On 1/1/2014, XYZ signed a 2 year, $6,000 non-interest note and received equipment from ABC Manufacturing. The equipment is estimated to be worth $5,144. Based on XYZ’s credit history, a reasonable market rate of interest on similar loans is estimated to be 9%. Since XYZ has recently obtained similar loans from a local bank, XYZ believes that the market interest rate is considered to be a more reliable estimate. Assume that the equipment will be depreciated over 2 years with no salvage value using the straight-line method. ABC Manufacturing primary business is equipment sales. Therefore, ABC believes that the equipment’s fair value is a more reliable estimate. The cost to manufacture the equipment was $4,400 and ABC carried this equipment as inventory on its books prior to the sale to XYZ. Part 1 - Prepare all required entries for 2014 and 2015. You should create entries for both ABC and XYZ. Assume that both companies amortize discounts using the effective interest rate method. Part 2 - Now assume that both companies amortize discounts using the straight-line interest rate method. Prepare the journal entry for 2014 for ABC and XYZ to record interest.
Part - A | |||
For ABC | |||
Estimate for Amount Borrowed = Fair Value of Equipment = $ 5,144 | |||
Date | Particulars | Debit ($) | Credit ($) |
1/1/2014 | Notes Receivable | 6000 | |
Sales | 5144 | ||
Discount on Notes Receivable | 856 | ||
31/12/2014 | Discount on Notes Receivable | 412 | |
Interest | 412 | ||
(Expn. 1) | |||
31/12/2015 | Discount on Notes Receivable | 444 | |
Interest | 444 | ||
(Expn. 1) | |||
31/12/2015 | Cash | 6000 | |
Notes Receivable | 6000 | ||
Expn. 1 | |||
Effective Interest Rate = 8% (Look up factor of 5,144 / 6,000 = .8573) | |||
Interest(Discount Amortization) for 2014 = 5,144 * 8% = 412 | |||
Interest(Discount Amortization) for 2015 = (5,144 + 412) * 8% = 444 | |||
For XYZ | |||
Estimate for Amount Borrowed = Fair Value based on Market Interest Rate = $ 6,000 * PVF (2,9%) = $ 5,050 | |||
Date | Particulars | Debit ($) | Credit ($) |
1/1/2014 | Equipment | 5050 | |
Discount on Notes Payable | 950 | ||
Notes Payable | 6000 | ||
31/12/2014 | Interest | 455 | |
Discount on Notes Payable | 455 | ||
(Expn. 1) | |||
31/12/2014 | Depreciation (($ 5,050-0)/2) | 2525 | |
Equipment | 2525 | ||
31/12/2015 | Interest | 495 | |
Discount on Notes Payable | 495 | ||
(Expn. 1) | |||
31/12/2015 | Depreciation (($ 5,050-0)/2) | 2525 | |
Equipment | 2525 | ||
31/12/2015 | Notes Payable | 6000 | |
Cash | 6000 | ||
Expn. 1 | |||
Effective Interest Rate = 9% (as provided that fair value of equipment and notes) | |||
Interest(Discount Amortization) for 2014 = 5,050 * 9% = 455 | |||
Interest(Discount Amortization) for 2015 = (5,050 + 455) * 9% = 495 | |||
Part - B | |||
For ABC | |||
Date | Particulars | Debit ($) | Credit ($) |
31/12/2014 | Discount on Notes Receivable | 428 | |
Interest | 428 | ||
For XYZ | |||
31/12/2014 | Interest | 475 | |
Discount on Notes Payable | 475 | ||
Expn. 2 | |||
ABC | |||
Interest = (Total Value - Fair Value)/2 years | |||
Interest = (6000 - 5144)/2 | |||
Interest = $ 428 | |||
XYZ | |||
Interest = (Total Value - Fair Value)/2 years | |||
Interest = (6000 - 5050)/2 | |||
Interest = $ 475 | |||
On 1/1/2014, XYZ signed a 2 year, $6,000 non-interest note and received equipment from ABC Manufacturing....
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