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Chapter 7: Question E7-27 (page 370)

(Expected Cash Flows) On December 31, 2017, Conchita Martinez Company signed a \(1,000,000 note to Sauk City Bank. The market interest rate at that time was 12%. The stated interest rate on the note was 10%, payable annually. The note matures in 5 years. Unfortunately, because of lower sales, Conchita Martinez鈥檚 financial situation worsened. On December 31, 2019, Sauk City Bank determined that it was probable that the company would pay back only \)600,000 of the principal at maturity. However, it was considered likely that interest would continue to be paid, based on the $1,000,000 loan.

Instructions

(a) Determine the amount of cash Conchita Martinez received from the loan on December 31, 2017.

(b) Prepare a note amortization schedule for Sauk City Bank up to December 31, 2019.

(c) Determine the loss on impairment that Sauk City Bank should recognize on December 31, 2019.

Short Answer

Expert verified

The business entity incurs an impairment loss of$284,251.

Step by step solution

01

Definition of Carrying Value

Carrying value can be defined as thevalue of the assets or liabilities on which it is reported in the statement of financial position. This information helps users of financial statements determine the true value of assets and liabilities.

02

Amount of Cash Received from Loan

Particular

Amount $

Present value of principal ($1,000,000 @12% for 5 years) (PVF: 0.5674)

$567,400

Present value of interest ($100,000 @12% for 5 years) (PVAF: 3.60)

360,000

Cash received

$927,400

03

Note Amortization Schedule

Date

Cash Received (10%)

Interest expenses (12%)

Increase in Carrying amount

Carrying value

31 Dec 2017

0

0

0

$927,400

31 Dec 2018

$100,000

$111,288

$11,288

$938,688

31 Dec 2019

$100,000

$112,643

$12,643

$951,331

04

Loss Due to Impairment

Particular

Amount $

Carrying value of loan on 31 Dec 2019

$951,331

Less: Present value of $600,000 @12% for 3 years (PVF: 0.7118)

(427,080)

Less: Present value of interest $100,000 @12% for 3 years (PVAF: 2.4)

(240,000)

Impairment loss

$284,251

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Most popular questions from this chapter

On September 30, 2016, Rolen Machinery Co. sold a machine and accepted the customer鈥檚 zero-interest-bearing note. Rolen normally makes sales on a cash basis. Since the machine was unique, its sales price was not determinable using Rolen鈥檚 normal pricing practices.

After receiving the first of two equal annual installments on September 30, 2017, Rolen immediately sold the note with recourse. On October 9, 2018, Rolen received notice that the note was dishonored, and it paid all amounts due. At all times prior to default, the note was reasonably expected to be paid in full.

Instructions

(1) How should Rolen determine the sales price of the machine?

(2) How should Rolen report the effects of the zero-interest-bearing note on its income statement for the year ended December 31, 2016? Why is this accounting presentation appropriate?

Assume that Toni Braxton Company has recently fallen into financial difficulties. By reviewing all available evidence on December 31, 2017, one of Toni Braxton鈥檚 creditors, the National American Bank, determined that Toni Braxton would pay back only 65% of the principal at maturity. As a result, the bank decided that the loan was impaired. If the loss is estimated to be $225,000, what entry(ies) should National American Bank make to record this loss?

What is the theoretical justification of the allowance method as contrasted with the direct write-off method of accounting for bad debts?

(Analysis of Receivables) Presented below is information for Jones Company.

1. Beginning-of-the-year Accounts Receivable balance was \(15,000.

2. Net sales (all on account) for the year were \)100,000. Jones does not offer cash discounts.

3. Collections on accounts receivable during the year were $70,000.

Instructions

(a) Prepare (summary) journal entries to record the items noted above.

(b) Compute Jones鈥檚 accounts receivable turnover and days to collect receivables for the year. The company does not believe it will have any bad debts.

(c) Use the turnover ratio computed in (b) to analyze Jones鈥檚 liquidity. The turnover ratio last year was 6.0

(Transfer of Receivables with Recourse) Beyonc茅 Corporation factors \(175,000 of accounts receivable with Kathleen Battle Financing, Inc. on a with recourse basis. Kathleen Battle Financing will collect the receivables. The receivables records are transferred to Kathleen Battle Financing on August 15, 2017. Kathleen Battle Financing assesses a finance charge of 2% of the amount of accounts receivable and also reserves an amount equal to 4% of accounts receivable to cover probable adjustments.

Instructions

(a) What conditions must be met for a transfer of receivables with recourse to be accounted for as a sale?

(b) Assume the conditions from part (a) are met. Prepare the journal entry on August 15, 2017, for Beyonc茅 to record the sale of receivables, assuming the recourse obligation has a fair value of \)2,000.
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