On January 1, 2010, Ann Price loaned $45,078 to Joe Kiger.A zero-interest-bearing note (face amount, $60,000) was exchanged solely for cash; no other rights or privileges were exchanged.The note is to be repaid on December 31, 2012.The prevailing rate of interest for a loan of this type is 10%.The present value of $60,000 at 10% for three years is $45,078.What amount of interest income should Ms.Price recognize in 2010?

Question

Quizplus · Accepted Answer

Since the present value of the note is equal to the amount loaned by Ann Price ($45,078), there is no initial interest income to recognize in 2010. The interest income will be recognized over the life of the loan (three years). Using the effective interest method, the interest income for the first year will be 10% of the beginning balance ($60,000) which is $6,000. However, since the note was initially issued at a discount (present value is less than face amount), the discount of $14,922 ($60,000 - $45,078) must be amortized over the life of the loan, reducing the interest income for the first year by $1,492 ($14,922/3). Therefore, the amount of interest income to be recognized in 2010 is $4,508 ($6,000 - $1,492).

On January 1, 2010, Ann Price Loaned $45,078 to Joe