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GAAP for zero-interest-bearing note

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Wie Company has been operating for just 2 years, producing specialty golf equipment for women golfers. To date, the company has been able to finance its successful operations with investments from its principal owner, Michelle Wie, and cash flows from operations. However, current expansion plans will require some borrowing to expand the company's production line.

As part of the expansion plan, Wie will acquire some used equipment by signing a zero-interest-bearing note. The note has a maturity value of $50,000 and matures in 5 years. A reliable fair value measure for the equipment is not available, given the age and specialty nature of the equipment. As a result, Wie's accounting staff is unable to determine an established exchange price for recording the equipment (nor the interest rate to be used to record interest expense on the long-term note). They have asked you to conduct some account research on this topic.

(a) Identify the authoritative literature that provides guidance on the zero-interest-bearing note. Use some of the examples to explain how the standard applies in this setting.
(b) How is present value determined when an established exchange price is not determinable and a note has no ready market? What is the resulting interest rate often called?
(c) Where should a discount or premium appear in the financial statements? What about issue costs?

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Solution Preview

This work requires that you consider the fair value of the note on the seller's books (note receivable). Portion of the codification are cut and pasted into the document for you.

There are two pieces of purchasing an asset with a note. The asset value and the value of the note. Here, the asset value is not known. Below it discusses that if you don't know the value of the asset, you use the value of what was exchanged for it.

Quotes from Codification
360 Assets
845 Nonmonetary Transactions
10 Overall
30 Initial Measurement

30-8 Fair value should be regarded as not determinable within reasonable limits if major uncertainties exist about the realizability of the value that would be assigned to an asset received in a nonmonetary transaction accounted for at fair value. An exchange involving parties with essentially opposing interests is not considered a prerequisite to determining a fair value of a nonmonetary asset transferred; nor does an exchange ensure that a fair value for accounting purposes can be ascertained within reasonable limits. If neither the fair value of a nonmonetary asset transferred nor the fair value of a nonmonetary asset received in exchange is determinable within reasonable limits, the recorded amount of the nonmonetary asset transferred from the entity may be the only available measure of the transaction.
310 Receivables
10 Overall
30 Initial Measurement
Certain Receivables

30-1 The following provides initial measurement guidance for certain notes receivable, specifically those exchanged for cash and those exchanged for ...

Solution Summary

Your response is 1,063 words plus a reference to the FASB codification. This work requires that you consider the fair value of the note on the seller's books (note receivable). Portion of the codification are cut and pasted into the document for you so you know the theory and then I answer the specific questions asked. The codification is provided as a courtesy and is not inserted into the discussion in footnote fashion. (Note: This is not for novices - it requires some experience with financial principles at the intermediate accounting level.)