Question

On January 1, 2017, Blue Company makes the two following acquisitions.

1.		Purchases land having a fair value of $320,000 by issuing a 4-year, zero-interest-bearing promissory note in the face amount of $485,782.
2.		Purchases equipment by issuing a 6%, 9-year promissory note having a maturity value of $360,000 (interest payable annually on January 1).

The company has to pay 11% interest for funds from its bank.

(a)		Record the two journal entries that should be recorded by Blue Company for the two purchases on January 1, 2017.
(b)		Record the interest at the end of the first year on both notes using the effective-interest method.

Answer 1

(a) Following are the journal entries required to be recorded as on January 1, 2017 :

1. Land..................................................... Dr. $320000
   Discount on Notes Payable................. Dr. $165782 [$485782 - $320000] (Bal. figure)
   To Notes Payable........................................... $485782
   (Being land purchased by issue of promissory note)
   
2. Equipment........................................... Dr. $260323 [Note-1]
   Discount on Notes Payable................. Dr. $99677 [$360000 - $260323] (Bal. figure)
   To Notes Payable........................................... $360000
   (Being equipment purchased by issue of promissory note)
   • Note-1 :
     For the purpose of valuing the equipment, we need to calculate the Present Value of the cash flow of the promissory note, which is shown as below -

     Year	Cash Flow	PVF @11%	Amount
     1 to 9	$21600 ($360000*6%)	5.5370	$119599
     9	$360000	0.3909	$140724
     		Total	$260323

     
     Therefore, Value of equipment will be $260323.

(b) Following are the journal entries required to be recorded at the end of first year :

1. Interest Expense.............................. Dr. $35200
   To Discount on Notes Payable.................. $35200
   (Being interest expense recorded)
   [$320000 * 11%]
   
2. Interest Expense.............................. Dr. $28636 [$260323 * 11%]
   To Notes Payable..................................... $21600 [$360000 * 6%]
   To Cash.................................................... $7036 (Bal. figure)
   (Being interest expenses recorded)