Final answer:
The journal entry for the sale includes a debit to Notes Receivable and credits to Sales Revenue and Interest Revenue. The collection entry is a debit to Cash and a credit to Notes Receivable. The effective annual interest rate is 12.73%.
Step-by-step explanation:
If Stridewell accepted a six-month, $700,000 noninterest-bearing note in exchange for delivering foods that have a cash sales price of $658,000, the transaction represents a financing arrangement. The difference between the face value of the note ($700,000) and the cash sales price of the food ($658,000) is the implied interest for the six-month period.
For the sale date of May 1, the journal entry would be:
- Debit Notes Receivable $700,000
- Credit Sales Revenue $658,000
- Credit Interest Revenue ($700,000 - $658,000) $42,000
On the collection date, November 1, the entry would be:
- Debit Cash $700,000
- Credit Notes Receivable $700,000
To calculate the effective annual interest rate, we can use the formula for the effective interest given by:
Effective Interest rate = (1 + i/n)nt - 1, where i is the nominal interest rate, n is the number of compounding periods per year, and t is the number of years.
In this case, we have to first find the nominal interest rate, which is the implied interest of $42,000 over the principal amount of $658,000. To calculate this interest rate for the 6-month period, we divide the interest by the principal and adjust for the period:
Nominal interest rate = ($42,000 / $658,000) * 2 (to annualize it, as we have a six-month period) = 0.1273 or 12.73%.
Since the note is noninterest-bearing, it implies a single compounding period. Therefore, the effective annual interest rate is the same as the nominal annual interest rate:
Effective Annual Interest Rate = 12.73%