In: Accounting
Arctic Cat sold Seneca Motor Sports a shipment of snowmobiles.
The snowmobiles were delivered on January 1, 2021, and Arctic
received a note from Seneca indicating that Seneca will pay Arctic
$40,000 on a future date. Unless informed otherwise, assume that
Arctic views the time value of money component of this arrangement
to be significant and that the relevant interest rate is 8%. (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:
Assume the note indicates that Seneca is to pay Arctic the $40,000 due on the note on December 31, 2021. Prepare the journal entry for Arctic to record the sale on January 1, 2021.
Assume the same facts as in requirement 1, and prepare the journal entry for Arctic to record collection of the payment on December 31, 2021.
Assume instead that Seneca is to pay Arctic the $40,000 due on the note on December 31, 2022. Prepare the journal entry for Arctic to record the sale on January 1, 2021.
Assume instead that Arctic does not view the time value of money component of this arrangement to be significant, and that the note indicates that Seneca is to pay Arctic the $40,000 due on the note on December 31, 2021. Prepare the journal entry for Arctic to record the sale on January 1, 2021.
Sale date = January 1, 2021
Notes receivable amount = $40,000 at a future date
interest rate (discount rate for Present value of note ) = 8%
1. If note is due on December 31, 2021, present value of note using PV table of $1 at 8% = $40,000 * 0.9259 =$ 37036.
The cost principle and revenue principle require that transaction be recorded at their cash value at the time of transaction. Since, $40,000 is to be received in the future, we need to determine the present value of such future amount to be recorded in books, which is $ 37,036 using discount factor 8%. So, at the time of sale, a portion of this note represents revenues earned and a portion represents implicit interest( or discount factor) based on time value of money. So, we record our asset Notes receivable as debit, we credit the sales revenues with present value and the difference is discount on notes receivable (This is not interest on note currently since it is not yet earned, it will be earned during the duration of the note.)
Journal entry on January 1, 2021 :
Note receivable Dr. $40,000
To Discount on notes receivable $2964
To Sales revenues $ 37,036
2.Journal entry at the time of collection of note :
Discount on notes receivable Dr. $2964
To Interest Revenue $ 2964
The above entry is for interest accrued on note
Cash A/c Dr. $ 40,000
To Note receivable $ 40,000
The above entry is to record collection of note on due date
3. Note is due on December 31, 2022
So, n= 2 years, i = 8%, PV factor of $1 @ 8% for 2 years = 0.8573
So, present value of note = $ 40,000 * 0.8573 = $ 34,292
Journal entry at the time of sale on January 1, 2021
Note receivable Dr. $40,000
To Discount on note receivable $ 5,708
To Sales revenue $ 34,292
In the above entry, we have calculated the present value of the note using PV tables, $ 34,292 is the present value and represents the revenue earned today. The difference in the value of note and $ 34,292 represents interest that will be earned on the note during the 2 year period.
4. Maturity date of note = Dec 31, 2021 (within 1 year). Therefore, it is basically a current asset like accounts receivable
Journal entry at the time of sale:
Note receivable $40,000
To Sales revenues $40,000