Question

On July 1, 2020, Bramble Inc. made two sales.

1. It sold land having a fair value of $905,820 in exchange for a 4-year zero-interest-bearing promissory note in the face amount of $1,425,321. The land is carried on Ayayai's books at a cost of $599,100.
2. It rendered services in exchange for a 3%, 8-year promissory note having a face value of $409,970 (interest payable annually). Ayayai Inc. recently had to pay 8% interest for money that it borrowed from British National Bank. The customers in these two transactions have credit ratings that require them to borrow money at 12% interest.

Required:
Record the two journal entries that should be recorded by Bramble Inc. for the sales transactions above that took place on July 1, 2020.

Answer 1

Journal entries for sales transactions involving promissory notes require accounting for present value. The market interest rate should be used to record revenues for sales of land and services. Examples of calculating present value for bonds with different interest rates are provided for understanding.

Step-by-step explanation:

To address the question regarding the journal entries for Bramble Inc., an understanding of the present value concepts combined with recognition of financial transactions is required. The calculations will employ the time value of money to properly record the sales of land and services in exchange for promissory notes.

Sales of Land

The sale of land for a zero-interest-bearing promissory note necessitates recognizing the present value of the note using the market interest rate, which in this case is 12%. The present value of the note would be calculated using the formula for the present value of a single sum that is due in the future.

For instance, let's consider a different situation where a simple two-year bond issued at $3,000 with an 8% interest rate would pay $240 in interest annually. To find the present value at an 8% discount rate, the first year's interest and the principal along with second year's interest would need to be discounted back to their present values.

If instead the applicable interest rate rose to 11%, the bond's present value would decrease as the future cash flows would be discounted at this higher rate.

Sales of Services

For services rendered in exchange for an interest-bearing note, the interest stated on the note is less than the market rate, suggesting the note's face value is more than its present value. As such, the present value of the note (both the principal and the interest payments) need to be calculated using the market rate of interest to find the revenue to be recognized from the service provided.

Answer 2

Bramble Inc.

Journal Entries:

July 1, 2020:

1.

Debit Long-term Note Receivable $1,425,321

Credit Land $599,100

Credit Interest Receivable $519,501

Credit Gain from Sale of Land $306,720

To record the sale of land for a 4-year zero-interest-bearing note.

2.

Debit Long-term Note Receivable $409,970

Credit Service Revenue $323,634

Credit Interest Receivable $86,336

To record the rendering of services in exchange for a 3%, 8-year note.

Step-by-step explanation:

a) Data and Analysis:

1. Long-term Note Receivable $1,425,321

Land $599,100

Interest Receivable $519,501 ($1,425,321 - $905,820)

Gain from Sale of Land $306,720 ($905,820 - $599,100)

2. Long-term Note Receivable $409,970

Service Revenue $323,634

Interest Receivable $86,336

NB: The interest receivable and the present value of the service revenue for 2 were obtained from an online financial calculator, using the future value of $409,970 and 3% interest rate for 8 years.