On January 1, 2010, West Co.exchanged equipment for a $400,000 zero-interest-bearing note due on January 1, 2013.The prevailing rate of interest for a note of this type at January 1, 2010 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 2011 income statement?

Question

Quizplus · Accepted Answer

The interest revenue should be recognized using the effective interest method, which is calculated by multiplying the carrying value of the note at the beginning of the period by the effective interest rate. The effective interest rate is the market rate of interest at the date of issuance of the note.

Carrying Value at Jan. 1, 2011 = 400,000 x 0.75 = $300,000 
Effective Interest Rate = 10%

Interest Revenue for 2011 = $300,000 x 10% = $30,000

Therefore, the correct answer is (C) $33,000.