Accounting Questions
| 835 Interest Table of Contents
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General
COMBINE SUBSECTIONS
25-1
This Section provides guidance on the imputation of interest.
> Imputation of Interest
25-2
If determinable, the established exchange price (which, presumably, is the same as the price for a cash sale) of property, goods, or service acquired or sold in consideration for a note may be used to establish the present value of the note. When notes are traded in an open market, the market rate of interest and quoted prices of the notes provide the evidence of the present value. These methods are preferable means of establishing the present value of the note.
25-3
If an established exchange price is not determinable and if the note has no ready market, the problem of determining present value is more difficult. To estimate the present value of a note under such circumstances, an applicable interest rate is approximated that may differ from the stated or coupon rate. This process of approximation is called imputation, and the resulting rate is called an imputed interest rate. Nonrecognition of an apparently small difference between the stated rate of interest and the applicable current rate may have a material effect on the financial statements if the face amount of the note is large and its term is relatively long.
>> Notes Exchanged for Cash or for Cash and Rights or Privileges
25-4
When a note is received or issued solely for cash and no other right or privilege is exchanged, it is presumed to have a present value at issuance measured by the cash proceeds exchanged. If cash and some other rights or privileges are exchanged for a note, the value of the rights or privileges shall be given accounting recognition as described in paragraph 835-30-25-6.
25-5
The total amount of interest during the entire period of a cash loan is generally measured by the difference between the actual amount of cash received by the borrower and the total amount agreed to be repaid to the lender. The difference between the face amount and the proceeds upon issuance is shown as either discount or premium. For example, if a bond is issued at a discount or premium, such discount or premium is recognized in accounting for the original issue. The coupon or stated interest rate is not regarded as the effective yield or market rate. Moreover, if a long-term non-interest-bearing note or bond is issued, its net proceeds are less than face amount and an effective interest rate is based on its fair value upon issuance.
25-6
A note issued solely for cash equal to its face amount is presumed to earn the stated rate of interest. However, in some cases the parties may also exchange unstated (or stated) rights or privileges, which are given accounting recognition by establishing a note discount or premium account. In such instances, the effective interest rate differs from the stated rate. For example, an entity may lend a supplier cash that is to be repaid five years hence with no stated interest. Such a non-interest-bearing loan may be partial consideration under a purchase contract for supplier products at lower than the prevailing market prices. In this circumstance, the difference between the present value of the receivable and the cash loaned to the supplier is appropriately regarded as an addition to the cost of products purchased during the contract term. The note discount shall be amortized as interest income over the five-year life of the note, as required by Section 835-30-35.
>> Note Exchanged for Property, Goods, or Services
25-7
A note exchanged for property, goods, or service represents the following two elements, which may or may not be stipulated in the note:
a. The principal amount, equivalent to the bargained exchange price of the property, goods, or service as established between the supplier and the purchaser
b. An interest factor to compensate the supplier over the life of the note for the use of funds that would have been received in a cash transaction at the time of the exchange.
25-8
Notes exchanged for property, goods, or services are valued and accounted for at the present value of the consideration exchanged between the contracting parties at the date of the transaction in a manner similar to that followed for a cash transaction.
25-9
The difference between the face amount and the present value upon issuance is shown as either discount or premium.
25-10
In circumstances where interest is not stated, the stated amount is unreasonable, or the stated face amount of the note is materially different from the current cash sales price for the same or similar items or from the fair value of the note at the date of the transaction, the note, the sales price, and the cost of the property, goods, or service exchanged for the note shall be recorded at the fair value of the property, goods, or service or at an amount that reasonably approximates the fair value of the note, whichever is the more clearly determinable. That amount may or may not be the same as its face amount, and any resulting discount or premium shall be accounted for as an element of interest over the life of the note.
25-11
In the absence of established exchange prices for the related property, goods, or service or evidence of the fair value of the note (as described in paragraph 835-30-25-2), the present value of a note that stipulates either no interest or a rate of interest that is clearly unreasonable shall be determined by discounting all future payments on the notes using an imputed rate of interest. This determination shall be made at the time the note is issued, assumed, or acquired; any subsequent changes in prevailing interest rates shall be ignored.
> Determining an Appropriate Interest Rate
25-12
Paragraph 835-30-10-1 identifies the objective of the guidance in this Subtopic for approximating an interest rate. The variety of transactions encountered precludes any specific interest rate from being applicable in all circumstances. However, this paragraph provides the following general guidelines:
a. The choice of a rate may be affected by the credit standing of the issuer, restrictive covenants, the collateral, payment and other terms pertaining to the debt, and, if appropriate, the tax consequences to the buyer and seller.
b. The prevailing rates for similar instruments of issuers with similar credit ratings will normally help determine the appropriate interest rate for determining the present value of a specific note at its date of issuance.
c. In any event, the rate used for valuation purposes shall be the rate at which the debtor can obtain financing of a similar nature from other sources at the date of the transaction.
XBRL ELEMENTS
25-13
The selection of a rate may be affected by many considerations. For instance, where applicable, the choice of a rate may be influenced by the following:
a. An approximation of the prevailing market rates for the source of credit that would provide a market for sale or assignment of the note
b. The prime or higher rate for notes that are discounted with banks, giving due weight to the credit standing of the maker
c. Published market rates for similar-quality bonds
d. Current rates for debentures with substantially identical terms and risks that are traded in open markets
e. The current rate charged by investors for first or second mortgage loans on similar property.
