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E14-17B (L03) (Imputation of Interest) Presented below are two independent situations: (a) On January 1, 2017, Excess...

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Accounting

E14-17B (L03) (Imputation of Interest) Presented below are twoindependent situations:

(a) On January 1, 2017, Excess Inc. purchased undeveloped landthat had an assessed value of $261,000 at the time of purchase. A$500,000, zero-interest-bearing note due January 1, 2022, was givenin exchange. There was no established exchange price for the land,nor a ready market value for the note. The interest rate charged ona note of this type is 15%. Determine at what amount the landshould be recorded at January 1, 2017, and the interest expense tobe reported in 2017 related to this transaction.

(b) On January 1, 2017, DonnAll Diamond borrowed $1,000,000(face value) from Allstar Co., a major customer, through azero-interest-bearing note due in 3 years. Because the note waszero-interest-bearing, DonnAll agreed to sell diamonds to thiscustomer at lower than market price. A 12% rate of interest isnormally charged on this type of loan. Prepare the journal entry torecord this transaction and determine the amount of interestexpense to report for 2017.

Answer & Explanation Solved by verified expert
3.7 Ratings (624 Votes)

(a) Land should be recorded at carrying value of note
Note due on Jan 1,2022
Note issued on Jan 1,2017
Life of the note=5 years
Discount factor=15%
Carrying value of note=Face value*Discount factor at 15% for 5th year=500000*0.49718=$ 248590
Land should be recorded at $ 248590
Interest expense=Carrying value of note*15%=248590*15%=37288.5=$ 37289
(b) Life of the note=3 years
Discount factor=12%
Carrying value of note=Face value*Discount factor at 12% for 3rd year=1000000*0.71178=$ 711780
Discount on notes payable=Face value-Carrying value=1000000-711780=$ 288220
Journal entry:
Account titles and explanation Debit Credit
Cash 1000000
Discount on notes payable 288220
Notes payable 1000000
Unearned sales revenue 288220
(Diamond borrowed for note)
Interest expense=Carrying value of note*12%=711780*12%=85413.6=$ 85414
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