On January 1, 2014, Jacobs Company sold property to Dains Company which originally cost Jacobs $1,330,000. There was no established exchange price for this property. Danis gave Jacobs a $2,100,000 zero-interest-bearing note payable in three equal annual installments of $700,000 with the first payment due December 31, 2014. The note has no ready market. The prevailing rate of interest for a note of this type is 10%. The present value of a $2,100,000 note payable in three equal annual installments of $700,000 at a 10% rate of interest is $1,740,900. What is the amount of interest income that should be recognized by Jacobs in 2014, using the effective-interest method?

Question

Quizplus · Accepted Answer

Under the effective-interest method, interest income is recognized using the effective interest rate, which is the prevailing rate of interest for a similar note. In this case, the prevailing rate of interest is 10%. Therefore, the amount of interest income that should be recognized by Jacobs in 2014 can be calculated as follows:
Effective interest = Beginning carrying value x Effective interest rate
Beginning carrying value = Present value of note = $1,740,900
Effective interest rate = 10%
Effective interest income = $174,090
Therefore, the correct answer is C, $174,090.

On January 1, 2014, Jacobs Company Sold Property to Dains