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Payal123
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Posted: 25 Jun 2009 at 18:03 | IP Logged  

Hey Zade thanx for trying......... Lets see if someone else could help us on this.

Good Luck! when are you taking this exam?


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kj_nyc
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Posted: 25 Jun 2009 at 23:41 | IP Logged  

For each year ending June 30, the interest expense will be 10% of the book value of the note as of the beginning of the year.  To get the amount for a calendar year ending December 31, you  take half of the interest expense for July 1 previous through June 30 this year plus half interest expense July 1 this year through June 30 next year.  Total interest expense over the life of the note will be the discount.  Why?  Because cash paid over the 5 years is $50,000 (the face value of the note), while the present value is only $37,908.  The difference is the interest expense.

beginning balance:
note payable  50,000
discount      12,092
book value    37,908

at 7/1/year2:

interest expense 3790.80
note payable(plug) 6209.20
 cash 10,000

book value: 37908-6209.20 = 31698.80

at 7/1/year3:

interest expense 3169.88
note payable(plug) 6830.12
 cash 10,000

book value: 31698.80-6830.12 = 24868.68

Interest expense for the calendar year ended 12/31/year2 would be (3790.80/2) + (3169.88/2) = 3480.34


And if you want to see the journal entries through the end of the note term (although it's easier, faster and more clear when you do it in Excel, but on the CPA exam we get only a barely functional Excel imitation for the simulations):

at 7/1/year4:

interest expense 2486.868
note payable(plug) 7513.132
 cash 10,000

book value: 24868.68-7513.132 = 17355.548

at 7/1/year5:

interest expense 1735.5548
note payable(plug) 8264.4452
 cash 10,000

book value: 17355.548-8264.4452 = 9091.1028

at 7/1/year6 (rounding the numbers as there will be a little rounding difference at the end):

interest expense 909
note payable(plug) 9091
 cash 10,000

book value: 9091-9091 = 0 as it's supposed to be.

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Payal123
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Posted: 26 Jun 2009 at 10:52 | IP Logged  

Hi Kj_NYC,

This is a mind blowing explanation.

It is very clear now. Thanx a ton for such a detailed explanation.

Good Luck with ur studies.


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