Chapter 13, Problem 13.1P

1. a

To determine

Long-term notes payable: Long-term notes payable represent a legal and written promise made by the business to pay a debt with interest over a period of more than a year. It is reported under the long-term liability section of the balance sheet.

Notes Receivables: Notes receivable is a legal agreement made between a borrower and the creditor. This agreement is acts as a written legal document between the parties; for example: Borrower pays cash as per the written document to the seller on a particular future date.

To prepare: Journal entries to record for the issuance of the note by B Plastics.

Explanation of Solution

a) Journal entry to record the issuance of the note by B Plastics.

Date		Accounts and Explanation			Post Ref	Debit ($)	Credit ($)
2016		Cash				14,000,000
October	1
			Notes payable				14,000,000
				(To record the issuance of note.)

Table (1)

Cash is an asset and is increased due to issuance by $14,000,000. Thus, debit cash account with $14,000,000. Notes payable is a liability and is increased by $14,000,000 due to issuance of note. Therefore, credit notes payable with $14,000,000.

1. b)

To determine

To prepare: Journal entries to record for the L&T Bank’s receivable on October 1, 2016.

Explanation of Solution

Journal entry to record Bank L’s receivable on October 1, 2016.

Date		Accounts and Explanation			Post Ref	Debit ($)	Credit ($)
2016		Notes Receivable				14,000,000
October	1
			Cash				14,000,000
				(To record the acceptance of notes receivable.)

Table (2)

Notes receivable is an asset and is increased by $14,000,000 due to acceptance of notes receivable. Therefore, debit notes receivable with $14,000,000. Cash is an asset and is decreased by $14,000,000 due to acceptance of notes receivable. Therefore, credit cash with $14,000,000.

2

To determine

To prepare: Journal entries by both firms to record all the subsequent events related to the note through January 31, 2017.

Explanation of Solution

Journal entry to record the accrual of interest payable.  

Date		Accounts and Explanation			Post Ref	Debit ($)	Credit ($)
2017		Interest Expense				420,000
December	31
			Interest Payable				420,000
				(To record the accrual of interest payable)

Table (3)

Interest expense is an expense and it decreases the value of stockholders’ equity. Thus, debit interest expense account by $420,000. Interest payable is a liability due to accrual of interest and it increases by $420,000. Therefore, credit interest payable account by $420,000.

Working note: Calculate interest expense for 3 months (from October 1 to December 31) on the notes payable.

$\begin{array}{c}\text{Interest}\text{expense}=\text{Principal}\text{amount}\times \text{Rate}\text{of interest}\times \text{Time}\\ =\$14,000,000\times 12\%\times \frac{3}{12}\\ =\$420,000\end{array}$

Journal entry to record the interest revenue earned, but not received.

Date		Accounts and Explanation			Post Ref	Debit ($)	Credit ($)
2017		Interest Receivable				420,000
December	31
			Interest Revenue				420,000
				(To record the interest revenue earned, but not receive)

Table (4)

Interest receivable is an asset and is increased by $420,000 due to recording of interest revenue earned. Thus, debit interest receivable with $420,000. Interest revenue is revenue and it increases the value of equity due to receipt of interest revenue earned. Thus, credit interest revenue account by $420,000.

Working note: Calculate interest revenue for 3 months (from October 1 to December 31) on the notes receivable.

$\begin{array}{c}\text{Interest}\text{revenue}=\text{Principal}\text{amount}\times \text{Rate}\text{of interest}\times \text{Time}\\ =\$14,000,000\times 12\%\times \frac{3}{12}\\ =\$420,000\end{array}$

Journal entry to record the payment of notes payable and interest for B Plastics at maturity.

Date		Accounts and Explanation			Post Ref	Debit ($)	Credit ($)
2017		Notes Payable				14,000,000
January	31
		Interest Expense				140,000
		Interest Payable				420,000
			Cash				14,560,000
				(To record the payment of notes payable and interest)

Table (5)

Notes payable is a liability and it decreases by $14,000,000 for recording of payment of notes payable and interest. Therefore, debit notes payable with $14,000,000. Interest expense is an expense and it decreases the value of equity due to notes payable. Therefore, debit interest expense account by $140,000. Interest payable is a liability and it decreases by $420,000. Therefore, debit interest payable account by $420,000. Cash is an asset account and it decreases by $14,560,000. Therefore, credit Cash account with $14,560,000.

Working note: Calculate interest expense for 1 month (from December 31 to January 31) on the notes payable.

$\begin{array}{c}\text{Interest}\text{expense}=\text{Principal}\text{amount}\times \text{Rate}\text{of interest}\times \text{Time}\\ =\$14,000,000\times 12\%\times \frac{1}{12}\\ =\$140,000\end{array}$

Journal entry to record for Bank L at maturity.

Date		Accounts and Explanation			Post Ref	Debit ($)	Credit ($)
2017		Cash				14,560,000
January	31
			Notes Receivable				14,000,000
			Interest Revenue				140,000
			Interest Receivable				420,000
				(To record the collection of note receivable and interest)

Table (6)

Cash is an asset account and it increases by $14,560,000 due to collection of notes receivable and interest. Thus, debit Cash account with $14,560,000. Notes receivable is an asset account and it decreases by $14,000,000. Thus, credit notes receivable with $14,000,000. Interest revenue is revenue and it increases the value of equity. Thus, credit interest revenue account by $140,000. Interest receivable is an asset account and it decreases by $420,000. Thus, credit interest receivable account by $420,000.

Working note: Calculate interest revenue for 1 month (from December 31 to January 31) on the note receivable.

$\begin{array}{c}\text{Interest}\text{revenue}=\text{Principal}\text{amount}\times \text{Rate}\text{of interest}\times \text{Time}\\ =\$14,000,000\times 12\%\times \frac{1}{12}\\ =\$140,000\end{array}$

3  a.

To determine

To prepare: Journal entry to record the issuance of the noninterest-bearing note by B Plastics on October 1, 2016.

Explanation of Solution

Date		Accounts and Explanation			Post Ref	Debit ($)	Credit ($)
2016		Cash				13,440,000
October	1
		Discount on Notes Payable				560,000
			Notes Payable				14,000,000
				(To record the issue of notes at 12% discounted rate)

Table (7)

Cash is an asset account and it increases due to issue of notes at 12% discounted rate. Thus, debit Cash account with $13,440,000. Discount on notes payable is a contra liability and decreases the liability due to issuance of notes at the discounted rate.   Thus, discount on notes payable account with debited with $560,000. Thus, credit notes payable with $14,000,000.

Journal entry to record the interest expense for three months.

Date		Accounts and Explanation			Post Ref	Debit ($)	Credit ($)
2016		Interest Expense				420,000
December	31
			Discount on Notes Payable				420,000
				(To record the interest expense for 3 months)

Table (8)

Interest expense is an expense and it decreases the value of stockholders’ equity. Thus, debit interest expense account by $420,000. Discount on notes payable is a contra liability and is increased to interest expense made for 3 months. Thus, credit discount on notes payable with $420,000.

Working notes: Calculate interest expense for 3 months (from October 1 to December 31) on the notes payable.

$\begin{array}{c}\text{Interest}\text{expense}=\text{Principal}\text{amount}\times \text{Rate}\text{of interest}\times \text{Time}\\ =\$14,000,000\times 12\%\times \frac{3}{12}\\ =\$420,000\end{array}$

Journal entry for B Plastics for the interest payment of note.

Date		Accounts and Explanation		Post Ref	Debit ($)	Credit ($)
2017		Interest Expense			140,000
January	31
			Discount on Notes Payable			140,000
			(To record the interest expense for 1 month)

Table (9)

Interest expense is an expense and it decreases the value of stockholders’ equity. Thus, debit interest expense account by $140,000. Discount on notes payable is a contra liability and is increased to interest expense made for 1 month. Thus, credit discount on notes payable with $140,000.

Journal entry for B Plastics for the payment of note at maturity.

Date		Accounts and Explanation			Post Ref	Debit ($)	Credit ($)
2017		Notes Payable (L–)				14,000,000
January	31
			Cash (A–)				14,000,000
				(To record the payment of notes at maturity)

Table (10)

Notes payable is a liability and decreased due to payment of notes made at maturity. Hence, liability is decreased and so, debit with $14,000,000. Cash is an asset and decreased due to payment made. So, credit cash with $14,000,000.

Working note: Calculate interest expense for 1 month (from December 31 to January 31) on the notes payable.

$\begin{array}{c}\text{Interest}\text{expense}=\text{Principal}\text{amount}\times \text{Rate}\text{of interest}\times \text{Time}\\ =\$14,000,000\times 12\%\times \frac{1}{12}\\ =\$140,000\end{array}$

3. b.

To determine

To calculate: The effective interest rate.

Answer to Problem 13.1P

$\begin{array}{c}\text{Annual effective interest rate = Interest for 4 months}\times \frac{12}{4}\\ =4.1666\%\times \frac{12}{4}\\ =12.5\%\end{array}$

Explanation of Solution

Firstly, determine the amount of discount for 4 months by multiplying principal amount, rate of discount, and time. Secondly, determine the amount of cash proceeds by determining the difference between notes payable and amount of discount for four months. Next, determine interest rate for four months by dividing discounts and cash proceeds. Annual effective interest rate is determined by multiplying interest for four months and 12 months by 4 months.

Working notes

Step 1: Calculate the amount of discount for 4 months (from October 1 to January 31).

$\begin{array}{c}\text{Discount for 4 months}=\text{Principal}\text{amount}\times \text{Rate}\text{of discount}\times \text{Time}\\ =\$14,000,000\times 12\%\times \frac{4}{12}\\ =\$560,000\end{array}$

Step 2: Calculate the amount of cash proceeds.

$\begin{array}{c}\text{Cash proceeds = Notes payable – Discount for 4 months}\\ \text{= \$14,000,000 –}\text{\$560,000}\\ \text{=}\text{\$13,440,000}\end{array}$

Step 3: Calculate interest rate for four months.

$\begin{array}{c}\text{Interest rate for 4 months = }\frac{\text{Discounts}}{\text{Cash}\text{Proceeds}}\times 100\\ =\frac{\$560,000}{\$13,440,000}\times 100\\ =4.1666\%\end{array}$

Conclusion

Thus, annual effective interest rate is 12.5%.