Noninterest-bearing note exchanged for cash and other privileges • The Jaecke Gr

Question

Noninterest-bearing note exchanged for cash and other privileges •

The Jaecke Group, Inc., manufactures various kinds of hydraulic pumps. In June 2018, the company signed a four-year purchase agreement with one of its main parts suppliers, Hydraulics, Inc. Over the four-year period, Jaecke has agreed to purchase 100,000 units of a key component used in the manufacture of its pumps. The agreement allows Jaecke to purchase the component at a price lower than the prevailing market price at the time of purchase. As part of the agreement, Jaecke will lend Hydraulics $200,000 to be repaid after four years with no stated interest (the prevailing market rate of interest for a loan of this type is 10%). Jaecke’s chief accountant has proposed recording the note receivable at $200,000. The parts inventory purchase from Hydraulics over the next four years will then be recorded at the actual prices paid. Required: Do you agree with the accountant’s valuation of the note and his intention to value the parts inventory acquired over the four-year period of the agreement at actual prices paid? If not, how would you account for the initial transaction and the subsequent inventory purchases?

Explanation / Answer

Solution:-

It seems that $2,00,000 (without interest) lended to the Hydraulics Inc is an additional benefit supplied as per the agreement to purchase the component. If the same amount lended to the market, 10% interest income would be there. Hence 10% of 2,00,000 is an additional consideration over the actual price of the component would be paid. So components need to be recorder to the actual price plus $20,000 (2,00,000*10%).

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