Question

On June 1, 2017, ABC INC approached XYZ Inc about buying a parcel of undeveloped land. XYZ Inc was asking $240,000 for the land and ABC INC saw that there was some flexibility in the asking price. ABC INC did not have enough money to make a cash offer to XYZ Inc and proposed to give, in return for the land, a $300,000, five-year promissory note that bears interest at the rate of 4%. The interest is to be paid annually to XYZ Inc on June 1 of each of the next five years. XYZ Inc insisted that the note taken in return become a mortgage note. XYZ Inc accepted the amended offer, and ABC INC  signed a mortgage note for $300,000 due June 1, 2022. ABC INC would have had to pay 10% at its local bank if it were to borrow the cash for the land purchase. XYZ Inc, on the other hand, could borrow the funds at 9%. Both ABC INC and XYZ Inc have December 31st year ends.

Required:

1) What is the difference between a promissory note payable and a mortgage note payable? Why would XYZ Inc insist on obtaining a mortgage note payable from ABC INC ?

2) Calculate the purchase price of the land.

3) Prepare the journal entry for the purchase of the land.

4) Prepare any adjusting journal entry that is required at the end of the fiscal year and the first payment made on June 1, 2018, assuming no reversing entries are used.

5) Assume that XYZ Inc had insisted on obtaining an installment note from ABC INC instead of a mortgage note. Then do the following: a. Calculate the amount of the installment payments that would be required for a five-year installment note. Use the same cost of the land to ABC INC Corporation that you deter- mined for the mortgage note in part (a).

2. Prepare the journal entry for the purchase of the land and the issuance of the installment note.
3. Prepare any adjusting journal entry that is required at the end of the fiscal year and the first payment made on June 1, 2018, assuming no reversing entries are used.
4. Compare the balances of the two different notes payable and related accounts at December 31, 2017. Be specific about the classifications on the statement of financial position.

Answer 1

Ans.1. A promissory note is basically an IOU—a signed agreement to repay money—from a borrower to a lender. The promissory note has language saying that the borrower promises to repay the loaned money and includes the terms for repayment. For example, a typical promissory note will specify:

(i) the total amount of the loan

(ii) the interest rate

(iii) the amount that the borrower must pay to the lender each period

(iv) the late charge if the borrower doesn’t make payments on time

(v) how long the borrower gets to repay the loan.

A mortgage also sets out your responsibilities for taking care of the property. A mortgage usually requires you to:

(i) keep the home in good shape

(ii) refrain from storing hazardous substances on the property

(iii) have homeowners’ insurance for the property

(iv) pay the property taxes.

Ans.2. Purchase Price of Land = [(12,000/1.09)+(12,000/1.09*1.09)+(12,000/1.09*1.09*1.09)+(12,000/1.09*1.09*1.09*1.09)+(312,000/1.09*1.09*1.09*1.09*1.09)] = $241,655.20

Ans.3.

Journal

Dt	Particulars	Amt	Amt
01-Jul-17	ABC Inc To Land	241,655.20	241655.20

Ans.4.

Journal

Dt	Particulars	Amt	Amt
01-Jul-17	Mortgage Note To ABC Inc To Differed Income	241,655.20	241655.20 58,344.80
30-Jun-18	Differed Income To Interest Income	11,668.96	11,668.96

Ans.5. Amount of Installment Payable = Cost of Land / PVIAf(9%,5) = $241,655.20 / 3.89 = $62,122.17