On July 1, 2016, Morgan Company needs exactly $206,400 in cash to pay an existin

Question

On July 1, 2016, Morgan Company needs exactly $206,400 in cash to pay an existing obligation. Morgan has decided to borrow from North Bank, which charges 14% interest on loans. The loan will be due in one year. Morgan is not sure whether to ask the bank for (a) an interest-bearing loan with interest and principal payable at the end of the year or (b) a non-interest-bearing loan due in one year but with interest deducted in advance.

What will be the face value of the note assuming that:

Interest is paid when the loan is due?

Interest is deducted in advance?

Calculate the effective interest rate on the note assuming that:

Interest is paid when the loan is due:

Interest is deducted in advance:

Assume that Morgan negotiates and signs the one-year note with the bank on July 1, 2016. Also, assume that Morgan’s accounting year ends December 31. Prepare all of the journal entries necessary to record the issuance of the note and the interest on the note assuming that:

Interest is paid when the loan is due.

7-1-16

To record issuance of note.

12-31-16

To record accrual of interest.

7-1-17

To record payment of note plus interest.

Interest is deducted in advance.

7-1-16

To record non-interest-bearing loan.

12-31-16

To record interest on loan.

7-1-17

To record payment of the loan.

Prepare the appropriate balance sheet presentation for July 1, 2016, immediately after the note has been issued assuming that:

Interest is paid when the loan is due.

Liability section of Balance Sheet:

Note Payable                         $

Interest is deducted in advance.

Liability section of Balance Sheet:

Note payable                                           $

-Discount on Note Payable            

=                                                                     

7-1-16

To record issuance of note.

Explanation / Answer

1) What will be the face value of the note assuming that: Interest is paid when the loan is due $206,400.00 Interest is deducted in advance = $206,400/(100% – 14%) $240,000.00 2) Calculate the effective interest rate on the note assuming that: Interest is paid when the loan is due = $206,400 × 14% = $28,896; $28,896/$206,400 14.00% Interest is deducted in advance = ($240,000 – $206,400)/$206,400 16.28% 3) Assume that Morgan negotiates and signs the one-year note with the bank on July 1, 2016. Also, assume that Morgan’s accounting year ends December 31. Prepare all of the journal entries necessary to record the issuance of the note and the interest on the note assuming that: Interest is paid when the loan is due. Description Debit Credit 7-1-16 Cash $206,400.00 Notes Payable $206,400.00 To record issuance of note. 12-31-16 Interest Expense ($206,400 × 14% × 6/12 ) $14,448.00 Interest Payable $14,448.00 To record accrual of interest. Interest is deducted in advance. 7-1-17 Notes Payable $206,400.00 Interest Payable $14,448.00 To record interest on loan. Interest Expense $14,448.00 Cash $235,296.00 To record payment of note plus interest. 7-1-16 Cash $206,400.00 Discount on Notes Payable $33,600.00 Notes Payable $240,000.00 To record non-interest-bearing loan. 12-31-16 Interest Expense $16,800.00 Discount on Notes Payable ($33,600 x 6/12) $16,800.00 To record interest on loan. 7-1-17 Notes Payable $240,000.00 Interest Expense $16,800.00 Discount on Notes Payable ($33,600 x 6/12) $16,800.00 Cash $240,000.00 To record payment of the loan. Prepare the appropriate balance sheet presentation for July 1, 2016, immediately after the note has been issued assuming that: Interest is paid when the loan is due. Liability section of Balance Sheet: Note Payable $206,400.00 Interest is deducted in advance. Liability section of Balance Sheet: Note payable $240,000.00 -Discount on Note Payable $33,600.00 $206,400.00

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