Sand Castle Co. borrowed $40,000 by issuing a four-year non-interest-bearing not

Question

Sand Castle Co. borrowed $40,000 by issuing a four-year non-interest-bearing note to a customer. In addition, Sand Castle agreed to sell inventory to the same customer at reduced prices over the four-year period. Sand Castle’s incremental borrowing rate was 8%, so the present value of the note was $29,400. The customer agreed to purchase an equal amount of inventory each year over the four-year period.

Required:

Prepare journal entries to:

a.

Issue the note

b.

Adjust at the end of the first year

c.

Adjust at the end of the second year

a.

Issue the note

b.

Adjust at the end of the first year

c.

Adjust at the end of the second year

Explanation / Answer

No. Accounts Titles & Explanation Debit ($) Credit ($) a. Issue the note Cash 40,000 Discount on Note [$40,000 - $29,400] 10,600 Notes Payable $40,000 Unearned Revenue [$40,000 - $29,400] 10,600 b. Adjust at the end of the first year Interest Expense [ $29,400 * 8 %] 2,352 Discount on Note 2,352 Unearned Revenue [ $10,600 /4 years] 2,650 Sales Revenue 2,650 c Adjust at the end of the second year Interest Expense [ ($29,400 + $2,352) * 8 %] 2,540.16 Discount on Note 2,540.16 Unearned Revenue [ $10,600 /4 years] 2,650 Sales Revenue 2,650

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