Use Table PV-1 (in Exhibit B-7) and Table PV-2 (in Exhibit B-9) On December 31,
ID: 2358656 • Letter: U
Question
Use Table PV-1 (in Exhibit B-7) and Table PV-2 (in Exhibit B-9) On December 31, Richland Farms sold a tract of land, which had cost $930,000, to Skyline Developers in exchange for $150,000 cash and a five-year, 4 percent note receivable for $900,000. Interest on the note is payable annually, and the principal amount is due in five years. The accountant for Richland Farms did not notice the unrealistically low interest rate on the note and made the following entry on December 31 to record this sale. Compute the present value of the note receivable from Skyline Developers at the date of sale, assuming that a realistic rate of interest for this transaction is 12 percent. (Hint: Consider both the annual interest payments and the maturity value of the note.) (Round your PV factor to 3 decimal places and final answer to the nearest dollar amount. Omit the "$" sign in your response.) Present value S Prepare the journal entry on December 31 to record the sale of the land correctly. (Round your PV factor to 3 decimal places and final answers to the nearest dollar amount. Omit the "$" sign in your response.) Net income for the year of the sale will be by $. Explain what effects the error made by Richland Farms's accountant will have on the combined net income of the next five years. Ignore income taxes. (Omit the "$" sign in your response.) The combined net income of the next five years will be by $ .Explanation / Answer
a. Because the market rate of interest is greater than the stated interest rate the note will be issued at a discount. The issue price of the note would be calculated as follows: Present value of principal: Face value 900,000 PV of 1, n=5, i=12% = 0.5674 PV of principal = 0.5674*900,000 = $510,660 Present value of interest: Face value 900,000 Stated interest 4% Interest payments 36,000 PVOA, n=5, i=12% = 3.6048 PV of interest payments= 3.6048*36000 = $129,773 So PV ie Issue price of note $380,887 ..............Ans (a) b. Dec 31 Cash Dr 150,000 Note Rx Dr 380,887 Prem on Note Rxable Dr $399,113 Land Cr 930,000 c1. Net Income will be overstated by (900,000-510660) 389340 c2. Income for 5 yrs will be understaed by PV of Int payments 129,773
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