On January 1, 2014, West Co. exchanged equipment for a $600,000 zero-interest-bearing note due on January 1, 2017. The prevailing rate of interest for a note of this type at January 1, 2014 was 10%. The present value of $1 at 10% for three periods is 0.75. What amount of interest revenue should be included in West's 2015 income statement?

Question

Quizplus · Accepted Answer

The present value of the note on January 1, 2014, is calculated as $600,000 * 0.75 = $450,000. This is the initial recorded amount of the note. The difference between the face value ($600,000) and the present value ($450,000) represents the total interest that will be recognized over the life of the note, which is $150,000 ($600,000 - $450,000). Since the interest rate is 10%, the interest revenue for the first year (2014) would be $450,000 * 10% = $45,000. Adding this interest to the initial value for the second year gives $495,000 ($450,000 + $45,000). Therefore, the interest revenue for 2015 would be $495,000 * 10% = $49,500.