Question

On january 1, 2020, blossom company makes the two following acquisitions. 1. purchases land having a fair value of $300,000 by issuing a 5-year, zero-interest-bearing promissory note in the face amount of $528,703. 2. purchases equipment by issuing a 6%, 9-year promissory note having a maturity value of $340,000 (interest payable annually). the company has to pay 12% interest for funds from its bank. (a) record the two journal entries that should be recorded by blossom company for the two purchases on january 1, 2020. (b) record the interest at the end of the first year on both notes using the effective-interest method.

Answer 1

(A) The journal entries for the two acquisitions would be as follows:

1. Acquisition of Land:

The land is purchased using a non-interest-bearing note, implying that the interest is included in the face value of the note. Therefore, the present value of the note is considered as the fair value of the land.

Land (Dr.) $300,000

Notes Payable (Cr.) $300,000

(Explanation: Land is debited because it's an asset that the company is acquiring. Notes Payable is credited because this represents a liability - the company has to pay this amount in the future.)

2. Acquisition of Equipment:

The equipment is purchased with a note that carries an interest rate of 6%, which is less than the company's borrowing rate of 12%. Therefore, the present value of the note is less than its face value.

Equipment (Dr.) $237,486

Notes Payable (Cr.) $237,486

(Explanation: The present value of the note is calculated using the formula PV = FV / (1 + r)^n, where FV is the future value of the note, r is the interest rate, and n is the number of years. Plugging in the given values, we get PV = $340,000 / (1 + 0.12)^9 ≈ $237,486. This is considered as the fair value of the equipment.)

(B) Interest at the end of the first year on both notes using the effective-interest method would be:

1. Interest on Land Note:

Since the land note is a zero-interest-bearing note, the interest expense is considered to be the difference between the face value of the note and its present value, spread over the term of the note.

Interest Expense (Dr.) $45,740

Notes Payable (Cr.) $45,740

(Explanation: The interest expense is calculated as ($528,703 - $300,000) / 5 = $45,740. This amount is added to the liability each year.)

2. Interest on Equipment Note:

The interest expense is calculated using the effective-interest method, which involves multiplying the carrying value of the debt by the market rate of interest.

Interest Expense (Dr.) $28,498

Cash (Cr.) $28,498

(Explanation: The interest expense is calculated as $237,486 * 0.12 = $28,498. This is the amount the company needs to pay at the end of the first year.)

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