How are notes valued and accounted for under the authoritative guidance?
ACCOUNTING FOR NOTES
Firms typically borrow from banks, insurance companies, and other financial institutions by signing a note, which specifies the terms of the borrowing arrangement.
Initial Valuation
The initial valuation of this loan equals the present value of the future cash payments discounted at the yield required by the lender.
When the stated interest rate for a loan equals the yield required by the lender, then the amount borrowed equals the principal amount of the loan (also called the face value in the case of bonds).
Measurement Subsequent to the Date of the Initial Loan
The carrying value of the loan on subsequent accounting periods equals the present value of the remaining cash flows discounted at the initial yield required by the lender at issuance
The amount reported on the balance sheet throughout the life of a loan (that is, its carrying value) equals the present value of the remaining cash flows discounted at the historical market interest rate . The current market interest rate usually differs from the historical market interest rate during the life of the loan. A firm that does not account for long-term notes and bonds using the fair value option, uses the historical market interest rate to account for the loan while it is outstanding.
An amortization schedule shows the amount of interest expense and cash payments each payment period and the resulting reduction in the carrying value of the loan during the periods. The interest expense equals the required yield times the unpaid balance of the loan at the beginning of each payment period. Common terminology refers to the calculations for amortizing a financial instrument to its maturity value over time as the effective interest method. The effective interest method has the following features:
1 . The note, bond, or other financial instrument will appear on the balance sheet both initially and at each subsequent date at the present value of the remaining cash flows discounted at the historical market interest rate (that is, its initial yield to maturity).
2 . The amount of interest expense each period equals the historical market interest rate times the carrying value of the financial instrument at the beginning of each period.
The carrying value of the note changes each period, increasing to reflect the nearer in time of all remaining cash flows and decreasing for the payment of interest and principal
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