Question

Presented below are two independent situations.

(a) On January 1, 2017, Robin Wright Inc. purchased land that had an assessed value of \(350,000 at the time of purchase. A \)550,000, zero-interest-bearing note due January 1, 2020, was given in exchange. There was no established exchange price for the land, nor a ready fair value for the note. The interest rate charged on a note of this type is 12%. Determine at what amount the land should be recorded at January 1, 2017, and the interest expense to be reported in 2017 related to this transaction.

(b) On January 1, 2017, Field Furniture Co. borrowed $5,000,000 (face value) from Gary Sinise Co., a major customer, through a zero-interest-bearing note due in 4 years. Because the note was zero-interest-bearing, Field Furniture agreed to sell furniture to this customer at lower than market price. A 10% rate of interest is normally charged on this type of loan. Prepare the journal entry to record this transaction and determine the amount of interest expense to report for 2017.

Short answer

1. The amount to be recorded for the land is $391,479
2. Interest expense is $341,505

Step-by-step solution

Meaning of Interest Expense

The cost incurred by a business for using another company's resources, usually in the form of a loan, is known as an interest expense. The specifics of the debt, such as the interest rate and payment schedule, are outlined in loan agreements.

(a) Determining the amount of land that should be reported

Face value of the zero-interest-bearing note	$550,000
Discount factor $\left(12\%\mathrm{for}3\mathrm{periods}\right)$	0.71178
Amount to be recorded for the land on January 1, 2017	$391,479

Carrying value of the note on January 1, 2017	$391,479
Applicable interest rate (12%)	0.12
Interest expense to be reported in 2017	$46,977

(b) Preparing journal entry

Date	Particulars	Debit ($)	Credit ($)
Jan. 1, 2017	Cash	5,000,000
	Discount on notes payable	1,584,950
	Notes payable		5,000,000
	Unearned sales revenue		1,584,950

Calculation of discount of notes payable

$\begin{array}{rcl}\mathbf{Unearned}\mathbf{}\mathbf{Sales}\mathbf{}\mathbf{revenue}& \mathbf{=}& \mathbf{Cash}\mathbf{-}\left(\mathrm{Cash}\times \mathrm{Discounted}\mathrm{factor}\right)\\ & \mathbf{=}& \mathbf{\$}\mathbf{5}\mathbf{,}\mathbf{000}\mathbf{,}\mathbf{000}\mathbf{-}\left(\$5,000,000\times 0.68301\right)\\ & \mathbf{=}& \mathbf{\$}\mathbf{1}\mathbf{,}\mathbf{584}\mathbf{,}\mathbf{950}\mathbf{}\end{array}$

Calculation of the amount of interest expense to be reported

Cash	$5,000,000
Less: Discount on notes	1,584,950
Carrying the value of the note	3,415,050
Rate of interest	10%
Interest expense	$341,505