Question

At the beginning of 2021, VHF Industries acquired a machine with a fair value of $6,760,200 by issuing a two-year, noninterest-bearing note in the face amount of $8 million. The note is payable in two annual installments of $4 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 11%. Prepare the journal entry to record the purchase of the machine. Complete this question by entering your answers in the tabs below. Required 2 to Required 1 4 Required 5 What is the effective rate of interest implicit in the agreement? Interest rate < Required 1 Required 2 to 4 >

Answer 1

1.

Present value = $6,760,200

Annual payment = $4,000,000

Therefore,

PVA = Present value/Annual payment = $6,760,200/$4,000,000 = 1.69005

There are only two payments to be made. So the number of periods is 2.

In the PVA table, by searching for 1.69005 in the second row, it can be determined that the discount rate is 12%.

Thus, interest rate is 12%.

2 to 4.

The following journal entries are required to be prepared:

Date	Account Titles and Explanation	Debit	Credit
Jan. 1, 2021	Equipment	6,760,200
	Instalment Note Payable		6,760,200
Dec. 31, 2021	Interest Expense (6,760,200 x 12%)	811,224
	Instalment Note Payable (4,000,000 - 811,224)	3,188,776
	Cash		4,000,000
Dec. 31, 2022	Interest expense                                         [(6,760,200 - 3,188,776) x 12%]	428,571
	Instalment Note Payable	3,571,429
	Cash		4,000,000

  

5.

Interest rate = 11%

Number of periods = 2

Therefore,

Present value of annual payments = $4,000,000 x PVA (11%, 2) = $4,000,000 x 1.71252 = $6,850,080

The following journal entry will be prepared in this case:

Date	Account Titles and Explanation	Debit	Credit
Jan. 1, 2021	Equipment	6,850,080
	Instalment Note Payable		6,850,080