Chapter 9, Problem 6P

Non-Interest-Bearing Note Payable: Present Value On January 1, 2019, Northern Manufacturing Company bought a piece of equipment by signing a non-interest-bearing $80,000, 1-year note. The face value of the note includes the price of the equipment and the interest. The effective interest rate is an annual rate of 16%, and the note is to be paid in four $20,000 quarterly installments on March 31, June 30, September 30, and December 31. The price of the equipment is the present value of the four payments discounted at the effective interest rate.

Required:

Prepare all journal entries to record the preceding information. Present value techniques should be used.

If Northern’s financial statements were issued on June 30, 2019, what amount would the company report as notes payable?

To determine

Prepare the journal entries to record by using the present value techniques.

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 on note:

Date	Account titles and explanation	Debit ($)	Credit($)
January 1, 2019	Machinery (1)	$72,597.90
	Discount on notes payable (2)	$7,402.10
	Notes Payable		$80,000.00
	(To record the purchase of machinery on note)

Table (1)

Working note (1):

Determine the present value of machinery or net obligation as on January 1, 2019.

$\begin{array}{c}\left(\begin{array}{l}\text{Present value of }\\ \text{machinery or Net obligation}\end{array}\right)\text{ = }\left\{\begin{array}{l}\text{Amount to be paid in four equal installment }\times \\ \text{Present value of an ordinary }\\ \text{annuity of \$1 at 4\% for 4 time periods}\end{array}\right\}\\ \text{=\$20,000×3}\text{.629895}\\ \text{=\$72,597}\text{.90}\end{array}$

Working note (2):

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

$\begin{array}{c}\begin{array}{l}\text{Total amount of interest expense}\\ \text{ or discount on notes payable }\end{array}\}=\text{Maturity value of note }-\text{Present value}\\ \text{=\$80,000}-\$72,597.90\\ =\$7,402.10\end{array}$

• Machinery is an asset account and it is increased. Thus, debit machinery account with $72,597.90.
• Discount on notes payable is a contra-liability account and it decreases the value of liability. Thus, debit discount on notes payable with $7,402.10.
• Notes payable is a liability account and it is increased. Thus, credit notes payable with $80,000.00

Prepare the journal entry to record the first instalment:

Date	Account titles and explanation	Debit ($)	Credit($)
March 31, 2019	Interest expense (3)	$2,903.92
	Notes payable	$20,000.00
	Discount on notes payable		$2,903.92
	Cash		$20,000.00
	(To record the payment of first instalment)

Table (2)

Working note (3):

Date	Payment of instalment	4% Interest expenses	Reduction of obligation	Net obligation
January 1, 2019				$72,597.90
March 31, 2019	$20,000.00	$2,903.92	$17,096.08	$55,501.82
June 30, 2019	$20,000.00	$2,220.07	$17,779.93	$37,721.89
September 30, 2019	$20,000.00	$1,508.88	$18,491.12	$19,230.77
December 31, 2019	$20,000.00	$769.23	$19,230.77
	$80,000.00	$7,402.10	$72,597.90

Table (3)

• Interest expense is an expense account and it decreases the stockholders’ equity. Therefore, debit interest expense with $2,903.92.
• Notes payable is a liability account and it is decreased. Therefore, debit notes payable with $20,000.00.
• Discount on notes payable is a contra-liability and it is decreased. Therefore, discount on notes payable with $2,903.92.
• Cash is an asset account and it is decreased. Therefore, credit cash with $20,000.00.

Prepare the journal entry to record the second instalment.

Date	Account titles and explanation	Debit ($)	Credit($)
June 30, 2019	Interest expense (3)	$2,220.07
	Notes payable	$20,000.00
	Discount on notes payable		$2,220.07
	Cash		$20,000.00
	(To record the payment of second instalment)

Table (3)

• Interest expense is an expense account and it decreases the stockholders’ equity. Therefore, debit interest expense with $2,220.7.
• Notes payable is a liability account and it is decreased. Therefore, debit notes payable with $20,000.00.
• Discount on notes payable is a contra-liability and it is decreased. Therefore, discount on notes payable with $2,220.7.
• Cash is an asset account and it is decreased. Therefore, credit cash with $20,000.00.

Prepare the journal entry to record the third instalment.

Date	Account titles and explanation	Debit ($)	Credit($)
September 30, 2019	Interest expense (3)	$1,508.88
	Notes payable	$20,000.00
	Discount on notes payable		$1,508.88
	Cash		$20,000.00
	(To record the payment of third instalment)

Table (4)

• Interest expense is an expense account and it decreases the stockholders’ equity. Therefore, debit interest expense with $1,508.88.
• Notes payable is a liability account and it is decreased. Therefore, debit notes payable with $20,000.00.
• Discount on notes payable is a contra-liability and it is decreased. Therefore, discount on notes payable with $1,508.88.
• Cash is an asset account and it is decreased. Therefore, credit cash with $20,000.00.

To determine

Determine the amount that would be reported as notes payable on the financial statement.

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 amount that would be reported as notes payable on the financial statement is as follows:

Company N
Balance sheet (Partial)
As at June 30, 2019
Liabilities	Amount	Amount
Current liabilities
Notes payable	$40,000.00
Less:  Discount on notes payable	$2,278.11	$37,721.89

Table (5)