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Unformatted text preview: Year 1, and the effective interest rate is constant, the interest expense recognized by
Tradewell in the second year will be greater than the interest expense recognized in the first year. =
=
= Face Value of Note – Discount on Notes Payable
$20,000.00 – ($8,652.00 – $1,361.76)
$12,709.76 Intuitively this makes sense. During Year 1, Tradewell only "borrowed" $11,348. Although Tradewell has to
compensate the creditor for using the creditor's money during Year 1, Tradewell did not make any such
payment to the creditor during Year 1 because the stated rate on the note is 0%. Thus, the amount that
Tradewell should have compensated the creditor (i.e., interest expense) is simply added on to what
Tradewell "borrowed" from the creditor. During Year 2, therefore, Tradewell has to pay interest not only on
the initial $11,348 it "borrowed," but also on the interest that it incurred, but did not pay, during Year 1.
As proof, Interest Expense for Year 2 = $12,709.76 [from part (d)] 12%
= $1,525.17 This amount exceeds the interest expense for Year 1 computed in part (c). E11–5
f. Concluded Since the note has not yet matured, the same logic used in part (e) can be applied to this question.
Consequently, the interest expense recognized by Tradewell in the third year will be greater than the
interest expense recognized in the second year.
As proof, Interest Expense for Year 3 = Book Value at Beginning of Year 3 12%
= [$20,000.00 – ($8,652.00 – $1,361.76 –
$1,525.17)] 12%
= $1,708.19 This amount exceeds the interest expense for Year 2 computed in part (e). E11–6
a. Stated interest rate = 8%
Cash (+A) 8,000
Notes Payable (+L) 8,000 Issued notes payable.
Interest Expense (E, –SE) 640
Cash (–A) 640 Incurred and paid interest.
Interest Expense (E, –SE) 640
Cash (–A) 640 Incurred and paid interest.
Notes Payable (–L) 8,000
Cash (–A) 8,000 Repaid notes payable.
b. Stated interest rate = 0%
Face value
Present value (i = 8%, n = 2)
Present value of face value...
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 Fall '08
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 Accounting

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