ASC 835: Imputed Interest on Noninterest-Bearing Notes Journal Entries

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Accounting Standards Codification (ASC) Topic 835, Interest, addresses the accounting for interest costs under Generally Accepted Accounting Principles (GAAP). One important aspect of ASC 835 is the recognition of imputed interest on noninterest-bearing notes. Imputed interest is the interest rate that the market would expect to earn on a similar note with interest. This article will explore the key aspects of imputed interest on noninterest-bearing notes under ASC 835 and provide examples of journal entries to help you better understand the accounting treatment.
 

ASC 835 Overview

ASC 835 provides guidance on how to account for imputed interest on noninterest-bearing notes or notes with below-market interest rates. The rationale for imputing interest is to ensure that the financial statements accurately reflect the time value of money associated with these transactions. Imputed interest is calculated using the effective interest method, which involves determining the present value of the future cash flows of the note at a market rate of interest.
 

Journal Entries for Imputed Interest on Noninterest-Bearing Notes

To illustrate the accounting treatment for imputed interest, let's consider an example. Company A issues a noninterest-bearing note to Company B with a face value of $10,000, due in three years. The market rate of interest for similar notes is 5%.
 

Here are the journal entries for Company A to record the issuance of the noninterest-bearing note and the imputed interest
 

1. Company A records the issuance of the note at the present value of the future cash flows, discounted at the market rate of interest (5%):

Debit: Cash $8,629
Credit: Note Payable (Discounted) $8,629
Calculation: $10,000 / (1 + 0.05)^3 = $8,629
 

2. Company A records the imputed interest expense for the first year:

Debit: Interest Expense $431
Credit: Note Payable (Discounted) $431
Calculation: $8,629 * 0.05 = $431

3. Company A records the imputed interest expense for the second year:

Debit: Interest Expense $453
Credit: Note Payable (Discounted) $453
Calculation: ($8,629 + $431) * 0.05 = $453
 

4. Company A records the imputed interest expense for the third year:

Debit: Interest Expense $476
Credit: Note Payable (Discounted) $476
Calculation: ($8,629 + $431 + $453) * 0.05 = $476
 

By the end of the third year, the Note Payable (Discounted) account will have a balance of $10,000, equal to the face value of the note. Company A will then record the repayment of the note:
 

5. Company A records the repayment of the note:

Debit: Note Payable $10,000
Credit: Cash $10,000

 

ASC 835 provides guidance on accounting for imputed interest on noninterest-bearing notes to ensure that the time value of money is accurately reflected in financial statements. By understanding the accounting treatment and journal entries associated with imputed interest, companies can maintain accurate financial records and comply with GAAP. Adhering to the provisions of ASC 835 helps companies provide transparent financial reporting that accurately reflects the economic substance of their transactions involving noninterest-bearing notes.