Question

(Expected Cash Flows) On December 31, 2017, Conchita Martinez Company signed a \(1,000,000 note to Sauk City Bank. The market interest rate at that time was 12%. The stated interest rate on the note was 10%, payable annually. The note matures in 5 years. Unfortunately, because of lower sales, Conchita Martinez’s financial situation worsened. On December 31, 2019, Sauk City Bank determined that it was probable that the company would pay back only \)600,000 of the principal at maturity. However, it was considered likely that interest would continue to be paid, based on the $1,000,000 loan.

Instructions

(a) Determine the amount of cash Conchita Martinez received from the loan on December 31, 2017.

(b) Prepare a note amortization schedule for Sauk City Bank up to December 31, 2019.

(c) Determine the loss on impairment that Sauk City Bank should recognize on December 31, 2019.

Short answer

The business entity incurs an impairment loss of$284,251.

Step-by-step solution

Definition of Carrying Value

Carrying value can be defined as thevalue of the assets or liabilities on which it is reported in the statement of financial position. This information helps users of financial statements determine the true value of assets and liabilities.

Amount of Cash Received from Loan

Particular	Amount $
Present value of principal ($1,000,000 @12% for 5 years) (PVF: 0.5674)	$567,400
Present value of interest ($100,000 @12% for 5 years) (PVAF: 3.60)	360,000
Cash received	$927,400

Note Amortization Schedule

Date	Cash Received (10%)	Interest expenses (12%)	Increase in Carrying amount	Carrying value
31 Dec 2017	0	0	0	$927,400
31 Dec 2018	$100,000	$111,288	$11,288	$938,688
31 Dec 2019	$100,000	$112,643	$12,643	$951,331

Loss Due to Impairment

Particular	Amount $
Carrying value of loan on 31 Dec 2019	$951,331
Less: Present value of $600,000 @12% for 3 years (PVF: 0.7118)	(427,080)
Less: Present value of interest $100,000 @12% for 3 years (PVAF: 2.4)	(240,000)
Impairment loss	$284,251