Question

Amber Mining and Milling, Inc., contracted with Truax Corporation to have constructed a custom-made lathe. The machine was completed and ready for use on January 1, 2021. Amber paid for the lathe by issuing a $800,000, three-year note that specified 5% interest, payable annually on December 31 of each year. The cash market price of the lathe was unknown. It was determined by comparison with similar transactions that 10% was a reasonable rate of interest. (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:
1-a. Complete the table below to determine the price of the equipment.
1-b. Prepare the journal entry on January 1, 2021, for Amber Mining and Milling’s purchase of the lathe.
2. Prepare an amortization schedule for the three-year term of the note.
3. Prepare the journal entries to record (a) interest for each of the three years and (b) payment of the note at maturity.

Answer 1

1-a.	Table values are based on
	n=3
	i=10%
	Cash flow	Amount	PV factor	Present value
	Interest	40000	2.48685	99474
		(800000*5%)	(For 3 years)
	Principal	800000	0.75132	601056
			(For 3rd year)
	Price of equipment			700530
1-b.	Date	General journal				Debit	Credit
	Jan 1,2021	Equipment				700530
		Discount on issue of notes		(800000-700530)		99470
		Note payable					800000
		(Equipment purchased by issue of notes)
2	Amortization schedule:
	Year	Cash payment	Effective interest	Increase in balance	Outstanding balance
					700530
	1	40000	70053	30053	730583
	2	40000	73058	33058	763641
	3	40000	76359	36359	800000
	Total	120000	219470	99470
	Effective interest=Beginning outstanding balance*10%
	Increase in balance=Effective interest-Cash payment
	Ending outstanding balance=Beginning outstanding balance+Increase in balance
3
a.	Date	General journal				Debit	Credit
	Dec 31,2021	Interest expense				70053
		Discount on issue of notes					30053
		Cash					40000
		(Interest paid)
	Dec 31,2022	Interest expense				73058
		Discount on issue of notes					33058
		Cash					40000
		(Interest paid)
	Dec 31,2023	Interest expense				76359
		Discount on issue of notes					36359
		Cash					40000
		(Interest paid)
b.	Date	General journal				Debit	Credit
	Dec 31,2023	Note payable				800000
		Cash					800000
		(Repayment of notes at maturity)