percent per year. Principal and interest are payable at maturity. The prevailing rate of interest for a loan of this type is 15 percent per year. What annual interest rate should be used to record interest expense for this year and next year?
This year Next Year

Question

Quizplus · Accepted Answer

Since the note was issued at face value and the prevailing rate is higher than the specified rate, there is no premium or discount on the note. Therefore, the interest expense should be recorded at the specified rate of 10 percent for both this year and next year.

A Two-Year Note Was Issued in an Arm's-Length Transaction at Face