In: Accounting
On January 1, Snipes Construction paid for earth moving equipment by issuing a 350,000, 2 year note that specified 4% interest to be paid on December 31 of each year. The equipments retail cash price was unknown, but it was determined that a reasonable interest rate was 7%
At what amount should Snipes record the equipment and the note?
what journal entry should it record for the transaction?
n= | ||
i= | ||
Loan repayments | Amount | Present Value |
Interest | ||
Principal | ||
Price of equipment |
Solution: | |||||
1. | |||||
n=2 | |||||
i=7% | |||||
Loan repayments | Amount | Present Value | |||
Interest | 14,000 | 25,312 | |||
Principal | 350,000 | 305,704 | |||
Price of equipment | 331,016 | ||||
Working Notes: | |||||
n=2 | |||||
i=7% | |||||
Loan repayments | Amount | PVF | Present Value | ||
Interest | 14,000 | 1.80802 | 25312 | I | |
[350,000 x 4%] | (a) | ||||
Principal | 350,000 | 0.87344 | 305704 | II | |
Price of equipment | (b) | 331016 | III = I + II | ||
(a) Present value of an ordinary annuity of $1:n= 2,i= 7% is 1.80802 | |||||
(b) Present value of $1: n = 2, i = 7% is 0.87344 | |||||
Notes: | Notes payable charged 4% , but market interest rate is 7 % hence, interest & principal payment is discounted using 7% value. | ||||
2. | |||||
General Journal | Debit | Credit | |||
Equipment | 331,016 | ||||
Discount on notes payable | 18,984 | ||||
Notes payable | 350,000 | ||||
Working Notes: | |||||
General Journal | Debit | Credit | |||
Equipment | 331,016 | a | |||
[Calculated in (1) ] | |||||
Discount on notes payable | 18,984 | b=a-c | |||
[balancing figure] | |||||
Notes payable | 350,000 | c | |||
[ face value of Notes payable] | |||||
Please feel free to ask if anything about above solution in comment section of the question. |