On January 1, 2020, Alvin Corp. sold property to Marvin Ltd., for which Alvin had originally paid $ 570,000. There was no established exchange price for this property. Marvin gave Alvin a $ 900,000, zero-interest-bearing note, payable in three equal annual instalments of $ 300,000, with the first payment due December 31, 2020. The note also has no ready market. The market rate of interest for a note of this type is 10%. The present value of a $ 900,000 note payable in three equal annual instalments of $ 300,000 at 10% is $ 746,056. To the nearest dollar, and using the effective-interest method, how much interest revenue should Alvin recognize in 2020?

Question

Quizplus · Accepted Answer

Since the market rate of interest for a note of this type is 10%, the present value of the note is $ 746,056. This means that the interest revenue for Alvin in 2020 is the difference between the face value of the note and its present value, which is $ 900,000 - $ 746,056 = $ 153,944.

Using the effective-interest method, Alvin should recognize a portion of this interest revenue in 2020. To calculate this, we need to find the interest expense that would be incurred if Alvin had borrowed $ 746,056 at 10% interest. This is:

$ 746,056 × 10% = $ 74,606

Therefore, the interest revenue that Alvin should recognize in 2020 is:

$ 153,944 × ( $ 74,606 / $ 746,056 ) = $ 15,394, which rounded to the nearest dollar, is $ 74,606.

So, the best choice is C.