Answered Essay: E14-17B (L03) (Imputation of Interest) Presented below are two independent situations:

E14-17B (L03) (Imputation of Interest) Presented below are two independent situations:

(a) On January 1, 2017, Excess Inc. purchased undeveloped land that had an assessed value of $261,000 at the time of purchase. A $500,000, zero-interest-bearing note due January 1, 2022, was given in exchange. There was no established exchange price for the land, nor a ready market value for the note. The interest rate charged on a note of this type is 15%. Determine at what amount the land should be recorded at January 1, 2017, and the interest expense to be reported in 2017 related to this transaction.

(b) On January 1, 2017, DonnAll Diamond borrowed $1,000,000 (face value) from Allstar Co., a major customer, through a zero-interest-bearing note due in 3 years. Because the note was zero-interest-bearing, DonnAll agreed to sell dia- monds to this customer at lower than market price. A 12% rate of interest is normally charged on this type of loan. Prepare the journal entry to record this transaction and determine the amount of interest expense to report for 2017.

Expert Answer

 

a) Duration of note is 5 years later. The transaction price of the land equates PV of note today. To calculate the PV, we will use 15% (interest rate on the note) as a discounting rate.
Zero Interest bearing Note $500,000
Present Value factor @15% for 5 years =1/(1.15)^5             0.4972
Present Value of Note = $5000,000*0.4972 $248,588
Interest Expense to be recorded = $248,588.37*15%= $37,288
So, the land value to be recorded is $248,588 and the interest expense to be recorded is $37,288 in January 2017.
b)
Date Accounts Debit$ Credit$
1) Cash $1,000,000
Discount on notes payable($1,000,000*1/(1.12)^3 ) =$1,000,000*0.71178 $711,780.25
To Notes payable @12% $1,000,000
To Unearned Revenues $711,780.25
(Journal entry to record this transaction)
2) Carrying Value of the note on January 1, 2017, $288,219.75
($1,000,000-$711,780.25)
Interest Rate 12%
Interest Expenses to be reported for 2017 $34,586.37
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