Question

SorCo. Inc. has just entered into a sale agreement with a customer. The contract is for $1,100,000. However, the payments will be made as follows: 1 August 20X1 on date of delivery $500,000; 1 August 20X2 $300,000 and 1 August 20X3 $300,000. SorCo has estimated that the interest rate required for this customer is 7%.

Required:

Prepare the journal entry required to record the sale on 1 August 20X1 and the receipt of cash on 1 August 20X2 and 20X3.

Answer 1

With the delayed payments, the contract consideration is the present value of the future cash flows to be received. Using 7% as the discount rate, the contract price is:

500,000 + 300,000/(1.07) + 300,000/(1.07)²

= 500,000 + 280,374 + 262,032 = 1,042,406

 

The table below shows how the interest is calculated for each period, using the effective rate method.

 

	Payment	Interest at 7%	Principal	Balance
Aug 1 20X1				542,406
Aug 1, 20X2	300,000	37,968	262,032	280,374
Aug 1, 20X3	300,000	19,626	280,374	0

 

Aug 1, 20X1

Dr. Long-term Accounts receivable                          542,406

Dr. Cash                                                                         500,000

             Cr. Revenue                                                                           1,042,406

 

Aug 1, 20X2

Dr. Cash                                                                        300,000

Cr. Long-term Accounts receivable                          262,032

            Cr. Interest income                                                                    37,968

 

Aug 1, 20X3

Dr. Cash                                                                        300,000

Cr. Long-term Accounts receivable                          280,374

            Cr. Interest income                                                                    19,626