M7 - Accounting for Interest-bearing Notes Ch14 & 15
Face value – Stated value of the note
Face interest rate (%) – Interest rate printed on the note that is used to determine
cash payments per period
Term – Life of the note (years)
Interest periods – Number of times interest (cash) is paid each year (annually,
semiannually)
Market or Effective rate (%) – Interest rate on other notes (Market rate is used to
determine the present value of the note)
Interest Rate Comparison
Face Interest Rate > Market Interest Rate
Proceeds (cash received)
Proceeds > Face value: PREMIUM
Market Interest Rate > Face Interest Rate
Proceeds < Face value: DISCOUNT
Face Interest Rate = Market Interest Rate
Proceeds = Face value
Value of a Note
Equal to:
1. Present value of the FACE VALUE of the note, plus
2. Present value of the INTEREST PAYMENTS
To calculate:
FV = Face value of the note
Pmt = Face value of the Note x Face rate x Time
c = number of payments per year
n = total number of payments
r = market rate
PV = Present value of the note
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Page 1 of 12
M7 - Accounting for Interest-bearing Notes Ch14 & 15
Helpful Hints
 FACE interest rate is used to determine the INTEREST PAYMENTS (Cash
paid)
 MARKET interest rate is used to determine the PRESENT VALUE of the
NOTE and INTEREST EXPENSE
INTEREST (CASH) PAYMENTS:
Face Value of the Note
x
Face Interest Rate / Interest Periods per Year
INTEREST EXPENSE:
Carrying Value of the Note
x
Market Interest Rate / Interest Periods Per Year
CARRYING VALUE OF A NOTE
Face value PLUS PREMIUM
Face value LESS DISCOUNT
Face value
COST OF BORROWING
Equal to:
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Total cash paid, less the cash proceeds
Page 2 of 12
M7 - Accounting for Interest-bearing Notes Ch14 & 15
Problem #1
A company issued a 5-year, 10% note with a face value of $1,000,000 on January
1. Interest is payable June 30 and December 31 each year. The market rate of
interest is 10%.
FV = Face value of the note = $1,000,000
Pmt = Face value of the Note x Face rate x Time = $1,000,000 x 10% x ½ = $50,000
c = number of payments per year = 2
n = total number of payments = 10
r = market rate = 10%
1. Will the note sell at face value, a discount or premium?
Face value (Face interest rate = Market interest rate)
2. What is the present value (proceeds) of the note?
$1,000,000
3. What is the journal entry to record the issuance of the note?
(Dr) Cash 1,000,000
(Cr)
Note Payable
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1,000,000
Page 3 of 12
M7 - Accounting for Interest-bearing Notes Ch14 & 15
4. Create the amortization table:
Interest
Period
Interest (Cash) to be Paid
Face Value x
Face Rate x Time
(10% / 2 = 5%)
Interest Expense
Carrying Value x
Effective Rate x Time
(10% / 2 = 5%)
Issue date
Carrying Value
End of Period
1,000,000
1 – Jun 30
50,000
50,000
1,000,000
2 – Dec 31
50,000
50,000
1,000,000
3 – Jun 30
50,000
50,000
1,000,000
4 – Dec 31
50,000
50,000
1,000,000
5
50,000
50,000
1,000,000
6
50,000
50,000
1,000,000
7
50,000
50,000
1,000,000
8
50,000
50,000
1,000,000
9
50,000
50,000
1,000,000
10
50,000
50,000
1,000,000
Total
500,000
500,000
5. What is journal entry to record interest expense on June 30?
(Dr) Interest Expense
(Cr)
Cash
50,000
50,000
6. What is journal entry to record interest expense on December 31?
(Dr) Interest Expense
(Cr)
Cash
50,000
50,000
7. What is journal entry to retire the note at maturity?
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M7 - Accounting for Interest-bearing Notes Ch14 & 15
(Dr) Note Payable
(Cr)
Cash
1,000,000
1,000,000
8. What is the cost of borrowing?
Total cash paid, less the cash proceeds
Cash paid:
Face value
Interest payments ($50,000 x 10)
Total cash paid
$1,000,000
$ 500,000
$1,500,000
Less: Cash proceeds
$1,000,000
Cost of borrowing
$ 500,000
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Page 5 of 12
M7 - Accounting for Interest-bearing Notes Ch14 & 15
Problem #2
A company issued a 5-year, 10% note with a face value of $1,000,000 on January
1. Interest is payable June 30 and December 31 each year. The market rate of
interest is 12%.
FV = Face value of the note = $1,000,000
Pmt = Face value of the Note x Face rate x Time = $1,000,000 x 10% x ½ = $50,000
c = number of payments per year = 2
n = total number of payments = 10
r = market rate = 12%
1. Will the note sell at face value, a premium or a discount?
Discount (Face interest rate < Market interest rate)
2. What is the present value (proceeds) of the note?
$926,000
3. What is the journal entry to record the issuance of the note?
(Dr) Cash 926,000
(Dr) Discount on Note Payable 74,000
(Cr)
Note Payable
1,000,000
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M7 - Accounting for Interest-bearing Notes Ch14 & 15
4. Create the amortization table:
Interest
Period
Issue date
1 – Jun 30
2 – Dec 31
3 – Jun 30
4 – Dec 31
5
6
7
8
9
10
Total
Carrying
Value
Beginning
of Period
926,000
931,560
937,454
943,701
950,323
957,342
964,783
972,670
981,030
989,892
A
B
C
D
E
Interest (Cash)
to be Paid
Interest Expense
Discount Amortized
Unamortized
Discount
Carrying Value
End of Period
Face Value x
Face Rate x Time
(10% / 2 = 5%)
Carrying Value x
Effective Rate x Time
(12% / 2 = 6%)
Interest Expense Cash Paid (B - A)
50,000
50,000
50,000
50,000
50,000
50,000
50,000
50,000
50,000
50,000
500,000
55,560
55,894
56,247
56,622
57,019
57,441
57,887
58,360
58,862
60,109
574,000
5,560
5,894
6,247
6,622
7,019
7,441
7,887
8,360
8,862
10,109
74,000
(D - C)
74,000
68,440
62,546
56,299
49,677
42,658
35,217
27,330
18,970
10,108
(0)
Face Value LESS
Unamortized
Discount
926,000
931,560
937,454
943,701
950,323
957,342
964,783
972,670
981,030
989,892
1,000,000
5. What is journal entry to record interest expense on June 30?
(Dr) Interest Expense
55,560
(Cr)
Discount on Note Payable
(Cr)
Cash
5,560
50,000
6. What is journal entry to record interest expense on December 31?
(Dr) Interest Expense
55,894
(Cr)
Discount on Note Payable
(Cr)
Cash
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5,894
50,000
Page 7 of 12
M7 - Accounting for Interest-bearing Notes Ch14 & 15
7. What is journal entry to retire the note at maturity?
(Dr) Note Payable
(Cr)
Cash
1,000,000
1,000,000
8. What is the cost of borrowing?
Total cash paid, less the cash proceeds
Cash paid:
Face value
Interest payments ($50,000 x 10)
Total cash paid
$1,000,000
$ 500,000
$1,500,000
Less: Cash proceeds
$ 926,000
Cost of borrowing
$ 574,000
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Page 8 of 12
M7 - Accounting for Interest-bearing Notes Ch14 & 15
Problem #3
A company issued a 5-year, 10% note with a face value of $1,000,000 on January
1. Interest is payable June 30 and December 31 each year. The market rate of
interest is 8%.
FV = Face value of the note = $1,000,000
Pmt = Face value of the Note x Face rate x Time
$1,000,000 x 10% x ½ = $50,000
c = number of payments per year = 2
n = total number of payments = 10
r = market rate = 8%
1. Will the note sell at face value, a premium or a discount?
Premium (Face interest rate >Market interest rate)
2. What is the present value (proceeds) of the note?
$1,081,550
3. What is the journal entry to record the issuance of the note?
(Dr) Cash
1,081,550
(Cr)
Premium on Note Payable
(Cr)
Note Payable
81,550
1,000,000
4. Create the amortization table:
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Page 9 of 12
M7 - Accounting for Interest-bearing Notes Ch14 & 15
A
Interest
Period
Issue date
1 – Jun 30
2 – Dec 31
3 – June 30
4 – Dec 31
5
6
7
8
9
10
Total
Carrying
Value
Beginning
of Period
1,081,550
1,074,812
1,067,804
1,060,517
1,052,937
1,045,055
1,036,857
1,028,331
1,019,465
1,010,243
B
C
D
E
Interest (Cash)
to be Paid
Interest Expense
Premium
Amortized
Unamortized
Premium
Carrying
Value End of
Period
Face Value x
Face Rate x Time
(10% / 2 = 5%)
Carrying Value x
Effective Rate x Time
(8% /2 = 4%)
Cash Paid Interest Expense
(A - B)
50,000
50,000
50,000
50,000
50,000
50,000
50,000
50,000
50,000
50,000
500,000
43,262
42,992
42,712
42,421
42,117
41,802
41,474
41,133
40,779
39,757
418,450
6,738
7,008
7,288
7,579
7,883
8,198
8,526
8,867
9,221
10,243
81,550
(D - C)
81,550
74,812
67,804
60,517
52,937
45,055
36,857
28,331
19,465
10,243
(0)
Face Value
PLUS
Unamortized
Premium
1,081,550
1,074,812
1,067,804
1,060,517
1,052,937
1,045,055
1,036,857
1,028,331
1,019,465
1,010,243
1,000,000
5. What is journal entry to record interest expense on June 30?
(Dr) Interest Expense
(Dr) Premium on Note Payable
(Cr)
Cash
43,262
6,738
50,000
6. What is journal entry to record interest expense on December 31?
(Dr) Interest Expense
(Dr) Premium on Note Payable
(Cr)
Cash
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42,992
7,008
50,000
Page 10 of 12
M7 - Accounting for Interest-bearing Notes Ch14 & 15
7. What is journal entry to retire the note at maturity?
(Dr) Note Payable
(Cr)
Cash
1,000,000
1,000,000
8. What is the cost of borrowing?
Total cash paid, less the cash proceeds
Cash paid:
Face value
Interest payments ($50,000 x 10)
Total cash paid
$1,000,000
$ 500,000
$1,500,000
Less: Cash proceeds
$1,081,550
Cost of borrowing
$ 418,450
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M7 - Accounting for Interest-bearing Notes Ch14 & 15
Cost of Borrowing Analysis
Cash paid
Cash proceeds
Cost of borrowing
Face
$1,500,000
$1,000,000
$500,000
Discount
$1,500,000
$926,000
$574,000*
Premium
$1,500,000
$1,081,550
$418,450
*Discount ($74,000 = $574,000 —$500,000) represents the additional cost of
borrowing, compared to the note issued at face value.
**Premium ($81,550= $500,000 —$418,450) represents the reduced cost of
borrowing, compared to the note was issued at face value.
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