Question

On December 31, 2015, Vaughn Manufacturing is in financial difficulty and cannot pay a note due that day. It is a $2900000 note with $290000 accrued interest payable to Cullumber, Inc. Cullumber agrees to accept from Vaughn equipment that has a fair value of $1440000, an original cost of $2410000, and accumulated depreciation of $1150000. Cullumber also forgives the accrued interest, extends the maturity date to December 31, 2018, reduces the face amount of the note to $1250000, and reduces the interest rate to 6%, with interest payable at the end of each year. Vaughn should record interest expense for 2018 of O $150000 $225000. O $75000. O $0.

Answer 1

Here, the Correct Answer is 75000, i.e Option C.

Such answer need not to be derived simply 1250000 X 6% = 75000. Such method is wrong. As 75000 is choosen becasue it clearly stated the expenses for the period 2018 only and not cumulative period of Interest expenses.

Period	Interest Expenses	PV Factor @ 6%	PV Value
year 1	75000	0.9434	70755
Year 2	75000	0.8900	66750
Year 3	75000	0.8396	62971
Year 3	1250000	0.8396	1049524
Net Value of Liability	1250000

Amortisation Schedule
Period	Value of Laibility	Interest Expenses ( Charged)	Interest Expenses Paid	Outsanding Liability
year 1	1250000	75000	-75000	1250000
Year 2	1250000	75000	-75000	1250000
Year 3- 2018	1250000	75000	-75000	1250000
Year 3- 2018	1250000	0	-125000	0

Here the Highlighted portion shows the libiality to be charged in Income statement. on Year 3 -2018