Interest-Bearing Notes vs. Non-Interest-Bearing Notes: Stated Rate and Effective Rate

When examining interest-bearing notes and non-interest-bearing notes, understanding the concepts of stated rate and effective rate is crucial for accurately assessing their financial implications.

Interest-Bearing Notes

An interest-bearing note features a stated interest rate, which refers to the nominal interest rate explicitly mentioned in the note's terms. This rate is calculated on the face value of the note and indicates the amount of interest the borrower is expected to pay in addition to the principal. According to Intermediate Financial Accounting 2, interest-bearing notes clearly outline the relationship between principal and interest payments.

• Stated Rate: This is the interest rate explicitly defined in the contract, which determines the cash flow payments made periodically.
• Effective Rate: In general, when a note is issued at par (meaning the issue price equals the face value), the stated rate and the effective rate are identical. However, when the note is issued at a discount or premium, the effective interest rate may differ from the stated rate. The effective interest rate more accurately reflects the true cost of borrowing on an annualized basis.

Non-Interest-Bearing Notes

On the other hand, a non-interest-bearing note does not include any stated interest rate. Instead, it is typically issued at a discount to its face value, with repayment at maturity equating to the full face value. This difference signifies the implicit interest embedded in the terms of the note. As stated in AccountingTools, there is no explicit interest to be paid, meaning lenders receive back more than they initially disbursed.

• Stated Rate: Non-interest-bearing notes lack a stated interest rate since they do not require periodic interest payments.
• Effective Rate: The effective rate in the case of a non-interest-bearing note can be viewed as the yield to maturity; it indicates the implicit interest recognized when the lender receives the face value at maturity after paying less at the initiation of the note.

Conclusion

In summary, key distinctions between interest-bearing and non-interest-bearing notes revolve around their stated and effective rates. Interest-bearing notes have a clear stated rate and an effective rate that may vary based on when the note is issued concerning its face value. Non-interest-bearing notes do not have an explicit stated rate and feature an effective rate based on the implied interest resulting from the discount at which they are issued.

For further learning, video resources like YouTube on Interest vs. Non-Interest Bearing Notes can provide visual explanations, while analysis via Chegg deepens the understanding of accounting perspectives on these financial instruments. Additionally, exploring insights from PwC will enhance comprehension of the nuances in interest rates overall.

Sources

13.2 Notes Payable – Intermediate Financial Accounting 26.3 Types of interest rates - PwC ViewpointInterest vs. non-interest bearing notes - YouTubeNotes Receivable Interest Bearing Vs Non Interest ... - YouTubeAccounting for a non interest bearing note - AccountingToolsSolved In accounting for interest-bearing notes receivable - Chegg[PDF] APB 21: Interest on Receivables and Payables - FASB

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