Question

E14-17B (L03) (Imputation of Interest) Presented below are two independent situations:

(a) On January 1, 2017, Excess Inc. purchased undeveloped land that had an assessed value of $261,000 at the time of purchase. A $500,000, zero-interest-bearing note due January 1, 2022, was given in exchange. There was no established exchange price for the land, nor a ready market value for the note. The interest rate charged on a note of this type is 15%. Determine at what amount the land should be recorded at January 1, 2017, and the interest expense to be reported in 2017 related to this transaction.

(b) On January 1, 2017, DonnAll Diamond borrowed $1,000,000 (face value) from Allstar Co., a major customer, through a zero-interest-bearing note due in 3 years. Because the note was zero-interest-bearing, DonnAll agreed to sell diamonds to this customer at lower than market price. A 12% rate of interest is normally charged on this type of loan. Prepare the journal entry to record this transaction and determine the amount of interest expense to report for 2017.

Answer 1

(a)	Land should be recorded at carrying value of note
	Note due on Jan 1,2022
	Note issued on Jan 1,2017
	Life of the note=5 years
	Discount factor=15%
	Carrying value of note=Face value*Discount factor at 15% for 5th year=500000*0.49718=$ 248590
	Land should be recorded at $ 248590
	Interest expense=Carrying value of note*15%=248590*15%=37288.5=$ 37289
(b)	Life of the note=3 years
	Discount factor=12%
	Carrying value of note=Face value*Discount factor at 12% for 3rd year=1000000*0.71178=$ 711780
	Discount on notes payable=Face value-Carrying value=1000000-711780=$ 288220
	Journal entry:
	Account titles and explanation				Debit	Credit
	Cash				1000000
	Discount on notes payable				288220
	Notes payable					1000000
	Unearned sales revenue					288220
	(Diamond borrowed for note)
	Interest expense=Carrying value of note*12%=711780*12%=85413.6=$ 85414
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