Question

On January 1, 1998, Umbrella Corporation sold inventory costing $30,000 to Burns Industries. In return, Umbrella Corporation received a 4-year, 9% note with a face value of $100,000. Blended payments will be made yearly on December 31, and will include principal and interest. The market rate of interest is 5%. Umbrella Corporation has a December 31 year-end while Burns Industries year-end is August 31.

Instructions:

a) Calculate the annual payments Umbrella Corporation will receive each year from Burns Industries. Use the stated rate of the note in your calculation.

Annual Payment

=$

b) Complete the following payment and amortization schedule for the note, except for where there is "keep blank" written. (Also please make sure to include 2 decimal places for all the answers for b).

	Cash Received	Interest Revenue (5%)	Principal Reduction	Carrying Value of Note
Jan. 1, 1998	Keep blank	Keep blank	Keep blank
Dec. 31, 1998
Dec. 31, 1999
Dec. 31, 2000
Dec. 31, 2001

c) Record the journal entries for Umbrella Corporation on January 1, 1998 and December 31, 1998.

Answer 1

	a) Calculation of annual payments, Umbrella Corporation will receive -
	Formula for calculating annual payments is [P X R X (1 + R)^N] / [{(1 + R)^N} - 1]
	where
	P - Amount of Note - $100,000
	R - Rate of Interest - 9% p.a.
	N - Number of Payments - 4
	Now,
	= [P X R X (1 + R)^N] / [{(1 + R)^N} - 1]
	= [100,000 X 0.09 X (1 + 0.09)^4] / [{(1 + 0.09 )^4} - 1]
	= [9,000 X 1.411582] / (1.411582 - 1)
	= 12,704.24 / 0.411582
	= $30,866.85
	Annual Payments = $30,866.85
	b)
	Annual Payments, Umbrella Corporation will receive if rate is 5% -
	= [P X R X (1 + R)^N] / [{(1 + R)^N} - 1]
	= [100,000 X 0.05 X (1 + 0.05)^4] / [{(1 + 0.05 )^4} - 1]
	= [5,000 X 1.215506] / (1.215506 - 1)
	= 6,077.53 / 0.215506
	= $28,201.21
	Annual Payments = $28,201.21
					Amounts in $
	Dates	Cash Received	Interest Revenue (5%)	Principal Reduction	Carrying Value of Note
	Jan 1, 1998	Keep Blank	Keep Blank	Keep Blank	100,000.00
	Dec 31, 1998	28,201.21	5,000.00	23,201.21	76,798.79
	Dec 31, 1999	28,201.21	3,839.94	24,361.27	52,437.52
	Dec 31, 2000	28,201.21	2,621.88	25,579.33	26,858.19
	Dec 31, 2001	28,201.21	1,342.91	26,858.30	(0.11)
	C) Journal Entries in the books of Umbrella Corporation
	Date	Particulars	Debit ($)	Credit ($)
	Jan 1 , 1998	Burns Industries A/c             Dr.	100,000.00
		To Sales A/c		100,000.00
	Jan 1 , 1998	Notes Receivable A/c          Dr.	100,000.00
		To Burns Industries A/c		100,000.00
	Dec 31 , 1998	Cash/Bank A/c                        Dr.	30,866.85
		To Notes Receivables A/c		21,866.85
		To Interest Recived A/c		9,000.00