Question

(Notes Receivable with Unrealistic Interest Rate) On December 31, 2015, Ed Abbey Co. performed environmental consulting services for Hayduke Co. Hayduke was short of cash, and Abbey Co. agreed to accept a $200,000 zero-interest-bearing note due December 31, 2017, as payment in full. Hayduke is somewhat of a credit risk and typically borrows funds at a rate of 10%. Abbey is much more creditworthy and has various lines of credit at 6%.

Instructions

(a) Prepare the journal entry to record the transaction of December 31, 2015, for the Ed Abbey Co.

(b) Assuming Ed Abbey Co.’s fiscal year-end is December 31, prepare the journal entry for December 31, 2016.

(c) Assuming Ed Abbey Co.’s fiscal year-end is December 31, prepare the journal entry for December 31, 2017.

Short answer

The discount on the note is equal to$165,290.

Step-by-step solution

Definition of Fiscal Year

Period of one year that is used by a business entity or individual for reporting their financial transactions for tax purposes is known as fiscal year. For example,1^st April 2019- 31^st March 2020.

Journal entry for 31 December 2015

Date	Accounts and Explanation	Debit $	Credit $
31 Dec 2015	Note receivables	$200,000
	Discount on note receivable $\left(\$200,000\left(\frac{1}{{\left(1+10\right)}^2}\right)\right)$		$165,290
	Service revenue		$34,710

Journal entry for 31 December 2016

Date	Accounts and Explanation	Debit $	Credit $
31 Dec 2016	Discount on note receivable $\left(\$165,290\times 10\%\right)$	$16,529
	Interest revenue		$16,259

Journal entry for 31 December 2017

Date	Accounts and Explanation	Debit $	Credit $
31 Dec 2017	Discount on note receivable$\left(\left(\$165,290+\$16,529\right)\times 10\%\right)$	$18,182
	Interest revenue		$18,182
31 Dec 2017	Cash	$200,000
	Note receivable		$200,000