(Expected Cash Flows) On January 1, 2017, Botosan Company issued a \(1,200,000, 5-year, zero-interest bearing note to National Organization Bank. The note was issued to yield 8% annual interest. Unfortunately, during 2018 Botosan fell into financial trouble due to increased competition. After reviewing all available evidence on December 31, 2018, National Organization Bank decided that the loan was impaired. Botosan will probably pay back only \)800,000 of the principal at maturity.

Instructions

(a) Prepare journal entries for both Botosan Company and National Organization Bank to record the issuance of the note on January 1, 2017. (Round to the nearest $10.)

(b) Assuming that both Botosan Company and National Organization Bank use the effective-interest method to amortize the discount, prepare the amortization schedule for the note.

(c) Under what circumstances can National Organization Bank consider Botosan’s note to be impaired?

(d) Compute the loss National Organization Bank will suffer from Botosan’s financial distress on December 31, 2018. What journal entries should be made to record this loss?

Step by step solution

01

Definition of Maturity Date

The date on which a borrower has to repay the loan amount along with the liable amount of interest to the lender is known as maturity date.

02

Journal Entries for Issuance

Botosan Company:

Date	Accounts and Explanation	Debit $	Credit $
1 Jan 2017	Cash $\left(\$1,200,000\times 0·6805\right)$	$816,600
	Discount on note payable	$383,400
	Note payable		$1,200,000
	(To record the note issued on discount)

National Organization Bank

Date	Accounts and Explanation	Debit $	Credit $
1 Jan 2017	Note receivable	$1,200,000
	Discount on note receivable		$383,400
	Note payable		$816,600
	(To record the note issued on discount)

Note: Present value factor for 5 years @ 8% is 0.6805

03

Amortization Schedule

Date	Cash paid	Interest expenses 8%	Discount Amortized	Carrying amount of note
1 Jan 2017	0			$816,600
31 Dec 2017	0	$65,328	$65,328	$881,928
31 Dec 2018	0	$70,554.24	$70,554.24	$952,482.24
31 Dec 2019	0	$76,198.58	$76,198.58	$1,028,868.08
31 Dec 2020	0	$82,294.46	$82,294.46	$1,110,975.28
31 Dec 2021	0	$88,878.02	$88,878.02	$1,200,000
Total		383,400

04

Circumstances under which note is considered impaired

The note can be impaired in situations where the National bank organization cannot collect all the interest and principal due on the note.

05

Loss and its Journal Entries

Particular	Amount $
Carrying value on 31 Dec 2018	$952,482.24
Less:
Present value of $800,000 for 3 years @ 8%	(635,071.84)
Loss	$317,410.4

National Organization Bank:

Date	Accounts and Explanation	Debit $	Credit $
31 Dec 2018	Bad debt expenses	$317,410.40
	Allowance for doubtful accounts		$317,410.40

Botosan Company will make no journal entry.

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