Question

Amber Mining and Milling, Inc., contracted with Truax Corporation to have constructed a custom-made lathe. The machine was completed and ready for use on January 1, 2018. Amber paid for the lathe by issuing a $900,000, three-year note that specified 5% interest, 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 that 8% was a reasonable rate of interest. (FV of $1, PV of $1, FVA of $1, PVA of $1, FVAD of $1 and PVAD of $1) (Use appropriate factor(s) from the tables provided.)

Required:
1-a. Complete the table below to determine the price of the equipment.
1-b. Prepare the journal entry on January 1, 2018, for Amber Mining and Milling’s 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

1-a)

Annual interest : 900000*.05 = 45000

Price of equipment : [PVA 8%,3*Annual interest]+ [PVF 8%,3*Par value]

             =[2.57710*45000]+ [.79383*900000]

             = 115969.5+ 714447

              = 830416.5   [rounded to 830,417]

1-b)

Date	Account	Debit	credit
January 1, 2018	Machinery	830,417
	Discount on note payable	69583
	Note payable		900000
	[being machine purchased

2)

Period ended	Interest paid	Interest expense	Discount amortised	carrying value at end
1 jan 2018				830417
31 jan2 018	45000	66433 [830417*.08]	21433     [66433-45000]	851850    [830417+21433]
31 jan 2019	45000	68148    [851850*.08]	23148	874998    [851850+23148]
31 jan2020	45000	70002	25002	900000

3)

Date	Account	Debit	credit
31Dec 2018	Interest expense	66433
	Discount on note payable		21433
	cash		45000
	[Being first interest paid]
31 dec 2019	Interest expense	68148
	Discount on note payable		23148
	cash		45000
31 dec 2020	Interest expense	70002
	Discount on note payable		25002
	cash		45000
	[third interest paid]
31 dec 2020	Note payable	900000
	cash		900000
	[being note repaid]