On January 1, 2014, Ball Co. exchanged equipment for a $500,000 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 Ball's 2015 income statement?

Question

Quizplus · Accepted Answer

The present value of the note on January 1, 2014, is calculated as $500,000 * 0.75 = $375,000. This is the initial recorded amount of the note. The difference between the face value ($500,000) and the present value ($375,000) represents the total interest that will be recognized over the life of the note, which is $125,000. Since the interest is recognized using the effective interest method, for the first year (2014), the interest revenue is $375,000 * 10% = $37,500. This increases the carrying amount of the note to $412,500 ($375,000 + $37,500) at the beginning of 2015. Therefore, the interest revenue for 2015 is $412,500 * 10% = $41,250.