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Chapter 14: Q12BE (page 754)

McCormick Corporation issued a 4-year, \(40,000, 5% note to Greenbush Company on January 1, 2017, and received a computer that normally sells for \)31,495. The note requires annual interest payments each December 31. The market rate of interest for a note of similar risk is 12%. Prepare McCormick鈥檚 journal entries for (a) the January 1 issuance and (b) the December 31 interest.

Short Answer

Expert verified

The total for both the debit and credit sides is $43,779.40.

Step by step solution

01

Meaning of Discount on Notes Payable

The difference between the face value and the amount received for notes is a discount if the face value is higher than the received amount. It is amortized over the maturity period of notes payable.

02

Journal Entry

Journal Entries

Date

Accounts and Explanation

Debit

Credit

January 1, 2017

Computer

$31,495

Discount on Notes Payable

$8,505

Notes Payable

$40,000

December 31, 2017

Interest Expenses

$3,779.40

Discount on Notes Payable

$1,779.40

Cash

$2,000.00

Working:

Discount on notes payable on January 1= ($40,000-$31,495) = $8,505

Interest expenses on December 31 = ($31,495 x 12%) = $3,779.40

Interest paid in cash paid on December 31= ($40,000 x 5%) = $2,000.

Discount on notes payable on December 31 ($3,779.40-$2,000) = $1,779.40.

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Most popular questions from this chapter

Question: (Restructure of Note under Different Circumstances) Halvor Corporation is having financial difficulty and therefore has asked Frontenac National Bank to restructure its \(5 million note outstanding. The present note has 3 years remaining and pays a current rate of interest of 10%. The present market rate for a loan of this nature is 12%. The note was issued at its face value.

Instructions

The following are four independent situations. Prepare the journal entry that Halvor and Frontenac National Bank would make for each of these restructurings.

(a) Frontenac National Bank agrees to take an equity interest in Halvor by accepting common stock valued at \)3,700,000 in exchange for relinquishing its claim on this note. The common stock has a par value of \(1,700,000.

(b) Frontenac National Bank agrees to accept land in exchange for relinquishing its claim on this note. The land has a book value of \)3,250,000 and a fair value of \(4,000,000.

(c) Frontenac National Bank agrees to modify the terms of the note, indicating that Halvor does not have to pay any interest on the note over the 3-year period.

(d) Frontenac National Bank agrees to reduce the principal balance due to \)4,166,667 and require interest only in the second and third year at a rate of 10%.

Question: What is the 鈥渃all鈥� feature of a bond issue? How does the call feature affect the amortization of bond premium or discount?

On June 30, 2009, County Company issued 12% bonds with a par value of \(800,000 due in 20 years. They were issued at 98 and were callable at 104 at any date after June 30, 2017. Because of lower interest rates and a significant change in the company鈥檚 credit rating, it was decided to call the entire issue on June 30, 2018, and to issue new bonds. New 10% bonds were sold in the amount of \)1,000,000 at 102; they mature in 20 years. County Company uses straight-line amortization. Interest payment dates are December 31 and June 30.

Instructions

  1. Prepare journal entries to record the redemption of the old issue and the sale of the new issue on June 30, 2018.
  2. Prepare the entry required on December 31, 2018, to record the payment of the first 6 months鈥� interest and the amortization of premium on the bonds.

What is off-balance sheet financing? Why might a company be interested in using off-balance sheet financing?

Describe the two criteria for determining the valuation of financial assets.
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