Case 7-4 Notes Receivable 1. Regardless of which offer it accepts, Larson should recognize $75,000 from the sale of the lot. This represents the cash equivalent selling price because it is the fair value of the property according to a recent appraisal. Both builders would pay more than this amount for the lot, but this is because they would be paying over a period of time. 2. First, the president is wrong to claim that the loan to Builder B would not involve interest. Because Builder B would pay more than fair value for the lot ($75,000) over the next year, there is an interest charge. It is implicit, that is, interest is built into the agreement. The sales manager is also wrong to claim that it doesn't matter which offer is accepted because both involve the receipt of more than the appraised value of the property. One of the two offers is better if we consider the time value of money. Both builders would pay $100,000 over the next year. However, of this total amount, Builder B would pay a higher amount immediately - $20,000 down as opposed to only $12,000 down from Builder A. Larson should accept the offer from Builder B.

Case 7-6 Notes Receivable 1. The method suggested by the vice-president to record the sale of the property violates two principles: the revenue recognition principle and the historical cost principle. Revenue is recognized at the appropriate time, when a sale takes place, but for the wrong amount. The fair value of the property, $7.5 million, should be used as a measure of the amount of revenue to be recognized, rather than the face value of the note. 2. Memo to the vice-president: This is in response to your suggestion as to the proper accounting for the recent sale of our 100-acre tract for the new shopping center. I have considered your recommendation that we recognize revenue in the amount of $10 million - which is equivalent to the $2 million installments on the note over each of the next five years. Please understand my interest in maximizing profits to our shareholders whenever possible. The suggested treatment for this sale, however, is a clear violation of generally accepted accounting principles. The reason for the violation is straight-forward: $10 million is not the value of the asset we sacrificed in exchange for the five-year note. The property was recently appraised at a fair market value of $7.5 million. The difference between the $10 million in face value of the notes and the $7.5 million fair value of the property represents the interest we will earn over the next five years as we collect on the note. We will, in fact, recognize this difference of $2.5 million as income, but only over the life of the note, and as interest income rather than sales revenue. For now the amount of revenue we should recognize is $7.5 million. Please call me at any time if you would like to discuss this matter further.