On January 1, year 2, the Carpet Company lent $100,000 to its supplier, Loom Corporation, evidenced by a note, payable in 5 years. Interest at 5% is payable annually with the first payment due on December 31, year 3.

 On January 1, year 2, the Carpet Company lent $100,000 to its supplier, Loom Corporation, evidenced by a note, payable in 5 years. Interest at 5% is payable annually with the first payment due on December 31, year 3. The going rate of interest for this type of loan is 10%. The parties agreed that Carpet’s inventory needs for the loan period will be met by Loom at favorable prices. Assume that the present value (at the going rate of interest) of the $100,000 note is $81,000 at January 1, year 2. What amount of interest income, if any, should be included in Carpet’s year 2 income statement?
$0
$4,050
$5,000
$8,100 Correct
 You Answered Correctly!
This answer is correct. The solutions approach is to recognize that (1) a note has been issued for cash and a future benefit, and (2) the provision for interest on the loan is not reasonable (per ASC Topic 835). The difference between the face value of the note ($100,000) and its present value ($81,000) represents interest on notes receivable of $19,000. Using an effective interest approach, interest income for Carpet is computed as follows:



$81,000 (carrying value of note) × 10% (imputed interest rate) = $8,100 interest income