What is called discounting a note receivable A. Purchasing a note receivable. B. Receiving less money than the principal amount of the note. C. Selling a note receivable before maturity. D. Giving up some of tile interest revenue of the note.
Assume that the maturity date of the Dorman note is January 18, 1995 and that General Electric discounts the Dorman note at First City National Bank on December 9, 1994. The discount period--which is the number of days from the date of discounting to the date of maturity (this is the period the bank will hold the note) -- is 40 days; 22 days in December, and 18 days in January. Assume the bank applies a 12 percent annual interest rate in computing the discount value of the note. The bank will want to use a discount rate that is higher than the interest rate on the note in order to increase its earnings. GE may be willing to accept this higher rate in order to get cash quickly. The discounted value, called the proceeds, is the amount that GE receives from the bank. The proceeds are computed as follows:
General Electric’s entry to record discounting the note is:
Dec. 9, 1994cash
$ 15 170
Note receivable
Dorman Builders
$ 15 000
Interest Revenue
$ 170
TO RECORD DISCOUNTING NOTE RECEIVABLEAt maturity the bank collects 15 375 from the maker of the note, earning 205 of interest revenue.
Observe two points in the above computation: (1) The discounting is computed on the maturity value of the note (principal plus interest) rather than on the original principal amount, and (2) the discounting period extends backwards from the maturity date (January 18, 1995) to the date of discounting (December 9, 1994).