On January 2, 1992, Emme Co. sold equipment with a carrying amount of $480,000 in exchange for a $600,000 non-interest bearing note due January 2, 1995. There was no established exchange price for the equipment. The prevailing rate of interest for a note of this type at January 2, 1992, was 10%. The present value of 1 at 10% for three periods is 0.75.

In Emme's 1992 income statement, what amount should be reported as interest income? The correct answer is B.

a. $9,000

b. $45,000

c. $50,000

d. $60,000

I am trying to make the JE for this transaction- But I am not sure at all.

Is it?? Can someone comfirm??

01/02/1992

Dr. Note receivable          $600,000

Dr. Loss on sale       $30,000

Cr.       Discount on Note receivable    $150,000

Cr        Equipment                                $480,000 (@ carrying amout)

THe PV of the Notes= $600,000 X 0.75 = $450,000

And in the year end, accrul interest income as-

Dr. Discount on N/R      $45,000*

Dr         Interest income       $45,000 *

* $450,000x 10% = $45,000

Or

01/02/1992

Dr: Notes receivable   $450,000

Dr: Loss on sale $30,000

     Cr: Equipment               $480,000

And at the year end,

Dr: N/R    $45,000

Cr:     Interest income    $45,000

Both ways are correct? Or which one is correct? THanks

The way it works in my mind is the second example, I will try to confirm later but I believe this is an example where you have to "impute" interest. The note is non-interest bearing but since you record it at PV, the interest income you earn builds the PV of the note to the final value you receive at payoff (i.e. $600k).

I'll double-check but that is the way I worked it out on some scrap paper here at the office. I didn't do the schedule but the quick math says that as you add 10% interest income to the growing balance ($450,000 + $450,000x10%) it will get very close to $600k at maturity.