On January 1, 2014, Ellen Greene Company makes the two following acquisitions. T
ID: 2486600 • Letter: O
Question
On January 1, 2014, Ellen Greene Company makes the two following acquisitions.
The company has to pay 10% interest for funds from its bank.
Record the interest at the end of the first year on both notes using the effective-interest method.
1. Purchases land having a fair value of $262,000 by issuing a 5-year, zero-interest-bearing promissory note in the face amount of $421,954. 2. Purchases equipment by issuing a 7%, 9-year promissory note having a maturity value of $274,000. (interest payable annually).Explanation / Answer
No.
Date
Account Titles and Explanation
Debit
Credit
(a) 1.
01/01/2014
Land
$262,000
Discount on notes payable ($421,954 - $262,000)
$159,954
Notes payable
$421,954
2
01/01/2014
Equipment (note 1)
$226,663
Discount on notes payable
$47,337
Notes payable
$274,000
(b) 1.
31/12/2014
Interest expense ($262,000 * 10%)
$26,200
Discount on notes payable
$26,200
2
31/12/2014
Interest expense ($226,663 * 11%)
$24,933
Discount on notes payable
$5,753
Cash ($274,000 * 7%)
$19,180
Note 1:
Amount to be recorded for equipment = Fair value of promissory note = Present value of interest payments + Present value of maturity value
Present value of annuity = Annuity * {1 – (1+r)-n}/r
Annual interest payment = $274,000 * 7% = $19,180
Present value of annuity of interest payments = $19,180 * (1-1.10-9)/010 = $110,457.62
Present value of maturity value = $274,000 / 1.109 = $116,205.10
Fair value of promissory note = $110,457.60 + $116,205.10 = $226,662.72
No.
Date
Account Titles and Explanation
Debit
Credit
(a) 1.
01/01/2014
Land
$262,000
Discount on notes payable ($421,954 - $262,000)
$159,954
Notes payable
$421,954
2
01/01/2014
Equipment (note 1)
$226,663
Discount on notes payable
$47,337
Notes payable
$274,000
(b) 1.
31/12/2014
Interest expense ($262,000 * 10%)
$26,200
Discount on notes payable
$26,200
2
31/12/2014
Interest expense ($226,663 * 11%)
$24,933
Discount on notes payable
$5,753
Cash ($274,000 * 7%)
$19,180
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