On January 1, 2014, Fishbone Corporation sold equipment to Lost Company that cost $250,000 and that had accumulated depreciation of $100,000 on the date of sale. Fishbone received as consideration a $240,000 non-interest-bearing note due on December 31, 2016. The prevailing rate of interest for a note of this type on January 1, 2014, was 5%.

Record the 1/1/14 transaction for Fishbone and all necessary entries from 2014-2016. Record the 1/1/14 transaction for Lost Company and all necessary enrties from 2014-2016.

Answer and Explanation:

Transaction in the books of purchaser of equipment

Face value of zero interest bearing notes issued $240,000

Maturity period 3 years

Prevailing rate of interest for such type of notes 5%

PVF for 3rd year at 10 % 0.864

Present Value of Notes on Jan, 01 2014 $207,360

($240,000 * 0.864)

Discount on notes $32,640

($240,000 - $207,360)

Present value of notes will be the capitalized value of equipment

Discount Amortization and interest expense schedule

Opening Effective interest Discount Amortization of

Balance at 5% Amortization balance (equal to interest expense)

a b a + b

$207,360 $10,368 $217,728 $10,368

$217,728 $10,886 $228,614 $10,886

$228,614 $11,426 $240,000 $11,426

a. Jan, 1 2014

Equipment Dr, $207,360

Discount on Issue of notes Dr, $32,640

To Notes Payable $240,000

(Being issue of notes and purchase of equipment is recorded)

b. Dec 31,2014

Interest Expense Dr, $10,368

To Discount on issue of notes $10,368

(Being the interest expense and amortization of discount is recorded)

c. Dec 31, 2015

Interest Expense Dr, $10,886

To Discount on issue of notes $10,886

(Being the interest expense and amortization of discount is recorded)

d. Dec 31,2016

Interest Expense Dr, $11,426

Notes Payable Dr, $240,000

To Discount on issue of notes $11,426

To Cash $240,000

(Being the interest expense and amortization of discount, and liability of notes payable repaid is recorded)

e. Jan, 1 2014

Notes Receivable Dr, $207,360

To Equipment $150,000

To Gain on sale of equipment $57,360

(Being the sale of equipment against zero interest bearing notes receivable is recorded)

f. Dec 31,2014

Notes Receivable Dr, $10,368

To Interest income on notes receivable $10,368

(Being the interest income at year end is recorded)

g. Dec 31, 2015

Notes Receivable Dr, $10,886

To Interest income on notes receivable $10,886

(Being the interest income at year end is recorded)

h. Dec 31,2016

Notes Receivable Dr, $11,426

To Interest income on notes receivable $11,426

(Being the interest income at year end is recorded)

i. Dec 31,2016

Cash Dr, 240,000

To Notes Receivable $240,000

(Being Notes receivable matured and cash received is recorded)