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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’s 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

When is the stated interest rate of a debt instrument presumed to be fair?

What are the two methods of amortizing discount and premium on bonds payable? Explain each.

All of the following are differences between IFRS and GAAP in accounting for liabilities except:

a) When a bond is issued at a discount, GAAP records the discount in a separate contra liability account. IFRS records the bond net of the discount.

b) Under IFRS, bond issuance costs reduce the carrying value of the debt. Under GAAP, these costs are recorded as an asset and amortized to expense over the terms of the bond.

c) GAAP, but not IFRS, uses the term “troubled-debt restructurings.”

d) GAAP, but not IFRS, uses the term “provisions” for contingent liabilities which are accrued.

(Issuance and Redemption of Bonds) Venezuela Co. is building a new hockey arena at a cost of \(2,500,000. It received a downpayment of \)500,000 from local businesses to support the project, and now needs to borrow \(2,000,000 to complete the project. It therefore decides to issue \)2,000,000 of 10.5%, 10-year bonds. These bonds were issued on January 1, 2016, and pay interest annually on each January 1. The bonds yield 10%.

Instructions

(a) Prepare the journal entry to record the issuance of the bonds on January 1, 2016.

(b) Prepare a bond amortization schedule up to and including January 1, 2020, using the effective-interest method.

(c) Assume that on July 1, 2019, Venezuela Co. redeems half of the bonds at a cost of $1,065,000 plus accrued interest. Prepare the journal entry to record this redemption.

On March 1, 2017, Sealy Company sold its 5-year, $1,000 face value, 9% bonds dated March 1, 2017, at an effective annual interest rate (yield) of 11%. Interest is payable semiannually, and the first interest payment date is September 1, 2017. Sealy uses the effective-interest method of amortization. The bonds can be called by Sealy at 101 at any time on or after March 1, 2018.

Instructions

a. (1) How would the selling price of the bond be determined?

(2) Specify how all items related to the bonds would be presented in a balance sheet prepared immediately after the bond issue was sold.

b. What items related to the bond issue would be included in Sealy’s 2017 income statement, and how would each be determined?

c. Would the amount of bond discount amortization using the effective-interest method of amortization be lower in the second or third year of the life of the bond issue? Why?

d. Assuming that the bonds were called in and redeemed on March 1, 2018, how should Sealy report the redemption of the bonds on the 2018 income statement?
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