Question

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On January 1, 2016, Worthylake Company sold used machinery to Brown Company, accepting a $25,000, non-interest-bearing note maturing on January 1, 2018. Worthylake carried the machinery on its books at a cost of $22,000 and a current book value of $15,000. Neither the fair value of the machinery nor the note was determinable at the time of sale; however, Brown’s incremental borrowing rate was 12%.

Required:

Prepare the journal entries on Worthylake’s books to record:

1.	sale of the machinery
2.	related adjusting entries on December 31, 2016, and 2017
3.	payment of the note by Brown on January 1, 2018 Jan 1,16 Notes Receivable 25,000 Accumulated Depreciation 7,000 Gain on sale of Machinery 4,929.85 Discount on Notes Receivable 5,070.15 Machinery 22,000 Dec 31,16 ???? 2,391.58 Interest Income 2,391.58 Dec 31, 17 ???? 2,678.57 Interest Income 2,678.58 Jan 1, 18 Cash ???? (NOT 25,000 as stated on another post) Notes Receivable ????

Answer 1

• All working forms part of the answer
• Note is Non interest bearing, hence we have to calculate the ‘implied interest revenue’ in that revenue.
• Interest rate = 12%, and Notes Receivable amount = $ 25,000 maturing after 2 years.
• PV of $1 at 12% for 2^nd year = [ 1/(1.12)²] = 0.797194
• Present Value of Note = $ 25,000 x 0.797194 = $ 19,929.85
• Working:

Notes Receivable face value (A)	$                                   25,000.00
Present Value of Note (B)	$                                   19,929.85
Discount on Notes Receivables (A – B)	$                                     5,070.15

Period	Beginning Value	Interest at 12%	Ending Value
31-Dec-16	$                                                      19,929.85	$                                     2,391.58	$                  22,321.43
31-Dec-17	$                                                      22,321.43	$                                     2,678.57	$                  25,000.00

• All Journal Entries, based on above working:

Date	Accounts Title	Debit	Credit
(1) 1 jan 2016	Notes Receivables	$                                   25,000.00
	Accumulated Depreciation	$                                     7,000.00
	Gain on Sale of Machinery		$                     4,929.85
	Machinery		$                  22,000.00
	Discount on Notes Receivables		$                     5,070.15
	(machinery sold)
(2) Dec 31, 2016	Discount on Notes Receivables	$                                     2,391.58
	Interest Revenue or Interest Income		$                     2,391.58
	(Interest earned recorded and adjusted)
(3) Dec 31, 2017	Discount on Notes Receivables	$                                     2,678.57
	Interest Revenue or Interest Income		$                     2,678.57
(4) Jan 1, 2018	Cash	$                                   25,000.00
	Notes receivables		$                  25,000.00
	(Cash received)