At the beginning of 2020, Graham Company received a three-year zero-interest-bearing $5,000 trade note. The market rate for equivalent notes was 10% at that time. Gannon reported this note as a $5,000 trade note receivable on its 2020 year-end statement of financial position and $5,000 as sales revenue for 2020. What effect did this accounting for the note have on Gannon's net earnings for 2020, 2021, 2022, and its retained earnings at the end of 2022, respectively?

Question

Quizplus · Accepted Answer

The correct accounting treatment for a zero-interest-bearing note should involve discounting the note to its present value at the market rate of interest at the time of issuance. This means that the initial recognition of the note and the sales revenue should be at a discounted value, not the face value of $5,000. Over the life of the note, interest income should be recognized, increasing the carrying amount of the note to its face value and increasing net earnings each year. By reporting the note at its face value initially, Gannon overstated its sales revenue and receivable in 2020, leading to an overstatement of net earnings in 2020. However, because there would be no interest income recognized in subsequent years (2021 and 2022), the net earnings for those years would not be directly affected by the initial misstatement. The overstatement in 2020 would carry through to retained earnings at the end of 2022, resulting in an overstatement of retained earnings. Therefore, none of the provided choices accurately describe the effects on Gannon's financial statements.

At the Beginning of 2020, Graham Company Received a Three-Year