Question

American Food Services, Inc., acquired a packaging machine from Barton and Barton Corporation. Barton and Barton completed construction of the machine on January 1, 2021. In payment for the $4 million machine, American Food Services issued a four-year installment note to be paid in four equal payments at the end of each year. The payments include interest at the rate of 10%. (FV of $1, PV of $1, FVA of $1, PVA of $1, FVAD of $1 and PVAD of $1) (Use appropriate factor(s) from the tables provided.)
Required:
1. Prepare the journal entry for American Food Services’ purchase of the machine on January 1, 2021.
2. Prepare an amortization schedule for the four-year term of the installment note.
3. Prepare the journal entry for the first installment payment on December 31, 2021.
4. Prepare the journal entry for the third installment payment on December 31, 2023.

Answer 1

Answer:

TODAY value of the future obligation ($4,000,000 payable in 4 years’ time, at 10% interest rate)

Present Value = Future Value / (1+r)^4 = 4000000/(1+0.1)^4 = 2,732,053.82

Explanation:

Calculations

TODAY value of the future obligation ($4,000,000 payable in 4 years’ time, at 10% interest rate)

Present Value = Future Value / (1+r)^4 = 4000000/(1+0.1)^4 = 2,732,053.82

1. Prepare the journal entry for American Food Services’ purchase of the machine on January 1, 2021.  

Dr. Machinery     2,732,053.82

Cr. Future Obligation     2,732,053.82

Being Purchase of Machine for deferred payment of $4m in 4 years @ 10%

2. Prepare an amortization schedule for the four-year term of the installment note.  

AMORTIZATION TABLE

Year     Future Obligation  Unwinding of Interest   Balance

1.            2,732,053.82                 273,205.38           3,005,259.2

2.           3,005,259.2                   300,525.92           3,305,785.12

3.            3,305,785.12                 330,578.51             3,636,363.63

4.            3,636,363.63                363,636.36            4,000,000.00

3. Prepare the journal entry for the first installment payment on December 31, 2021.  

At the end of 2021, the obligation will increase because we are one year closer to having to pay the $4,000,000

The amount by which it increases is the unwinding of the interest

10% x 2,732,053.82 = 273,205.38 and the double entry to record that increase is:

Dr Finance charges.......273,205.38

Cr Obligation account.........................273,205.38

Being the unwinding of 10% interest on deferred finance obligation on machinery for the year.

4. Prepare the journal entry for the third installment payment on December 31, 2023.

10% x 3,305,785.12 = 330,578.51 and the double entry to record that increase is:

Dr Finance charges.......330,578.51

Cr Obligation account.........................330,578.51

Being the unwinding of 10% interest on deferred finance obligation on machinery for the year.