Question

At the beginning of 2021, VHF Industries acquired a machine with a fair value of $9,245,760 by issuing a six-year, noninterest-bearing note in the face amount of $12 million. The note is payable in six annual installments of $2 million at the end of each year. (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. What is the effective rate of interest implicit in the agreement?
2. to 4. Prepare the necessary journal entries.
5. Suppose the market value of the machine was unknown at the time of purchase, but the market rate of interest for notes of similar risk was 7%. Prepare the journal entry to record the purchase of the machine.

Answer 1

Solution 1:

Let effective interest rate implicit in agreement = i

Now at i present value of annual installment = Fair value of machine

Cumulative PV Factor at i for 6 periods = $9,245,760 / $2,000,000 = 4.62288

Refer PV factor table, this factor falls at i =8%

Therefore implicit interest rate in agreement = 8%

Solution 2-4:

Journal Entries - VHF Industries
Date	Particulars	Debit	Credit
1-Jan-21	Equipment Dr	$9,245,760.00
	To Notes Payable		$9,245,760.00
	(To record equipment purchased on issue of note)
31-Dec-21	Interest expense Dr ($9,245,760*8%)	$739,661.00
	Notes Payable Dr	$1,260,339.00
	To Cash		$2,000,000.00
	(To record installment payment)
31-Dec-22	Interest expense Dr [($9,245,760 - $1,260,339)*8%]	$638,834.00
	Notes Payable Dr	$1,361,166.00
	To Cash		$2,000,000.00
	(To record installment payment)

Solution 5:

Fair value of machine = $2,000,000 * Cumulative PV Factor at 7% for 6 periods

= $2,000,000 * 4.76654 = $9,533,080

Journal Entries - VHF Industries
Date	Particulars	Debit	Credit
1-Jan-21	Equipment Dr	$9,533,080.00
	To Notes Payable		$9,533,080.00
	(To record equipment purchased on issue of note)