 Hello and welcome to the session. This is Professor Farhad and this session I'm going to look at a discounting of a note receivable and specifically I'm going to go over a question that I get common inquiries about on the CPA exam. Hopefully this question will illustrate the concept and will help you understand how you should approach these type of questions on the exam. As always, I would like to remind you to connect with me on LinkedIn. If you haven't done so, YouTube is where you would need to subscribe. I have 1600 plus accounting, auditing, finance and tax lectures, and I have plenty of CPA questions that I go over, just like this question. If you like my recording, please like them, share them, put them in playlist. If they help you, it means they might help others subscribe, connect with me on Instagram and on my website. If you're looking to add those seven to 10 extra points to pass your CPA exam, I'm here to help you. I have plenty of resources, thousands of CPA questions, lectures, exercises that are quasi simulations that will help you understand and build your basic knowledge to pass the exam. So let's take a look at this question and had several students emailing me about this question. They got the solution. They still don't understand how to solve the problem. So, well, obviously, people don't discount notes payable on a regular basis. I understand why students will have hard time with this problem. So let's take a look at the first section of this problem. Ace, Ace company sold to King a 20,008% note that required five annual year end payments. So here's what happened. We have two companies. Ace and King, Ace sold the note to King. Now, obviously they sold the note to King. King paid a certain amount of money for the note and King would receive the future payment of this note. So this is basically what happened. Now, what is this note? This note is a $20,000 note. So the face value of the note is 20,000. It will pay 8% for five years and five equal annual payments. So we're looking at an annuity. So you're telling me here five equal payments at year end. It's an ordinary annuity. Now, the note was discounted to yield 9% to King. So remember, King paid the Ace, but King wants to earn 9%. The note pays 8%. King wants to earn 9%. Although the note says, you know, on the note, you're going to get 8%. King says, yes, I will buy the note, but I want to make sure whatever I pay, I earn 9%. The present value factor of an ordinary annuity of one payment for five period are as follow, 8%. That says 3.992, 9%, 3.890. What should be the total interest revenue earned by King? So they're asking us for the interest revenue. Now, the first question is this, what is King purchasing? When you buy the note, what are you really buying? You are buying five annual payments. So what you're buying is this on a timeframe is one, two, three, four, five. You're buying five annual payments. Now, before I proceeds, in case you don't know what an annuity is and you're not comfortable with this concept, time, value of money, if you are not familiar with this concept, in the description of this video, I'm going to put my recording about the time value concept because you have to have a good understanding about the time value of concept to apply it in different circumstances on the CPA exam. And this is one of those circumstances. So what King is buying is those payments, five payments. That's what you're buying. But what you're doing is you're buying those payments, how much will you pay for those payments is the present value. So that's what King is buying. King is buying the payments. But the question is, what is the payment? That's the question because we're not giving the payment. So the first thing we have to find out is the payments. What is the payment that King is buying? Well, we don't know this information, but from what we are giving, what I highlighted in yellow above, we can find the payment. How do we find the payment? We know that if we take the payment, whatever that payment is, which is we don't know the payment, if we take the payment, multiply the payment by the factor, specifically the annuity, because this is an annuity problem, annuity factor, it's going to give us 20,000. Why 20,000? Because 20,000 is the face value of the note, is the present value of the note, the face value of the note. So if we take the payment, which is we don't know, times the annuity factor, which is we have the information about the annuity factor, the note n equal to 5, i equal to 8%. So if we take the payment to solve for the payment, times this factor for the note 3.992 will give us 20,000. Now we can find the payment by dividing both sides by 3.992, the payment equal to 20,000, divided by 3.992. The payment is $5,010. Now we know the payment. So each of these payments is $5,010. Each of these payments is $5,010. $5,010. $5,010. $5,010. Each of these payments is $5,010. Now we know everything about the note that's being sold. So now, basically what I just did, I added to this line, the payment is $5,010. Now you should be able to solve the problem, because once you have the payment, wow, great. Now I have everything. I'm going to change colors here to indicate that now, I'm going to show you how much would King pay for these payments. Now we have everything about the note that's being sold. The question is how much is King is going to pay, and based on how much he's going to pay, we will know the interest revenue. King said, okay, you're paying $5,010 five times. I want to pay, I want to discount those payments based on 9%, not 8%. So for King, n equal to 5, he's going to be buying 5 payments. However, King wants to earn 9%. Simply put, King is not willing to pay 20,000. Why? Because he wants to buy this note at a discount. He wants to buy it at a discount. You're offering 8, he wants to earn 9%. Therefore, all we have to do is take the payment now, knowing how the time value of money work, and we have the factor. So King is willing to pay $5,010 times the present value annuity factor n equal to 5, i equal to 9, 3.890. So King will pay for this note, 19,490. They will not pay you 20,000. They're going to pay you less than 20,000. Now, that's how much, if the question was how much would King pay for the note? This is how much will King pay for the note? But the question is, what is the interest on this note? Well, the interest on this note is if King is paying 19,490, this is negative, King would receive in total 5 payments of $5,010, which is equal to $25,050. Therefore, King would earn in interest $5,560. That's how much King will earn in interest, and that's our answer. How much would King earn in interest revenue $5,560? Now, obviously, it took me a little bit longer to explain to you the concept. It should not take you that long on the exam. You have the factors. First, find the payment, and the key here, what trap the students is they don't know how to find the payment. You need to know, you need to be comfortable with the time value of money because you will need it for discounting a note. You will need this topic for leases, the time value of money. You will need it for bonds. You will need it for notes payable, and many others. Matter of fact, every time you have an asset or a liability, that's going to give you future payments or future receipt. You have to find the present value of it. Therefore, the time value of money is critical to your understanding and to your preparation for the CPA exam. On my website, what I do at the beginning of every CPA course, the first module is the time value of money. Don't start reviewing unless you have the time value of money prepared on my website because it's critical that you know how to use the time value of money. Because the exam, they're not going to test you about the time value of money. They're not going to tell you find the present value of this amount. They're going to give you an application of the time value of money. Can you use the time value of money in an application? If you have any questions, obviously, you can email me. Obviously, I'm going to remind you to connect with me and to visit my website for additional resources for your CPA exam. If you want to get those seven to 10 extra points on your exam to get to 75, I can help you. Study hard. Stay safe. The CPA is a lifetime investment. Don't shortchange yourself and be safe once again during those coronavirus outbreak. Good luck.