Notes Payable Exercises – Problems 2 to 5 (Solutions)

Problem 2 — Omega Corporation

Issue date Sept 1, 20X5

Principal ■5,000,000.00
Stated rate 12% annually
Interest dates Every June 30 (annual)
Accrued interest paid at issuance
Jul 1 - Aug 31 (2 months)
Reporting date Dec 31

1) Journal entry on Sept 1, 20X5 (issuance)

Treatment: record cash received net of accrued interest paid; record prepaid interest for the 2 months (so it can be
applied to the upcoming interest payment).
Date Account Debit Credit
Sept 1, 20X5 Cash ■4,900,000.00
Prepaid Interest (Jul-Aug) ■100,000.00
Notes Payable ■5,000,000.00

2) Adjusting entry on Dec 31, 20X5 (accrued interest Sep-Dec)

Date Account Debit Credit
Dec 31, 20X5 Interest Expense ■200,000.00
Interest Payable ■200,000.00

3) Interest payment on June 30, 20X6 — application of prepaid interest

Annual interest due (Jul 1, 20X5 - Jun 30, 20X6): ■600,000.00
Date Account Debit Credit
June 30, 20X6 Interest Payable ■200,000.00
Prepaid Interest (apply) ■100,000.00
Interest Expense (Jan-Jun) ■300,000.00
Cash ■600,000.00

4) Interest expense recognized

Year Computation Interest Expense
20X5 Accrued Sep-Dec ■200,000.00
20X6 Jan-Jun (paid part) + Jul-Dec (accrued) ■600,000.00

5) Carrying value as of Dec 31, 20X5 (and classification)

Notes Payable is interest-bearing at face value; carrying amount = face value = ■5,000,000.00
Accrued interest payable at Dec 31, 20X5 = ■200,000.00
Classification as of Dec 31, 20X5: Current portion = ■0 (no principal due within 12 months); Non-current = ■5,000,000.
Problem 3 — ABC Corporation
Transactions during 20X5:
1. Purchased raw materials worth ■500,000 by issuing a non-interest-bearing 2-year note. Market rate = 12%.
2. Borrowed ■1,000,000 by issuing a one-year interest-bearing note at 10%, payable at maturity.
3. Obtained a machine by issuing a 3-year note payable with stated 12% but market/effective 10%. Annual payments
■440,000 at year-end.

Note A — Non-interest-bearing 2-year note (raw materials)

Face amount due in 2 years: ■500,000.00; market rate: 12%; Present value (recorded) = ■398,596.94
Year Beg CV Interest (12%) Payment End CV
1 ■398,596.94 ■47,831.63 ■0.00 ■446,428.57
2 ■446,428.57 ■53,571.43 ■500,000.00 ■0.00

Interest expense Year 1 = ■47,831.63; Year 2 = ■53,571.43

Carrying value end of Year1 = ■446,428.57; end of Year2 = ■0.00
Current portion: Year1 = ■0 (not due within 12 months); Year2 = amount due at maturity = ■500,000.

Note B — One-year interest-bearing note (■1,000,000 at 10%)

Interest expense Year1 = ■100,000.00; Carrying value end Year1 = ■1,000,000.00; Current portion Year1 =
■1,000,000.00 (due within 12 months).

Note C — 3-year installment note for machine (payments ■440,000, market rate 10%)
Present value (cost of machine) = ■1,094,214.88 (PV of annuity 440000 for 3 years at 10%)

Year Beg CV Interest (10%) Payment Principal End CV

1 ■1,094,214.88 ■109,421.49 ■440,000.00 ■330,578.51 ■763,636.36
2 ■763,636.36 ■76,363.64 ■440,000.00 ■363,636.36 ■400,000.00
3 ■400,000.00 ■40,000.00 ■440,000.00 ■400,000.00 ■0.00

Interest expense (Machine) Year1 = ■109,421.49; Year2 = ■76,363.64

Carrying value end Year1 = ■763,636.36; end Year2 = ■400,000.00
Current portion Year1 = principal portion due within 12 months = ■330,578.51; Year2 = ■363,636.36
Problem 4 — XYZ Enterprises
1. Equipment costing ■800,000 by issuing a three-year non-interest-bearing note. Market rate 10%.
2. Borrowed ■2,000,000 under a 5-year note stated 8%, market rate 10%, interest payable annually.
3. Delivery van via installment note: 4 annual payments ■300,000; stated = market = 10% (so straightforward
amortizing).

Note 4.1 — Non-interest-bearing 3-year note (equipment)

Present value recorded (cost) = ■601,051.84

Year Beg CV Interest 10% Payment End CV

1 ■601,051.84 ■60,105.18 ■0.00 ■661,157.02
2 ■661,157.02 ■66,115.70 ■0.00 ■727,272.73
3 ■727,272.73 ■72,727.27 ■800,000.00 ■0.00

Interest expense Year1 = ■60,105.18; Year2 = ■66,115.70

Carrying value end Year1 = ■661,157.02; end Year2 = ■727,272.73
Current portion Year1 = ■0 (no principal due within 12 months); Year2 = ■0 (still >12 months until maturity).

Note 4.2 — 5-year note (2,000,000), stated 8%, market 10%

Proceeds (PV at market 10%) = ■1,848,368.53

Year Beg CV Interest 10% Cash Interest (8%) Amortization (Discount)End CV

1 ■1,848,368.53 ■184,836.85 ■160,000.00 ■24,836.85 ■1,873,205.38
2 ■1,873,205.38 ■187,320.54 ■160,000.00 ■27,320.54 ■1,900,525.92
3 ■1,900,525.92 ■190,052.59 ■160,000.00 ■30,052.59 ■1,930,578.51
4 ■1,930,578.51 ■193,057.85 ■160,000.00 ■33,057.85 ■1,963,636.36
5 ■1,963,636.36 ■196,363.64 ■160,000.00 ■36,363.64 ■2,000,000.00

Interest expense Year1 = ■184,836.85; Year2 = ■187,320.54

Carrying value end Year1 = ■1,873,205.38; end Year2 = ■1,900,525.92
Current portion Year1 = ■0 (no principal due within 12 months); Year2 = ■0 (still >12 months).

Note 4.3 — Installment note (4 annual payments ■300,000, rate 10%)

Present value (proceeds/obligation) = ■950,959.63

Year Beg CV Interest 10% Payment Principal End CV

1 ■950,959.63 ■95,095.96 ■300,000.00 ■204,904.04 ■746,055.60
2 ■746,055.60 ■74,605.56 ■300,000.00 ■225,394.44 ■520,661.16
3 ■520,661.16 ■52,066.12 ■300,000.00 ■247,933.88 ■272,727.27
4 ■272,727.27 ■27,272.73 ■300,000.00 ■272,727.27 ■0.00
Interest expense Year1 = ■95,095.96; Year2 = ■74,605.56
Carrying value end Year1 = ■746,055.60; end Year2 = ■520,661.16
Problem 5 — LMN Manufacturing
Multiple financing transactions in 20X7. We'll compute PVs, amortization and interest expense for Year1 and Year2 for
each obligation.

5.1 — Non-interest-bearing 2-year note (furniture)

Recorded cost (PV) = ■478,316.33
Year Beg CV Interest 12% Payment End CV
1 ■478,316.33 ■57,397.96 ■0.00 ■535,714.29
2 ■535,714.29 ■64,285.71 ■600,000.00 ■0.00
Interest expense Year1 = ■57,397.96; Year2 = ■64,285.71

5.2 — 4-year note ■1,200,000; stated 14%; market 12%

Proceeds (PV at market 12%) = ■1,272,896.38
Year Beg CV Interest 12% Cash Interest (14%) Amortization End CV
1 ■1,272,896.38 ■152,747.57 ■168,000.00 ■-15,252.43 ■1,257,643.95
2 ■1,257,643.95 ■150,917.27 ■168,000.00 ■-17,082.73 ■1,240,561.22
3 ■1,240,561.22 ■148,867.35 ■168,000.00 ■-19,132.65 ■1,221,428.57
4 ■1,221,428.57 ■146,571.43 ■168,000.00 ■-21,428.57 ■1,200,000.00

5.3 — 5-year note for land; stated 12%; market 10%; face? implied to produce land cost ■3,000,000
Face (approx) = ■2,788,581.63; Annual cash interest (12% of face) = ■334,629.80; Proceeds (PV) = ■3,000,000
(given).

Year Beg CV Interest 10% Cash Interest (12%) Amortization End CV

1 ■3,000,000.00 ■300,000.00 ■334,629.80 ■-34,629.80 ■2,965,370.20
2 ■2,965,370.20 ■296,537.02 ■334,629.80 ■-38,092.78 ■2,927,277.43
3 ■2,927,277.43 ■292,727.74 ■334,629.80 ■-41,902.05 ■2,885,375.38
4 ■2,885,375.38 ■288,537.54 ■334,629.80 ■-46,092.26 ■2,839,283.12
5 ■2,839,283.12 ■283,928.31 ■334,629.80 ■-50,701.48 ■2,788,581.63

5.4 — Non-interest-bearing installment note: 4 annual payments ■400,000; market 10%

Present value (proceeds = cost of equipment) = ■1,267,946.18
Year Beg CV Interest 10% Payment Principal End CV
1 ■1,267,946.18 ■126,794.62 ■400,000.00 ■273,205.38 ■994,740.80
2 ■994,740.80 ■99,474.08 ■400,000.00 ■300,525.92 ■694,214.88
3 ■694,214.88 ■69,421.49 ■400,000.00 ■330,578.51 ■363,636.36
4 ■363,636.36 ■36,363.64 ■400,000.00 ■363,636.36 ■0.00

5.5 — Installment note: 3 annual payments ■500,000; stated 8%; market 10%
Present value (proceeds) = ■1,243,426.00
Year Beg CV Interest 10% Payment Principal End CV
1 ■1,243,426.00 ■124,342.60 ■500,000.00 ■375,657.40 ■867,768.60
2 ■867,768.60 ■86,776.86 ■500,000.00 ■413,223.14 ■454,545.45
3 ■454,545.45 ■45,454.55 ■500,000.00 ■454,545.45 ■0.00