Question

(Purchase of Equipment with Zero-Interest-Bearing Debt) Chippewas Inc. has decided to purchase equipment from Central Michigan Industries on January 2, 2017, to expand its production capacity to meet customers’ demand for its product. Chippewas issues an \(800,000, 5-year, zero-interest-bearing note to Central Michigan for the new equipment when the prevailing market rate of interest for obligations of this nature is 12%. The company will pay off the note in five \)160,000 installments due at the end of each year over the life of the note.

Instructions (Round to nearest dollar in all computations.)

1. Prepare the journal entry(ies) at the date of purchase.
2. Prepare the journal entry(ies) at the end of the first year to record the payment and interest, assuming that the company employs the effective-interest method.
3. Prepare the journal entry(ies) at the end of the second year to record the payment and interest.
4. Assuming that the equipment had a 10-year life and no salvage value, prepare the journal entry necessary to record depreciation in the first year. (Straight-line depreciation is employed.)

Short answer

1. Equipment = $576,765
2. Interest expense = $160,000
3. Discount on notes payable = $58,317
4. Accumulated-depreciation = $57,667

Step-by-step solution

Meaning of Non-interest Bearing Liabilities

Non-Interest Bearing Liabilities are the sums of money due by a corporation(a debt on the balance sheet, current or non-current)that are not subject to interest or penalties.

(a) Preparing journal entries

Date	Particular	Debit ($)	Credit ($)
	Equipment	576,765
	Discount on Notes Payable	223,235
	Notes Payable		800,000
	(To record the purchase of equipment)

Working notes:

Calculating the value of equipment

$\begin{array}{rcl}\mathit{E}\mathit{q}\mathit{u}\mathit{i}\mathit{p}\mathit{m}\mathit{e}\mathit{n}\mathit{t}& \mathbf{=}& \mathit{N}\mathit{o}\mathit{t}\mathit{e}\mathbf{}\mathit{i}\mathit{n}\mathit{s}\mathit{t}\mathit{a}\mathit{l}\mathit{l}\mathit{m}\mathit{e}\mathit{n}\mathit{t}\mathbf{\times }\mathit{P}\mathit{r}\mathit{e}\mathit{s}\mathit{e}\mathit{n}\mathit{t}\mathbf{}\mathit{v}\mathit{a}\mathit{l}\mathit{u}\mathit{e}\\ & \mathbf{=}& \mathbf{\$}\mathbf{160}\mathbf{,}\mathbf{000}\mathbf{\times }\mathbf{3}\mathbf{.}\mathbf{60478}\\ & \mathbf{=}& \mathbf{\$}\mathbf{576}\mathbf{,}\mathbf{765}\end{array}$

(b) Preparing journal entries

Date	Particular	Debit ($)	Credit ($)
	Interest Expense	69,212
	Notes Payable	160,000
	Discount on Notes Payable		69,212
	Cash		160,000
	(To record the payment )

Working notes:

Calculation of interest expense

$\begin{array}{rcl}\mathit{I}\mathit{n}\mathit{t}\mathit{e}\mathit{r}\mathit{e}\mathit{s}\mathit{t}\mathbf{}\mathit{e}\mathit{x}\mathit{p}\mathit{e}\mathit{n}\mathit{s}\mathit{e}& \mathbf{=}& \mathit{E}\mathit{q}\mathit{u}\mathit{i}\mathit{p}\mathit{m}\mathit{e}\mathit{n}\mathit{t}\mathbf{\times }\mathit{M}\mathit{a}\mathit{r}\mathit{k}\mathit{e}\mathit{t}\mathbf{}\mathit{r}\mathit{a}\mathit{t}\mathit{e}\\ & \mathbf{=}& \mathbf{\$}\mathbf{576}\mathbf{,}\mathbf{765}\mathbf{\times }\mathbf{12}\mathbf{\%}\\ & \mathbf{=}& \mathbf{\$}\mathbf{69}\mathbf{,}\mathbf{212}\end{array}$

Year	Note Payment	12% Interest	Reduction of Principal	Balance
1/2/17				$576,765
12/31/17	$160,000	$69,212	$90,788	485,977
12/31/18	160,000	58,317	101,683	384,294

(c) Preparing journal entries

Date	Particular	Debit ($)	Credit ($)
	Interest Expense	58,317
	Notes Payable	160,000
	Discount on Notes Payable		58,317
	Cash		160,000
	(To record the payment )

(d) Preparing journal entries

Date	Particular	Debit ($)	Credit ($)
	Depreciation Expense	57,677
	Accumulated Depreciation- Equipment		57,677
	(To record depreciation)

Working notes:

$\begin{array}{rcl}\mathit{A}\mathit{c}\mathit{c}\mathit{u}\mathit{m}\mathit{u}\mathit{l}\mathit{a}\mathit{t}\mathit{e}\mathit{d}\mathbf{-}\mathit{D}\mathit{e}\mathit{p}\mathit{r}\mathit{e}\mathit{c}\mathit{i}\mathit{a}\mathit{t}\mathit{i}\mathit{o}\mathit{n}& \mathbf{=}& \frac{\mathbf{E}\mathbf{q}\mathbf{u}\mathbf{i}\mathbf{p}\mathbf{m}\mathbf{e}\mathbf{n}\mathbf{t}\mathbf{}\mathbf{c}\mathbf{o}\mathbf{s}\mathbf{t}}{\mathbf{U}\mathbf{s}\mathbf{e}\mathbf{f}\mathbf{u}\mathbf{l}\mathbf{}\mathbf{l}\mathbf{i}\mathbf{f}\mathbf{e}}\\ & \mathbf{=}& \frac{\mathbf{\$}\mathbf{576}\mathbf{,}\mathbf{765}}{\mathbf{10}}\\ & \mathbf{=}& \mathbf{\$}\mathbf{57}\mathbf{,}\mathbf{667}\end{array}$