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Entries for zero-interest- bearing notes

On 12/31/07 Joe Smith Company acquired a computer from Louis Corporation by issuing a $400,000 zero-bearing note payable in full on 12/31/11. Joe Smith Company's credit rating permits it to borrow funds from its several lines of credit at 10%. The computer is expected to have a 5-year life and a %50,000 salvage value.

A.) Prepare the journal entry for the purchase 12/31/07.

B.) Prepare any necessary adjusting entries relative to depreciation (use straight-line) and amortization (use effective interest method) on 12/31/08.

C.) Prepare any necessary adjusting entries relative to depreciation and amortization on 12/31/09.

Solution Preview

A)
First of all, we need to determine the present value of the principal by simply discounting the future value of $400,000 by 10% over 5 periods
Present value of principal = $400,000 / (1 + 10%)^5 = $248,369
Present value of interest = $0 (since this is a zero-interest note)
Total present value = $248,369 + $0 = $248,369. This is the value of the computer that should go into the book
The discount of the transaction = $400,000 note face value - $248,369 total present value = $151,631

The journal entry is thus as follows:
Debit: Computer $248,369
Debit: Discount ...

Solution Summary

The solution examines journal entries for zero-interest. The necessary adjusting entries relative to depreciation and amortization are discussed.

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