Chapter 9, Problem 4E

Discounting of Notes Payable On October 30, 2019, Sanchez Company acquired a piece of machinery and signed a 12-month note for $24,000. The lace value of the note includes the price of the machinery and interest. The note is to be paid in four $6,000 quarterly installments. The value of the machinery is the present value of the four quarterly payments discounted at an annual interest rate of 16%.

Required:

1. Prepare all the journal entries required to record the preceding information including the year-end adjusting entry and any payments. Present value techniques should be used.

2. Show how the preceding items would be reported on the December 31, 2019, balance sheet.

To determine

Prepare the journal entries and adjusting entry in the books of Company S.

Explanation of Solution

Note payable: Note payable denotes a long-term liability that describes the amount borrowed, signed and issued note. The note carries all the details of payable amounts, interest amounts, and maturity dates.

Prepare the journal entry to record the purchase of machinery:

Date	Account titles and explanation	Debit ($)	Credit($)
October 30, 2019	Machinery (1)	$21,779.37
	Discount on notes payable (2)	$2,220.63
	Notes Payable		$24,000.00
	(To record the purchase of machinery on note)

Table (1)

Working note (1):

Determine the present value of machinery or net obligation as on October 30, 2019.

$\begin{array}{c}\left(\begin{array}{l}\text{Present value of }\\ \text{machinery or Net obligation}\end{array}\right)\text{ = }\left\{\begin{array}{l}\text{Amount to be paid in four equal installment }\times \\ \text{Present value of an ordinary }\\ \text{annuity of \$1 at 4\% for 4 time periods}\end{array}\right\}\\ \text{=\$6,000×3}\text{.629895}\\ \text{=\$21,779}\text{.37}\end{array}$

Working note (2):

Determine the total amount of interest expenses or discount on notes payable.

$\begin{array}{c}\begin{array}{l}\text{Total amount of interest expense}\\ \text{ or discount on notes payable }\end{array}\}=\text{Maturity value of note }-\text{Present value}\\ \text{=\$24,000}-\$21,779.37\\ =\$2,220.63\end{array}$

Prepare the adjusting entry to record the interest expense:

Date	Account titles and explanation	Debit ($)	Credit($)
December 31, 2019	Interest expense (4)	$580.78
	Discount on notes payable		$580.78
	(To record accrued expense)

Table (2)

Working note (3):

Prepare the schedule of interest expense and obligation reduction:

Date	Payment of instalment	4% Interest expenses	Reduction of obligation	Net obligation
October 30, 2019				$21,779.37
January 31, 2020	$6,000.00	$871.17	$5,128.83	$16,650.54
April 30, 2020	$6,000.00	$666.02	$5,333.98	$11,316.56
July 31, 2020	$6,000.00	$452.66	$5,547.34	$5,769.22
October 30, 2020	$6,000.00	$230.78	$5,769.22	$0.00
	$24,000.00	$2,220.63	$21,779.37

Table (3)

Working note (4):

Determine the accrued expenses for the month of November and December.

$\begin{array}{c}\text{Accrued expenses = }\left[\begin{array}{l}\text{4\% interest expenses payable at first quarter }\times \\ \frac{2\text{ month accrued in first quarter}}{\text{Number of months in a quarter}}\end{array}\right]\\ =\$871.17\times \frac{2}{3}\\ =\$580.78\end{array}$

Note: Refer the schedule of interest expenses and obligation reduction for 4% interest expenses payable at first quarter.

Prepare the journal to record the payment of first instalment.

Date	Account titles and explanation	Debit ($)	Credit($)
January 31, 2020	Interest expense (5)	$290.39
	Notes payable	$6,000.00
	Discount on notes payable		$290.39
	Cash		$6,000.00
	(To record the payment of first instalment)

Table (4)

Working note (5):

Determine the accrued expenses for the month of January.

$\begin{array}{c}\text{Accrued expenses = }\left[\begin{array}{l}\text{4\% interest expenses payable at first quarter }\times \\ \frac{\text{January month}}{\text{Number of months in a quarter}}\end{array}\right]\\ =\$871.17\times \frac{1\text{month}}{3\text{month}}\\ =\$290.39\end{array}$

Prepare the journal to record the payment of second instalment.

Date	Account titles and explanation	Debit ($)	Credit($)
April 30, 2020	Interest expense (Refer Table (3))	$666.02
	Notes payable	$6,000.00
	Discount on notes payable		$666.02
	Cash		$6,000.00
	(To record the payment of second instalment)

Table (5)

Prepare the journal to record the payment of third instalment.

Date	Account titles and explanation	Debit ($)	Credit($)
July 31, 2020	Interest expense (Refer Table (3))	$452.66
	Notes payable	$6,000.00
	Discount on notes payable		$452.66
	Cash		$6,000.00
	(To record the payment of third instalment)

Table (6)

Prepare the journal to record the payment of fourth instalment.

Date	Account titles and explanation	Debit ($)	Credit($)
August 30, 2020	Interest expense (Refer Table (3))	$230.78
	Notes payable	$6,000.00
	Discount on notes payable		$230.78
	Cash		$6,000.00
	(To record the payment of fourth instalment)

Table (7)

To determine

Show the manner in which the preceding items would be reported on the balance sheet as at December 31, 2019.

Explanation of Solution

Balance sheet: This financial statement reports a company’s resources (assets) and claims of creditors (liabilities) and stockholders (stockholders’ equity) over those resources. The resources of the company are assets which include money contributed by stockholders and creditors. Hence, the main elements of the balance sheet are assets, liabilities, and stockholders’ equity.

The manner in which the preceding items would be reported on the balance sheet is as follows:

Company S
Balance sheet (Partial)
As at December 31, 2019
Assets	Amount ($)	Amount ($)
Property, Plant, and Equipment
Machinery		21,779.37
Liabilities	Amount ($)	Amount ($)
Current liabilities:
Notes payable	24,000.00
Less:  Discount on notes payable	1,639.85	22,360.15

Table (8)