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Intermediate Accounting: Reporting...

3rd Edition
James M. Wahlen + 2 others
ISBN: 9781337788281

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Intermediate Accounting: Reporting...

3rd Edition
James M. Wahlen + 2 others
ISBN: 9781337788281
Textbook Problem
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Non-Interest-Bearing Note Payable: Present Value On January 1, 2019, Northern Manufacturing Company bought a piece of equipment by signing a non-interest-bearing $80,000, 1-year note. The face value of the note includes the price of the equipment and the interest. The effective interest rate is an annual rate of 16%, and the note is to be paid in four $20,000 quarterly installments on March 31, June 30, September 30, and December 31. The price of the equipment is the present value of the four payments discounted at the effective interest rate.

Required:

Prepare all journal entries to record the preceding information. Present value techniques should be used.

If Northern’s financial statements were issued on June 30, 2019, what amount would the company report as notes payable?

1.

To determine

Prepare the journal entries to record by using the present value techniques.

Explanation

Note payable: Note payable denotes a long-term liability that describes the amount borrowed, signed and issued note. The note carries all the details of payable amounts, interest amounts, and maturity dates.

Prepare the journal entry to record the purchase of machinery on note:

DateAccount titles and explanationDebit ($)Credit($)
January 1, 2019Machinery (1)$72,597.90 
 Discount on notes payable (2)$7,402.10 
        Notes Payable $80,000.00
 (To record the purchase of machinery on note)  

Table (1)

Working note (1):

Determine the present value of machinery or net obligation as on January 1, 2019.

(Present value of machinery or Net obligation) = {Amount to be paid in four equal installment ×Present value of an ordinary annuity of $1 at 4% for 4 time periods}=$20,000×3.629895=$72,597.90

Working note (2):

Determine the total amount of interest expenses or discount on notes payable.

Total amount of interest expense or discount on notes payable }=Maturity value of note Present value=$80,000$72,597.90=$7,402.10

  • Machinery is an asset account and it is increased. Thus, debit machinery account with $72,597.90.
  • Discount on notes payable is a contra-liability account and it decreases the value of liability. Thus, debit discount on notes payable with $7,402.10.
  • Notes payable is a liability account and it is increased. Thus, credit notes payable with $80,000.00

Prepare the journal entry to record the first instalment:

DateAccount titles and explanationDebit ($)Credit($)
March 31, 2019Interest expense (3)$2,903.92 
 Notes payable$20,000.00 
        Discount on notes payable $2,903.92
        Cash $20,000.00
 (To record the payment of first instalment)  

Table (2)

Working note (3):

DatePayment of instalment4% Interest expensesReduction of obligationNet obligation
January 1, 2019   $72,597

2.

To determine

Determine the amount that would be reported as notes payable on the financial statement.

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