Question

Holly Springs, Inc. contracted with Coldwater Corporation to have constructed a custom-made lathe. The machine was completed and ready for use on January 1, 2018. Holly Springs paid for the lathe by issuing a $310,000 note due in three years. Interest, specified at 4%, was payable annually on December 31 of each year. The cash market price of the lathe was unknown. It was determined by comparison with similar transactions for which 8% was a reasonable rate of interest. Holly Springs uses the effective interest method of amortization.

Required:
1. Prepare the journal entry on January 1, 2018, for Holly Springs’ purchase of the lathe.
2. Prepare an amortization schedule for the three-year term of the note.
3. Prepare the journal entries to record (a) interest for each of the three years and (b) payment of the note at maturity.

Answer 1

Answer 1.

Face Value of Note = $310,000

Annual Interest Rate = 4%
Annual Interest = 4% * $310,000
Annual Interest = $12,400

Period = 3 years
Annual Market Interest Rate = 8%

Present Value of Note = $12,400 * PVA of $1 (8%, 3) + $310,000 * PV of $1 (8%, 3)
Present Value of Note = $12,400 * 2.57710 + $310,000 * 0.79383
Present Value of Note = $278,043

Answer 2.

Answer 3.