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, 2021. Holly Springs paid for the lathe by issuing a $350,000 note due in three years. Interest, specified at 3%, 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 7% was a reasonable rate of interest. Holly Springs uses the effective interest method of amortization. (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. Prepare the journal entry on January 1, 2021, 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

Details given in the question:

Face value of note = $350,000

Coupon rate = 3%
Years = 3 years

Reasonable rate = discounting rate=7%

Yearly Interest = $350000 x 3% = $10,500

Requirement 1 - Calculation of Purchase price of the lathe.

Purchase price = Present value of Notes payable = Present value of annual interests + Present value of Principal

Present value of annual interest = Interest x PVIFA(7%,3year)

PVIFA(7%,3year) = 2.6243 (rounded to 4 decimals)

Present value of annual interest = $10,500 x 2.6243 = $27,555

Present value of Principal = Face value of note x PVIF (7%,3year)

PVIF(7%,3Year) =0.8163 (rounded to 4 decimals)

Present value of Principal = $350,000 x 0.8163 = $285,705

Present value of Notes payable = $27,555 + $285,705 = $313,260

Discount on notes payable = Face value of note – Present value of note payable = $350,000 -$313,260 =$36,740

Journal Entry

Date	General Journal	Debit	Credit
Jan. 1 , 2021	Machinery	$313,260
	Discount on notes payable	$36,740
	Notes Payable		$350,000
	(to record issuance of note for lathe purchase)

Requirement 2- Amortization Schedule

A	B	C	D	E	F
Year	Opening Carrying value	Cash Payment	Interest expense (B x 7%)	Discount amortization (D-C)	Closing Carrying value (B+E)
0					$313,260
1	$313,260	$10,500	$21,928	$11,428	$324,688
2	$324,688	$10,500	$22,728	$12,228	$336,916
3	$336,916	$10,500	$23,584	$13,084	$350,000

Requirement 3 Journal Entries

(a) Interest for Each three years

Date	General Journal	Debit	Credit
Dec 31, 2021	Interest Expense	$21,928
	Discount on bonds payable		$11,428
	Cash		$10,500
	(to record Interest payment)
Dec 31, 2022	Interest Expense	$22,728
	Discount on bonds payable		$12,228
	Cash		$10,500
	(to record Interest payment)
Dec 31, 2023	Interest Expense	$23,584
	Discount on bonds payable		$13,084
	Cash		$10,500
	(to record Interest payment)

(b) Payment of the Note at maturity

Date	General Journal	Debit	Credit
Dec 31, 2023	Notes Payable	$350,000
	Cash		$350,000
	(to record Payment of note at maturity)