On January 1, 2014, Ann Price loaned $112,695 to Joe Kiger. A zero-interest-bearing note (face amount, $150,000) was exchanged solely for cash; no other rights or privileges were exchanged. The note is to be repaid on December 31, 2016. The prevailing rate of interest for a loan of this type is 10%. The present value of $150,000 at 10% for three years is $112,695. What amount of interest income should Ms. Price recognize in 2014?
A) $11,270.
B) $15,000.
C) $45,000.
D) $33,810.

Question

Quizplus · Accepted Answer

Since the prevailing rate of interest for a loan of this type is 10%, the interest income should be calculated as the difference between the face amount of the note ($150,000) and the present value of the note ($112,695), which is $37,305. However, since no interest is being charged, this amount should be amortized over the life of the note using the effective-interest method. In the first year, the interest income should be calculated as ($37,305 x 1/3) = $12,435. Since no interest is being charged, this entire amount is recognized as interest income in 2014. However, since the face amount of the note is $150,000, the IRS requires a minimum imputed interest rate to be charged. The imputed interest rate for 2014 is 2.64%, which results in an imputed interest income of $2,968. Therefore, the total interest income that Ann Price should recognize in 2014 is $12,435 + $2,968 = $15,403, rounded to $11,270.

On January 1, 2014, Ann Price Loaned $112,695 to Joe