Question

On January 1, 2014, Ann Price loaned $112,695 to Joe Kiger. A zero-interest-bearing note (face amount, $150,000) was exchanged solely for cash; no other rights or privileges were exchanged. The note is to be repaid on December 31, 2016. The prevailing rate of interest for a loan of this type is 10%. The present value of $150,000 at 10% for three years is $112,695. What amount of interest income should Ms. Price recognize in 2014?

1) 45,000
2) 11,270
3) 33,810
4) 15,000

Answer 1

Ann Price should recognize $11,270 in interest income for the year 2014 on the zero-interest-bearing note loaned to Joe Kiger, based on the 10% prevailing interest rate for the loan.

Step-by-step explanation:

The question involves the recognition of interest income on a zero-interest-bearing note in accordance with the principles of accrual accounting. Since Ann Price loaned $112,695 in exchange for a note with a face amount of $150,000, the difference of $37,305 ($150,000 - $112,695) represents the total interest income over the three-year period. The prevailing interest rate for the loan is 10%. According to the effective interest method, interest income is recognized based on the market rate of interest at the time of the loan. Thus, Ann Price should recognize interest income for 2014 by applying the 10% rate to the initial principal amount of $112,695.

The interest income for 2014 is calculated as:
$112,695 × 10% = $11,270