Question

Accounting, Analysis, and Principles Johnson Co. accepts a note receivable from a customer in exchange for some damaged inventory. The note requires the customer make semiannual installments of $50,000 each for 10 years. The first installment begins six months from the date the customer takes delivery of the damaged inventory. Johnson's management estimates that the fair value of the damaged inventory is $679,517. Accounting (a) What interest rate is Johnson implicitly charging the customer? Express the rate as an annual rate but assume semiannual compounding. (HINT: USE PVF-OA formula with 20 periods. 679,517= 50,000 X PVF-OA....... rearrange PVF-OA = 679,517 / 50,000.) (b) At what dollar amount do you think Johnson should record the note receivable on the day the customer takes delivery of the damaged inventory? Analysis Assume the note receivable for damaged inventory makes up a significant portion of Johnson's assets. If interest rates increase, what happens to the fair value of the receivable? Briefly explain why. Principles The Financial Accounting Standards Board has issued an accounting standard that allows companies to report assets such as notes receivable at fair value. Discuss how fair value versus historical cost potentially involves a trade-off of one desired quality of accounting information against another.

Answer 1

1.Present value of note = $679,517

Semiannual payment = $50,000

So using 679517/50000 = 13.59034 as PVF-OA for 20 periods using the table we nd that rate is 4% for semiannual or 8% p.a. with semi annual compounding

2. a)Notes receivable should be recorded at $679,517 since other part represent only interest portion on note.

b)When the rates are increased the fair value of receivables will decrease since when we discount the cash ow with higher interest rates present value will decrease.

c) Fair value and historical cost involves a trade off , since fair value is more relevant but subjective in nature which involves discretion. But historical cost is more reliable and fixed. Fair value is useful to the users of nancial statements since it represents present scenario.