question archive On April 1, 2020, the KFC Delivery Service issued a P9,000,000 non-interest bearing note due March 31, 2023 for a piece of land with a cash price of P6,949,800
On April 1, 2020, the KFC Delivery Service issued a P9,000,000 non-interest bearing note due March 31, 2023 for a piece of land with a cash price of P6,949,800
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On April 1, 2020, the KFC Delivery Service issued a P9,000,000 non-interest bearing note due March 31, 2023 for a piece of land with a cash price of P6,949,800. REQUIRED: (a) Determine the effective interest rate of this note. (b) Prepare a table of discount amortization over the term of the note. (c) Determine the interest expense for the year ended December 31, 2020 and the carrying amount of the note at December 31, 2020. (d) Prepare the necessary entries for years 2020 through 2023 relative to the foregoing, including any adjustments at year- end, December 31,
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Here are the proper answers:
Letter A:
Answer: 9%
Letter B:
Presented below is the amortization table of discount on notes payable.
| A | B | C | D | E | F |
|---|---|---|---|---|---|
| Date | Interest Expense (9% Previous BV in F) | Discount Amortization (C = B) | Debit Balance of Account "Discount on Notes Payable" | Credit Balance in Account "Notes Payable" | Notes Carrying Amount |
| Debit Interest Expense | Credit Discount on Notes Payable | ||||
| 01-Apr-20 | - | - | 2,050,200 | 9,000,000 | 6,949,800 |
| 31-Mar-21 | 625,482 | 625,482 | 1,424,718 | 9,000,000 | 7,575,282 |
| 31-Mar-22 | 681,775 | 681,775 | 742,943 | 9,000,000 | 8,257,057 |
| 31-Mar-23 | 742,943 | 742,943 | - | 9,000,000 | 9,000,000 |
Letter C:
- Interest expense: ?469,111.50 or ?469,112
- Carrying amount: ?7,418,911.50 or ?7,418,912
Letter D:
Here are the proper journal entries for the whole term of the notes.
| Date | Account Title | Debit | Credit |
|---|---|---|---|
| 01-Apr-20 | Cash | 6,949,800 | |
| Discount on notes payable | 2,050,200 | ||
| Notes payable | 9,000,000 | ||
| To record the issuance of notes | |||
| 31-Dec-20 | Interest expense | 469,112 | |
| Discount on notes payable | 469,112 | ||
| To record partial first amortization of discount | |||
| 31-Mar-21 | Interest expense | 156,371 | |
| Discount on notes payable | 156,371 | ||
| To record the remaining first discount amortization | |||
| 31-Dec-21 | Interest expense | 511,331 | |
| Discount on notes payable | 511,331 | ||
| To record partial second amortization of discount | |||
| 31-Mar-22 | Interest expense | 170,444 | |
| Discount on notes payable | 170,444 | ||
| To record the remaining second discount amortization | |||
| 31-Dec-22 | Interest expense | 557,207 | |
| Discount on notes payable | 557,207 | ||
| To record partial third amortization of discount | |||
| 31-Mar-23 | Interest expense | 185,736 | |
| Discount on notes payable | 185,736 | ||
| To record the remaining third discount amortization | |||
| 31-Mar-23 | Notes payable | 9,000,000 | |
| Cash | 9,000,000 | ||
| To record the repayment of notes |
Step-by-step explanation
Here are the proper computations and explanations for the provided answers:
Letter A:
To solve the effective interest, we're going to use the present value of future amount formula.
Formula:
PV = FV / (1 + i)^n
Where:
- PV = present value or cash price
- FV = future value
- i = effective interest
- n = number of periods
Given:
- PV = present value or the cash price, 6,949,800
- FV = 9,000,000
- i = ?
- n = 3 periods (From April 1, 2020 to March 31, 2023
Solution:
PV = FV / (1 + i)^n
6,949,800 = 9,000,000 / (1 + i)^3
3√? 6,949,800 = 3√? 9,000,000 / (1 + i)^3 (we put both sides in radical, cube root not square root)
6,949,800 = 9,000,000 / (1 + i)^3
190.834739 = 208.008382 / (1 + i)
190.834739 * (1 + i) = 208.008382
190.834739 + 190.834739(i) = 208.008382
190.834739(i) = 208.008382 - 190.834739
190.834739(i) = 17.173643
190.834739(i) / 190.834739 = 17.173643 / 190.834739
i = 0.089992
i = 8.9992% or 9 %
Letter B:
Since the note is "non-interest bearing", the nominal interest here is zero or none. This means, there will be no cash payment involved when amortizing the discount. This only means the computed interest expense is the same as the amortization of the discount.
Letter C:
| Computation of interest expense on December 31, 2020 | |
|---|---|
| Face value of the note | ? 9,000,000.00 |
| Discount on notes payable (9,000,000 - 6,949,800) | (2,050,200.00) |
| Book value of the notes before December 31, 2020 | 6,949,800.00 |
| Times effective interest rate | 9% |
| Annual interest expense | 625,482.00 |
| Times no. of months from Apr 1, 2020 to Dec 31, 2020 over 12 months | 9/12 |
| Interest expense for the year ended December 31, 2020 | ? 469,111.50 |
| Computation of carrying amount of notes payable | |
|---|---|
| Book value of the notes before December 31, 2020 | ? 6,949,800.00 |
| Discount amortization | 469,111.50 |
| Carrying amount of notes payable at December 31, 2020 | ? 7,418,911.50 |
Letter D:
- Even though the date of the note is April 1, there shall be an adjustment on each of the year-end. This adjustment pertains to the partial amortization of the discount. Each year, the partial amortization is 75% of the whole interest expense.
- At the end of the term of the notes, we shall record its repayment. At that time the carrying amount of the notes is the same as its face value.
