Johnson Co. accepts a note receivable from a customer in exchange for some damaged inventory. The note requires the customer make semiannual installments of $50,000 each for 10 years. The first installment begins six months from the date the customer takes delivery of the damaged inventory. Johnson's management estimates that the fair value of the damaged inventory is $679,517.

Accounting

(a)

What interest rate is Johnson implicitly charging the customer? Express the rate as an annual rate but assume semiannual compounding.

(HINT: USE PVF-OA formula with 20 periods. 679,517= 50,000 X PVF-OA....... rearrange PVF-OA = 679,517 / 50,000.)

(b)

At what dollar amount do you think Johnson should record the note receivable on the day the customer takes delivery of the damaged inventory?

Analysis

Assume the note receivable for damaged inventory makes up a significant portion of Johnson's assets. If interest rates increase, what happens to the fair value of the receivable? Briefly explain why.

Principle

The Financial Accounting Standards Board has issued an accounting standard that allows companies to report assets such as notes receivable at fair value. Discuss how fair value versus historical cost potentially involves a trade-off of one desired quality of accounting information against another.