Chapter Six and Seven (Notes Receivable) Practice Problems

Note: PV tables in the format they will be provided in the exam are posted to e-campus under Course
Content : Practice Exams
1. ABC Company purchased a machine with a fair market value of $75,000 by signing a note
requiring ten equal annual payments. The stated interest rate was 8%

a. Compute the amount of the equal payments if the first payment is made immediately.

PV = $75,000
n = 10
I = 8%
PMT = ?
PV of Annuity Due factor: 7.24689

$75,000 = PMT x 7.24689

PMT = $10,349

b. Compute the amount of the equal payments if the first payment is made at the end of
the first year.

PV = $75,000
n = 10
I = 8%
PMT = ?
PV of Ordinary Annuity factor: 6.71008

$75,000 = PMT x 6.71008

PMT = $11,177

2. On January 1, ABC Company issued $100,000 of 8% 20-year bonds with interest payable June 30
and December 31. The market rate of interest is 6% compounded semiannually. Determine the
selling price of the bonds.

FV: $100,000
Semiannual cash interest payments (PMT): $100,000 x 0.08/2 = $4,000
n = 20 x 2 = 40
i = 6%/2 = 3%
PV of a lump sum factor: 0.30656
PV of an ordinary annuity: 23.11477
PV = ?

Selling price = PV = $100,000(0.30656) + $4,000(23.11477) = $123,115

3. ABC Company purchased land for $19,472 by signing a note requiring six equal annual payments
with the first payment made immediately and following payments made at the end of each year.
The stated interest rate was 8%.

a. Compute the amount of the equal payments.

PV = $19,472
n=6
i = 8%
PMT = ?
PV of an annuity due factor: 4.99271

$19,472 = PMT x 4.99271

PMT = $3,900

b. If the interest expense for the first year is the rate of interest times the present value of
the note at the beginning of the year, what would the present value of the note be at
the end of the first year?

There are two ways to solve this problem.

First way:
PV after first payment on day of purchase: $19,472 - $3,900 = $15,572
Year 1 interest expense = CV x interest rate = $15,572 x 0.08 = $1,246
Cash payment: $3,900
New CV = Old CV – Cash payments + Interest expense* = $15,572 - $3,900 + $1,246 =
$12,918

*We add interest expense back because interest reduces the amount of cash available
to pay off the principal of the note.

Second way:
PV = ?
PMT = $3,900
n = 6 – 2 = 4 (2 payments already made at this point)
i = 8%
PV of ordinary annuity factor (next payment at the end of the period): 3.31213

PV = $3,900(3.31213) = $12,917
4. ABC Company purchased a new truck in exchange for a 3-year non-interest bearing note with a
maturity value of $80,000. The market rate of interest for similar notes is 6% compounded
annually.

a. Assume that ABC recorded the value of the truck as $80,000. Ignoring the effect of
depreciation, determine the effect of this error on the financial statements at the time
of purchase.

FV = $80,000 (error was recording $80,000 as PV)

n=3
i = 6%
PMT = $0 (non-interest bearing)
PV of a lump sum factor: 0.83962
PV = ?

PV = $80,000(0.83962) = $67,170

Recorded JEs:
Truck 80,000
Note payable 80,000

Correct JE:
Truck 67,170
Discount on note 12,830
Note payable 80,000

Assets Liabilities Net Income Owner's Equity

O $12,830 O $12,830

b. Suppose that the $80,000 note paid interest of 2% at the end of each year for three
years. In that case, what is the correct historical cost of the truck?

FV = $80,000
n=3
i = 6%
PMT = $80,000 x 0.02 = $1,600
PV of a lump sum factor: 0.83962
PV of an ordinary annuity factor: 2.67301
PV = ?

PV = $80,000(0.83962) + $1,600(2.67301) = $71,447

 5. ABC Company buys a new building today costing $67,736.39. They make a $10,000 down
payment and receive a 10-year mortgage for the balance. The mortgage bears interest at 8%
compounded quarterly, and calls for equal quarterly payments, beginning in three months.

a. What is the amount of each quarterly payment?

PV = $67,736.39 - $10,000 = $57,736.39

n = 10 x 4 = 40
i = 8%/4 = 2%
PMT = ?
PV of an ordinary annuity factor: 27.35548

$57,736.39 = PMT x 27.35548

PMT = $2,111

b. What is the total sum of cash that ABC will spend on the down payment and the loan?

Cash components:
Down payment: $10,000
Cash payments: $2,111 x 40 = $94,440

c. What is the total amount of interest that ABC will pay over the life of the loan?

Total interest = Total cash paid – cost of building = $94,440 - $67,736.39 = $26,703.61

For Questions 6-10, determine: service revenue to recognize in year 1, interest revenue years 1, 2 and 3,
CV of the note for end of year 1 and end of year 2.

6. At the beginning of year 1, ABC performed services in exchange for $30,000 to be paid at end of
year 3. The interest rate on the note is 10%, which is the customer’s normal borrowing rate,
with interest to be paid at the end of each year.

FV = $30,000
i = 10% (also face rate), so PV = $30,000

Y1 Revenue Y1 Int. Rev. Y2 Int. Rev. Y3 Int. Rev. End Y1 CV End Y2 CV

(PV) CV x Mkt. Int. CV x Mkt. Int. CV x Mkt. Int. Beg. CV – Beg. CV –
Rate Rate Rate Cash + Int. Cash + Int.
$30,000 $3,000 $3,000 $3,000 $30,000 $30,000
 7. At the beginning of year 1, ABC performed services with a fair value of $30,000. ABC will be paid
equal amounts at the end of each quarter for three years. The interest rate is 10%, which is the
customer’s normal borrowing rate.

PV = $30,000
i = 10%/4 = 2.5%
n = 3 x 4 = 12
PMT = ?
PV of an ordinary annuity factor: 10.25776

$30,000 = PMT x 10.25776

PMT = $2,925

Amortization Table: (Easiest Way to Solve):

Year Quarter Cash Interest Principal Carrying
Payment Revenue Reduction Value
1 Inception 0 0 0 $30,000
1 2,925 $750 $2,175 $27,825
2 2,925 $696 $2,229 $25,596
3 2,925 $640 $2,285 $23,311
4 2,925 $583 $2,342 $20,968
2 1 2,925 $524 $2,401 $18,567
2 2,925 $464 $2,461 $16,107
3 2,925 $403 $2,522 $13,584
4 2,925 $340 $2,585 $10,999
3 1 2,925 $275 $2,650 $8,349
2 2,925 $209 $2,716 $5,633
3 2,925 $141 $2,784 $2,848
4 2,925 $71 $2,854 ($5)*
*Not 0 due to rounding

Y1 Revenue Y1 Int. Rev. Y2 Int. Rev. Y3 Int. Rev. End Y1 CV End Y2 CV

$30,000 $750 + $696 + $524 + $464 + $275 + $209 + $20,968 $10,999
$640 + $583 = $403 + $340 = $141 + $71 =
$2,669 $1,731 $696

8. At the beginning of year 1, ABC performed services in exchange for a $30,000 3-year non-
interest bearing note. The customer had a credit rating which required that money be
borrowed at 10% interest.

FV = $30,000
n=3
i = 10%
PV = ?
PV of a lump sum factor: 0.75131

PV = $30,000(0.75131) = $22,539

Y1 Revenue Y1 Int. Rev. Y2 Int. Rev. Y3 Int. Rev. End Y1 CV End Y2 CV

$22,539 $22,539 x 0.1 $24,793 x 0.1 $27,272 x 0.1 $22,539 + $24,793 +
= $2,254 = $2,479 = $2,727 $2,254 = $2,479 =
$24,793 $27,272

9. At the beginning of year 1, ABC performed services in exchange for a non-interest bearing note
requiring three $10,000 payments. The payments will be made at the end of each year for three
years. The customer had a credit rating that required that money be borrowed at 10%.

PV = ?
PMT = $10,000
n=3
i = 10%
PV of ordinary annuity factor: 2.48685

PV = $10,000(2.48685) = $24,869

Y1 Revenue Y1 Int. Rev. Y2 Int. Rev. Y3 Int. Rev. End Y1 CV End Y2 CV

$24,869 $24,869 x 0.1 $17,356 x 0.1 $9,092 x 0.1 = $24,869 - $17,356 -
= $2,487 = $1,736 $909 $10,000 + $10,000 +
$2,487 = $1,736 =
$17,356 $9,092

10. At the beginning of year 1, ABC performed services in exchange for a 3 year $30,000 6% interest
bearing note with the interest to be paid at the end of each year. The customer had a credit
rating that required that money be borrowed at 10% interest.

FV = $30,000
PMT = $30,000 x 0.06 = $1,800
n=3
i = 10%
PV = ?
PV of an ordinary annuity factor: 2.48685
PV of a lump sum factor: 0.75131
PV = $30,000(0.75131) + $1,800(2.48685) = $27,016

Y1 Revenue Y1 Int. Rev. Y2 Int. Rev. Y3 Int. Rev. End Y1 CV End Y2 CV

$27,016 $27,016 x 0.1 $27,918 x 0.1 $28,910 x 0.1 $27,016 - $27,918 -
= $2,702 = $2,792 = $2,891 $1,800 + $1,800 +
$2,702 = $2,792 =
$27,918 $28,910

11. On January 1, 20Y1, Whoop Inc. performed services in exchange of a two-year non-interest
bearing note for $24,000. The customer’s normal market rate is 10% compounded annually.

a. Record the service revenue for 1/1/Y1.

FV = $24,000
PMT = $0
n=2
i = 10%
PV of a lump sum: 0.82645

PV = $24,000(0.82645) = $19,835

Note receivable 24,000

Discount on note 4,165
Service revenue 19,835

b. Record Interest Revenue for 20Y1.

Interest revenue = CV x eff. int. rate = $19,835 x 0.1 = $1,984

Discount 1,984
Interest revenue 1,984

c. Determine the Carrying Value at year-end (December 31, 20Y1):

CV = Old CV – cash paid + interest = $19,835 - $0 + $1,984 = $21,819

FYI, Balance Sheet presentation:

Note Receivable $24,000
Less: Discount ($2,181)
Carrying Value $21,819

12. Howdy Company performed services in exchange for a $100,000, 10%, 10-year note receivable
on January 1, 20Y1 and received a $10,000 down payment. The terms of the note receivable
was for it to provide for semiannual installment payments. The effective interest rate is 10%.
 a. Determine the amount of each semiannual payment.
FV = PV = $100,000 (Down payment is in addition to the note)
PMT = ?
n = 10 x 2 = 20
i = 10%/2 = 5%
PV of ordinary annuity factor: 12.46221

$100,000 = PMT x 12.46221

PMT = $8,024

b. Prepare the appropriate journal entry to record the first payment on June 30, 20Y1:
Interest revenue = $100,000 x 0.05 = $5,000

Cash 8,024
Interest revenue 5,000
Note receivable 3,024

c. Determine interest revenue recorded as of December 31, 20Y1:

Interest revenue = CV x market interest rate = ($100,000 - $3,024) x 0.05 = $4,849

Total interest: $4,849 + $5,000 - $9,849

d. How much service revenue should have been recorded on January 1, 20Y1?

PV of note + down payment = $100,000 + $10,000 = $110,000

13. Howdy Company performed services in exchange for a $100,000, non-interest bearing, 10-year
note receivable on January 1, 20Y1. The terms provide for semiannual installment payments.
The customer had a credit rating which required that money be borrowed at 10% interest.
Howdy Company incurred $12,000 in salary expense to deliver the service.

a. Determine the amount of each semiannual payment.

$100,000/(10 x 2) = $5,000

b. Prepare the appropriate journal entry to record the first payment on June 30, 20Y1:
Selling price (initial CV):

PMT = $5,000
n = 10 x 2 = 20
i = 10%/2 = 5%
PV of ordinary annuity factor: 12.46221

PV = $5,000 x 12.46221 = $62,311

 Interest revenue: $62,311 x 0.05 = $3,116

Cash 5,000
Note receivable 5,000
Discount 3,116
Interest revenue 3,116

c. Determine the income statement impact of all journal entries that occurred during 20Y1:

Revenues:
Service revenue (PV calculated above): $62,311
Interest revenue: $3,116 + ($62,311 - $5,000 + $3,116) x 0.05 = $6,137
Total revenues: $68,448
Total expenses: $12,000
NI impact: $56,448

14. E-Walk Inc. performed services in exchange of a $200,000, 12%, note receivable on January 1,
20Y0. The note is to be paid off at the end of 10 years and will have semi-annual interest
payments. The customer’s normal borrowing rate is 10%.

a. Determine the carrying value at the beginning of 20Y4.

FV = $200,000
PMT = $200,000 x (0.12/2) = $12,000
n = (10-4) x 2 = 12
i = 10%/2 = 5%
PV of a lump sum factor: 0.55684
PV of an ordinary annuity: 8.86325

PV = $200,000(0.55684) + $12,000(8.86325) = $217,727

b. Determine the carrying value at the end of 20Y4.

Interest revenue (first half): $217,727 x 0.05 = $10,886
Interest revenue (second half): ($217,727 - $12,000 + $10,886) x 0.05 = $10,831
CV = $217,727 - $24,000 + $10,886 + $10,831 = $215,444

--- OR ---

FV = $200,000
PMT = $12,000
n = (10 – 5) x 2 = 10
i = 5%
PV of a lump sum factor: 0.61391
PV of an ordinary annuity: 7.72173
 PV = $200,000(0.61391) + $12,000(7.72173) = $215,443 (rounding difference)

c. Determine interest revenue for the period ended December 31, 20Y4.
Interest revenue (first half): $217,727 x 0.05 = $10,886
Interest revenue (second half): ($217,727 - $12,000 + $10,886) x 0.05 = $10,831
Total interest revenue: $21,717