As winter was approaching, Kendall’s Carpentry Company finished the framing and “drying-in” a new lake house for Dave Hampton, one of the company’s clients, who accepted the work as satisfactory. Hampton is building the lake hours as a weekend and summer retreat for himself and his family on a lot he bought for $18,000 last spring with some inheritance money. The keep construction costs to a minimum, Hampton decided to be his own general contractor.
Although the lot is fully paid for, the house must be financed. Because local lenders do not make loans to individuals on dwelling that are not yet habitable, Hampton has had to work out some short-term financing arrangements. He arranged with a building supply company to buy all the materials needed on a six-month note and has made similar arrangements with Kendall’s Carpentry Company for the labor. Now that the house is “dried-in,” Hampton plans to spend his winter weekends doing all the finishing work so that the house will be ready for use by late spring. Once the lake house is completed, Hampton intends to get a conventional mortgage on it for about $40,000 and use the proceeds to pay the notes to the building supply company and Kendall’s Carpentry.
The job required a total of 310 hours of labor, for which Kendall’s Carpentry usually bills $50 an hour on a cash basis (the workers are paid an hourly rate of $30). However, because of Hampton’s good credit rating, the company has agreed to take a non-interesting-bearing note in the face amount of $15,500 due in 6 months. Collateral for the note is a lien on the lake property (the same as on the note to the building supply company). Based on inquiries to its own bank and a few others, Kendall’s carpentry knows the note can be discounted with recourse for about $14,100 or without recourse for about $12,900.
From its own experience with similar notes, Kendall’s Carpentry believes the risk of loss from default is about 5 %. Also, the company changes a 12% annual discount rate.
Required: How should Kendall’s Carpentry recognized the note receivable and the related service revenue?