Question

On June 1, 2017, ABC Corporation approached 123 Corporation about buying a parcel of undeveloped land. 123 Corp was asking $240,000 for the land and ABC saw that there was some flexibility in the asking price. ABC did not have enough money to make a cash offer to 123 Corp and proposed to give, in return for the land, a $300,000, five-year promissory note that bears interest at the rate of 4%. The interest is to be paid annually to 123 Corp Corporation on June 1 of each of the next five years. 123 Corp insisted that the note taken in return become a mortgage note. 123 Corp accepted the amended offer, and ABC Corp signed a mortgage note for $300,000 due June 1, 2022. ABC would have had to pay 10% at its local bank if it were to borrow the cash for the land purchase. 123 Corp, on the other hand, could borrow the funds at 9%. Both ABC Corp and 123 Corp have December 31st year ends.

1) Calculate the purchase price of the land.

2) Prepare the journal entry for the purchase of the land.

3) Prepare any adjusting journal entry that is required at the end of the fiscal year and the first payment made on June 1, 2018, assuming no reversing entries are used.

Answer 1

Question 1

The purchase price of the land is the present value of the Mortgage Note for ABC Corporation. The present Value can be computed as:-

Annual Interest Payment = 300000*4% = 12,000

The discount rate used is 10% since that would be 10% as the purchase price is from the perspective of ABC Corp.

12000/(1+10%) + 12000/(1+10%)² + 12000/(1+10%)³ + 12000/(1+10%)⁴ + 12000/(1+10%)^{5 +} + 300000/(1+10%)⁵

= 10909.09 + 9917.36 + 9015.77 + 8196.16 + 7451.05 + 169342.18 = $214,832.

Question 2

The Journal Entry at the time of Purchase is as follows:

	Debit	Credit
Land	2,14,832
Unamortized Discount on Mortgage	85,168
4% Mortgage Note		3,00,000

Question 3

At the year end, we need to amortize part of the discount. We are using Straight Line Method for amortizing the discount. The discount to be amortized = 85,168/5 = 17,034. The journal to be entered is as follows:

	Debit	Credit
Interest Expense	29,034
Unamortized Discount on Mortgage		17,034
Cash		12,000