Question

On January 1, 2017, Ellen Carter Company makes the two following acquisitions.

1. Purchases land having a fair value of \(200,000 by issuing a 5-year, zero-interest-bearing promissory note in the face amount of \)337,012.
2. Purchases equipment by issuing a 6%, 8-year promissory note having a maturity value of $250,000 (interest payable annually).

The company has to pay 11% interest for funds from its bank

Instructions

(Round answers to the nearest cent.)

1. Record the two journal entries that should be recorded by Ellen Carter Company for the two purchases on January 1, 2017.
2. Record the interest at the end of the first year on both notes using the effective-interest method.

Short answer

1. The discount on notes payable is $64,325.70.
2. Interest expense is $20,424.17.

Step-by-step solution

Meaning of Promissory Note

A composed guarantee to pay cash to a particular individual or to the carrier at a particular or predetermined future time is known as a promissory note.

(a) Preparing journal entry

Date	Particulars	Debit ($)	Credit ($)
Jan. 1, 2017 (1)	Land	200,000.00
	Discount on Notes Payable	137,012.00
	Notes Payable		337,012.00
(2)	Equipment	185,674.30
	Discount on Notes payable	64,325.70
	Notes payable		250,000.00

Notes payable on January 1, 2017: The $200,000 capitalized land cost represents the present value of the note discounted for five years at 11%.

Working notes:

Computation of the discount on notes payable:

Maturity value	$250,000
Present value of $250,000 due in 8 years at 11% $\left(\$250,000\times 0.43393\right)$ $108,482.50
Present value of $15,000 payable annually for 8 years at 11% annually $\left(\$15,000\times 5.14612\right)$ 77,191.80
Present value of the note	(185,674.30)
Discount	$64,325.70

(b) Preparing journal entry

Date	Particulars	Debit ($)	Credit ($)
1	Interest expense$\left(\$200,000\times 0.11\right)$	22,000
	Discount on Notes Payable		22,000
2	Interest expense $\left(\$185,674.30\times 0.11\right)$	20,424.17
	Discount on notes payable		5,424.17
	Cash $\left(\$250,000\times 0.06\right)$		15,000.00