Little Corp was experiencing cash flow problems and was

unable #1958
Little Corp was experiencing cash flow problems and was unable

Little Corp. was experiencing cash flow problems and was unable to pay its $105,000 account
payable to Big Corp. when it fell due on September 30, 2017. Big agreed to substitute a one-
year note for the open account. The following two options were presented to Little by Big Corp.:

Option 1: A one-year note for $105,000 due September 30, 2018. Interest at a rate of 8% would
be payable at maturity.

Option 2: A one-year non-interest-bearing note for $113,400. The implied rate of interest is 8%.
Assume that Big Corp. has a December 31 year end.

Instructions

(a) Assuming Little Corp. chooses Option 1, prepare the entries required on Big Corp.'s books
on September 30, 2017, December 31, 2017, and September 30, 2018.

(b) Assuming Little Corp. chooses Option 2, prepare the entries required on Big Corp.'s books
on September 30, 2017, December 31, 2017, and September 30, 2018.

(c) Compare the amount of interest income earned by Big Corp. in 2017 and 2018 under both
options. Comment briefly.

(d) From management's perspective, does one option provide better liquidity for Big at
December 31, 2017? Does one option provide better cash flows than the other?

Little Corp was experiencing cash flow problems and was unable

ANSWER
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