ABC Corporation, a household plastic product manufacturer, borrowed $14 million cash on October 1, 2016, to provide working capital for year-end production. ABC issued a four-month, 12% promissory note to XYZ Bank under a prearranged short-term line of credit. Interest on the note was payable at maturity. Each firm's fiscal period is the calendar year.
1. Prepare the journal entries to record (a) the issuance of the note by ABC Corporation and (b) XYZ Bank's receivable on October 1, 2016.
2. Prepare the journal entries by both firms to record all subsequent events related to the note through January 31, 2014.
3. Suppose the face amount of the note was adjusted to include interest (a noninterest-bearing note) and 12% is the bank's stated discount rate. (a) Prepare the journal entries to record the issuance of the noninterest-bearing note by ABC Corporation on October 1, 2016, the adjusting entry at December 31, and payment of the note at maturity. (b) What would be the effective interest rate?
This solution looks at the issuance of bonds for working capital and the related journal entries for both the company and bank.