On October 1, year 1, Fleur Retailers signed a 4-month, 16% note payable to finance the purchase of holiday merchandise. At that date, there was no direct method of pricing the merchandise, and the note’s market rate of interest was 11%. Fleur recorded the purchase at the note’s face amount. All of the merchandise was sold by December 1, year 1. Fleur’s year 1 financial statements reported interest payable and interest expense on the note for 3 months at 16%. All amounts due on the note were paid February 1, year 2. Fleur’s year 1 cost of goods sold for the holiday merchandise was
　　A. Overstated by the difference between the note’s face amount and the note’s October 1, year 1 present value plus 11% interest for 2 months.
　　B. Understated by the difference between the note’s face amount and the note’s October 1, year 1 present value.
　　C. Understated by the difference between the note’s face amount and the note’s October 1, year 1 present value plus 16% interest for 2 months.
　　D. Overstated by the difference between the note’s face amount and the note’s October 1, year 1 present value.
　　Answer:B
　　B is corrent. Per ASC Topic 835, when a note is exchanged for property, goods, or services, the stated interest rate is presumed to be fair unless (1) interest is not stated, (2) the stated rate is unreasonable, or (3) the current cash price of the property, goods, or services is materially different from the market value of the note. In these circumstances, the note and the cost of the property, goods, or services should be recorded at the fair value of the property, goods, or services or the market value of the note, whichever is more clearly determinable. The note signed by Fleur bears an unreasonable interest rate of 16% as compared to the market rate of 11%.
　　If the note payable had been for more than 1 year, the correct entry would have recorded the inventory at the market value of the note, since at the time of the transaction there was no direct method of pricing the merchandise. A premium on the note payable would have been recorded (since the stated rate was greater than the market rate) and the premium would have been subsequently amortized over the term of the note payable.
　　However, since the term of the note is less than 1 year (4 months), Fleur’s recording of the inventory purchase and the note payable at the face amount of the note is appropriate accounting treatment per ASC Topic 835.
　　Because the entry records inventory at the face amount of the note rather than at its present value, and the inventory was all sold prior to December 31, year 1, cost of goods sold would already be recorded appropriately.  However, since that is not an option for the solution, the best answer would be that the cost of goods sold would be understated by the difference between the face value of the note and the present value of the note. (If the market rate of 11% had been used to value the note, the purchases would have been recorded at a higher amount.)
　　A is incorrect. Per ASC Topic 835, when a note is exchanged for property, goods, or services, the stated interest rate is presumed to be fair unless (1) interest is not stated, (2) the stated rate is unreasonable, or (3) the current cash price of the property, goods, or services is materially different from the market value of the note. In these circumstances, the note and the cost of the property, goods, or services should be recorded at the fair value of the property, goods, or services or the market value of the note, whichever is more clearly determinable. The note signed by Fleur bears an unreasonable interest rate of 16% as compared to the market rate of 11%.  However, since the term of the note is less than 1 year (4 months), Fleur’s recording of the inventory purchase and the note payable at the face amount of the note is appropriate accounting treatment per ASC Topic 835.
　　C is incorrect. Per ASC Topic 835, when a note is exchanged for property, goods, or services, the stated interest rate is presumed to be fair unless (1) interest is not stated, (2) the stated rate is unreasonable, or (3) the current cash price of the property, goods, or services is materially different from the market value of the note. In these circumstances, the note and the cost of the property, goods, or services should be recorded at the fair value of the property, goods, or services or the market value of the note, whichever is more clearly determinable. The note signed by Fleur bears an unreasonable interest rate of 16% as compared to the market rate of 11%.  However, since the term of the note is less than 1 year (4 months), Fleur’s recording of the inventory purchase and the note payable at the face amount of the note is appropriate accounting treatment per ASC Topic 835.
　　D is incorrect. Per ASC Topic 835, when a note is exchanged for property, goods, or services, the stated interest rate is presumed to be fair unless (1) interest is not stated, (2) the stated rate is unreasonable, or (3) the current cash price of the property, goods, or services is materially different from the market value of the note. In these circumstances, the note and the cost of the property, goods, or services should be recorded at the fair value of the property, goods, or services or the market value of the note, whichever is more clearly determinable. The note signed by Fleur bears an unreasonable interest rate of 16% as compared to the market rate of 11%.  However, since the term of the note is less than 1 year (4 months), Fleur’s recording of the inventory purchase and the note payable at the face amount of the note is appropriate accounting treatment per ASC Topic 835.