Question

Problem 1

On December 31, 20x0, the Western Corporation sold inventory to Southern Inc. on the following terms: the full value of the inventory of $400,000 is payable on December 31, 20x3 and interest of 3% on the face value of the note ($400,000) is payable each December 31. Western’s incremental borrowing rate is 5% and Southern’s incremental borrowing rate is 9%.

Required –

1. a) Prepare all journal entries relating to the above transaction for the length of the note assuming that Western is:

   1. a publicly accountable entity, and

   2. a private company following ASPE who wants to keep accounting for

      these types of transactions as simple as possible

2. b) Repeat Part (a) on the assumption that the terms are as follows: Southern is to pay

   Western equal annual payments of principal and interest at an interest rate of 3%

   over 4 years starting December 31, 20x1.

3. c) Assume now that neither company’s incremental borrowing rate is known but we

   know that the cash price of the equipment is $350,000. The terms are as follows: 0% interest for 3 years and the full $400,000 is payable on December 31, 20x3. Assuming that Western is a publicly accountable entity, prepare all journal entries for the length of the note.

Answer 1

JOURNAL ENTRIES AS ON DEC 20X0 :

a) SUNDRY DEBTORS a/c DR $ 400,000.00

TO SALES a/c $ 400,000.00

BEING ENTRY TO RECORD SALES

b) Loan advance a/c DR $ 400,000.00

To Inventory a/c $ 400,000.00

being entry to transfer inventory to advance a/c.

JOURNAL ENTRY AS ON DEC 2011 :

a) Interest receivable a/c dr $ 12,000.00

to interest   a/c $ 12,000.00

being entry to record the interest receivable

b) when 1st installement received along with interest :

cash / bank a/c dr $ 87,000.00

to Interest receivable a/c $ 12,000.00

to Loan advance a/c $ 75,000.00

JOURNAL ENTRY AS ON DEC 2012 :

a) Interest receivable a/c dr $ 9,000.00

to interest   a/c $ 9,000.00

being entry to record the interest receivable

b) when 2nd installement received along with interest :

cash / bank a/c dr $ 84,000.00

to Interest receivable a/c $ 9,000.00

to Loan advance a/c $ 75,000.00

JOURNAL ENTRY AS ON DEC 2013 :

a) Interest receivable a/c dr $ 6,000.00

to interest   a/c $ 6,000.00

being entry to record the interest receivable

b) when 3rd installement received along with interest :

cash / bank a/c dr $ 81,000.00

to Interest receivable a/c $ 6,000.00

to Loan advance a/c $ 75,000.00

JOURNAL ENTRY AS ON DEC 2014 :

a) Interest receivable a/c dr $ 3,000.00

to interest   a/c $ 3,000.00

being entry to record the interest receivable

b) when 4th installement received along with interest :

cash / bank a/c dr $ 78,000.00

to Interest receivable a/c $ 3,000.00

to Loan advance a/c $ 75,000.00