At the beginning of 2018, VHF Industries acquired a equipment with a fair value

Question

At the beginning of 2018, VHF Industries acquired a equipment with a fair value of $5,070,150 by issuing a two-year, noninterest- bearing note in the face amount of $6 million. The note is payable in two annual installments of $3 million at the end of each year. (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. What is the effective rate of interest implicit in the agreement? 2. to 4. Prepare the necessary journal entry. 5. 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.

Explanation / Answer

Solution:

1.

PVIFA @ r%, 2 x $3,000,000 = $5,070,150

PVIFA @ r%, 2 = $5,070,150 ÷ $3,000,000 = 1.69005

The discount rate for 2 payments that equates to 1.69005 is 12%

2. Machine .......................... 5,070,150

Installment notes payable ................. 5,070,150

3. Installment Notes payable .......................2,391,582

Interest expense ..........................................608,418

Cash.................................................................... 3,000,000

4. Installment Notes payable .....................2,678,572

Interest expense ........................................321,428

Cash ........................................................................... 3,000,000

5. Present value of future payments = $3,000,000 x FVIFA @ 11%, 2 = $6,330,000

Machine .................................... 6,330,000

Notes payable ................................ 6,330,000

Date Payment Interest @ 12% Principal Balance 1/1/2018 5,070,150 12/31/2018 3,000,000 608418 2,391,582 2,678,568 12/31/2019 3,000,000 321428.2 2,678,572 0

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