Question

At the beginning of 2021, VHF Industries acquired a machine with a fair value of $4,803,660 by issuing a three-year, noninterest-bearing note in the face amount of $6 million. The note is payable in three annual installments of $2 million at the end of each year.
Required:
a. What is the effective rate of interest implicit in the agreement?
b. Prepare the necessary journal entry.
c. Suppose the market value of the equipment was unknown at the time of purchase, but the market rate of interest for notes of similar risk was 11%. Prepare the journal entry to record the purchase of the equipment.

Answer 1

Answer:

a. What is the effective rate of interest implicit in the agreement?

I used an Excel spreadsheet and the RATE function:

PV = 4,803,660

FV = 6,000,000 (optional)

Nper = 3

Payment = -2,000,000

Rate = 12%

b. Prepare the necessary journal entry.

Dr Machinery 4,803,660

Dr Discount on notes payable 1,196,340

    Cr Notes payable 6,000,000

c. Suppose the market value of the equipment was unknown at the time of purchase, but the market rate of interest for notes of similar risk was 11%. Prepare the journal entry to record the purchase of the equipment.

we would need to determine the present value, again using an Excel spreadsheet and the PV function:

PV = $4,887,429.43 ≈ $4,887,429

Dr Machinery 4,887,429

Dr Discount on notes payable 1,112,571

    Cr Notes payable 6,000,000