Question

On December 31, 2015, Milton Company acquired a computer from Hamil Corporation by issuing a $600,000 zero-interest-bearing note, payable in full on December 31, 2019. Milton Company’s credit rating permits it to borrow funds from its several lines of credit at 10%. The computer is expected to have a 5-year life and a $70,000 residual value.
Prepare the journal entry for the purchase on December 31, 2015 and any necessary adjusting entries relative to depreciation (use straight-line) and amortization on December 31, 2016

Answer 1

Cost of machinery is equal to present value of the zero-interest bearing note discounted using 10% cost of borrowing. Present value of zero-interest note is:

Present value of zero-interest note =

= $600,000 / (1+10%)^4 = $409,808.07

Cost of computer shall also be $409,808.07

Journal entries at purchase and on year end are:

Date	Account	Debit	Credit
Dec 31. 2015	Computer	$ 409,808.07
	Zero interest note payable		$ 409,808.07
	[Computer acquired through zero interest note payable]
Dec 31. 2016	Depreciation expense	$   81,961.61
	Accumulated depreciation		$   81,961.61
	[Depreciation provided for comuter using striaght line method]
Dec 31. 2016	Interest expense	$   40,980.81
	Zero interest note payable		$   40,980.81
	[Interest accrued on zero interest note payable]

Depreciation expense under straight line method = Cost of asset/ useful life = $409,808.07 / 5 years = $81,961.61 per year

Interest expense for the year = Note payable book balance X interest rate = $409,808.07 X 10% = $40,980.81

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