On January 1, 2006, Marr Co.exchanged equipment for a $400,000 zero-interest-bearing note due on January 1, 2009.The prevailing rate of interest for a note of this type at January 1, 2006 was 10%.The present value of $1 at 10% for three periods is 0.75.What amount of interest revenue should be included in Marr's 2007 income statement?

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Quizplus · Accepted Answer

Since the note is zero-interest-bearing, there is no stated interest revenue to be recognized. However, the note was not issued at fair value since the prevailing rate of interest was 10% at the time of issuance. Therefore, interest revenue must be imputed using the present value of the note. The difference between the present value of the note ($300,000) and the face amount of the note ($400,000) is $100,000. This $100,000 represents the amount of imputed interest over the life of the note. To allocate this interest over the three-year life of the note, divide $100,000 by the present value factor of an ordinary annuity due of 1 for three periods at 10%, which is 2.48685. This calculation results in an annual interest revenue of $40,140, rounded to $40,000. However, since the note was exchanged on January 1, 2006, no interest revenue should be recognized in 2006. Therefore, the interest revenue recognized in 2007 should be $33,513, calculated as $40,140 x 0.834 (2 years remaining on the note divided by the total life of the note).