Problem 14-12 Noninterest-bearing installment note [LO14-3,] At the beginning of
ID: 2521916 • Letter: P
Question
Problem 14-12 Noninterest-bearing installment note [LO14-3,] At the beginning of 2018, VHF Industries acquired a equipment with a fair value of $8,450,250 by issuing a two-year, noninterest bearing note in the face amount of $10 million. The note is payable in two annual installments of $5 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 entry 5. Suppose the market value of the equipment 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 equipment.Explanation / Answer
Solution 1:
Face value of bond = $10,000,000
Maturity period = 2 years
Fair value of equipment = $8,450,250
Thererfore effective rate of interest implicit in the agreement, is the rate at which present value of $10,000,000 is equal to fair value of equipment in 2 years.
Let effective rate is i.
Now
$5,000,000 * Cumulative PV factor at i rate for 2 period = $8,450,250
Cumulative PV factor at i rate for 2 period = 1.69005
This PV factor is fallling at i rate of 12%
Therefore effective rate of interest implicit in the agreement is 12%.
Solution 2 to 4:
Solution 5:
Market rate of interest = 11%
Market value of equipment = Present value of payment discounted at 11%
= $5,000,000 * PV Factor for 1st year at 11% + $5,000,000 * PV Factor for 2nd year at 11%
=$5,000,000 * 0.900901 + $5,000,000*0.811622 = $8,562,617
Journal Entries - VHF Industries Date Particulars Debit Credit 1-Jan-18 Equipment Dr $8,450,250.00 Discount on notes Payable Dr $1,549,750.00 To Notes Payable $10,000,000.00 (To record purchase of equipment and issue of note) 31-Dec-18 Interest Expense Dr ($8,450,250 * 12%) $1,014,030.00 Notes Payable Dr $5,000,000.00 To Cash $5,000,000.00 To discount on note payable $1,014,030.00 (To record interest expense and installment payment 31-Dec-19 Interest Expense Dr [($8,450,250 + $1,014,030 - $5,000,000)*12%] $535,720.00 Notes Payable Dr $5,000,000.00 To Cash $5,000,000.00 To discount on note payable $535,720.00 (To record interest expense and installment payment