Chapter AC, Problem AC.2PA

Recording Equipment Purchase with Two-Year Note

Peabody Corporation purchased equipment and in exchange signed a three-year promissory note. The note requires Peabody to make a single payment of $20,000 in three years. Peabody has other promissory notes that charge interest at the annual rate of 6 percent.

Required:

1. 1. Compute the present value of the note, rounded to the nearest dollar, using Peabody’s typical interest rate of 6 percent.
2. 2. Show the journal entry to record the equipment purchase (round to the nearest dollar).
3. 3. Show the adjusting journal entry at the end of the first year to record interest on the note.
4. 4. Show the adjusting journal entry at the end of the second year to record interest on the note.
5. 5. Show the adjusting journal entry at the end of the third year to record interest on the note (but do not record the payment of $20,000 yet).
6. 6. Show the journal entry at the end of the third year to record the payment of $20,000.

To determine

To Compute: The present value of the note, rounded to the nearest dollar, using a typical interest rate of 6%.

Answer to Problem AC.2PA

The present value of the note, rounded to the nearest dollar, using a typical interest rate of 6%, is $16,792.

Explanation of Solution

Present value is the amount of future value reduced or discounted at a rate of interest till particular current date.

Formula to compute present value of single payment with tables:

$\begin{array}{l}\text{Present}\\ \text{value}\end{array}\}\text{ = }\left\{\begin{array}{l}\text{Single payment × Present value of }\\ \text{\$1 at interest rate for time periods}\end{array}\right\}$

Compute the present value of the note, rounded to the nearest dollar, using a typical interest rate of 6%.

$\begin{array}{c}\begin{array}{l}\text{Present}\\ \text{value}\end{array}\}\text{ = }\left\{\begin{array}{l}\text{Single payment × Present value of }\\ \text{\$1 at interest rate for time periods}\end{array}\right\}\\ =\$20,000\times 0.83962\\ =\$16,792.40\\ =\$16,792\left(\text{rounded}\right)\end{array}$

To determine

To Journalize: An entry to record the purchase of the equipment, rounded to the nearest dollar.

Answer to Problem AC.2PA

The journal entry to record the purchase of equipment is shown below.

Date	Account Title	Debit ($)	Credit ($)
	Equipment	$16,792
	Notes payable		$16,792
	(To record the purchase of equipment)

Table (1)

Explanation of Solution

Journal entry: Journal entry is a set of economic events which can be measured in monetary terms. These are recorded chronologically and systematically.

Debit and credit rules:

• Debit an increase in asset account, increase in expense account, decrease in liability account, and decrease in stockholders’ equity accounts.
• Credit decrease in asset account, increase in revenue account, increase in liability account, and increase in stockholders’ equity accounts.

To determine

To Journalize: An adjusting entry to record the interest on the note at the end of the first year.

Answer to Problem AC.2PA

The adjusting entry to record the interest on the note at the end of the first year is shown below.

Date	Account Title	Debit ($)	Credit ($)
	Interest Expense	$1,008
	Notes payable		$1,008
	(To record the interest on notes payable)

Table (2)

Explanation of Solution

Journal entry: Journal entry is a set of economic events which can be measured in monetary terms. These are recorded chronologically and systematically.

Debit and credit rules:

• Debit an increase in asset account, increase in expense account, decrease in liability account, and decrease in stockholders’ equity accounts.
• Credit decrease in asset account, increase in revenue account, increase in liability account, and increase in stockholders’ equity accounts.

Working Notes:

Calculate the interest on the notes payable:

$\begin{array}{c}\text{Interest = Principal × Rate of Interest ×Time Period}\\ =\$16,792\times 6\%\times 1\\ =\$16,792\times \frac{6}{100}\\ =\$1,008\end{array}$

To determine

To Journalize: An adjusting entry to record the interest on the note at the end of the second year.

Answer to Problem AC.2PA

The adjusting entry to record the interest on the note at the end of the second year is shown below.

Date	Account Title	Debit ($)	Credit ($)
	Interest Expense	$1,068
	Notes payable		$1,068
	(To record the interest on notes payable)

Table (3)

Explanation of Solution

Journal entry: Journal entry is a set of economic events which can be measured in monetary terms. These are recorded chronologically and systematically.

Debit and credit rules:

• Debit an increase in asset account, increase in expense account, decrease in liability account, and decrease in stockholders’ equity accounts.
• Credit decrease in asset account, increase in revenue account, increase in liability account, and increase in stockholders’ equity accounts.

Working Notes:

Calculate the interest on the notes payable:

$\begin{array}{c}\text{Interest = Principal × Rate of Interest ×Time Period}\\ =\left(\$16,792+\$1,008\right)\times 6\%\times 1\\ =\$17,800\times \frac{6}{100}\\ =\$1,068\end{array}$

To determine

To Journalize: An adjusting entry to record the interest on the note at the end of the third year.

Answer to Problem AC.2PA

The adjusting entry to record the interest on the note at the end of the third year is shown below.

Date	Account Title	Debit ($)	Credit ($)
	Interest Expense	$1,132
	Notes payable		$1,132
	(To record the interest on notes payable)

Table (4)

Explanation of Solution

Journal entry: Journal entry is a set of economic events which can be measured in monetary terms. These are recorded chronologically and systematically.

Debit and credit rules:

• Debit an increase in asset account, increase in expense account, decrease in liability account, and decrease in stockholders’ equity accounts.
• Credit decrease in asset account, increase in revenue account, increase in liability account, and increase in stockholders’ equity accounts.

Working Notes:

Calculate the interest on the notes payable:

$\begin{array}{c}\text{Interest = Principal × Rate of Interest ×Time Period}\\ =\left(\$16,792+\$1,008+\$1,068\right)\times 6\%\times 1\\ =\$18,868\times \frac{6}{100}\\ =\$1,132.08\\ =\$1,132\left(\text{rounded}\right)\end{array}$

To determine

To Journalize: An entry to record the payment for the equipment, rounded to the nearest dollar.

Answer to Problem AC.2PA

The journal entry to record the payment for equipment is shown below.

Date	Account Title	Debit ($)	Credit ($)
	Notes payable	$20,000
	Cash		$20,000
	(To record the payment on notes payable)

Table (5)

Explanation of Solution

Journal entry: Journal entry is a set of economic events which can be measured in monetary terms. These are recorded chronologically and systematically.

Debit and credit rules:

• Debit an increase in asset account, increase in expense account, decrease in liability account, and decrease in stockholders’ equity accounts.
• Credit decrease in asset account, increase in revenue account, increase in liability account, and increase in stockholders’ equity accounts.