Exercise 10-1B Interest only versus an installment note

Accounting for Long-Term Debt

Exercise 10-1B Interest only versus an installment note

Pare Co. borrowed $80,000 from National Bank by issuing a note with a five-year term. Pare has two options with respect to the payment of interest and principal. Option 1 requires the payment of interest only on an annual basis with the full amount of the principal due at maturity. Option 2 calls for an annual payment that includes interest due plus a partial repayment of the principal balance. The effective annual interest rate on both notes is identical.

Required
Write a memo explaining how the two alternatives will affect:
(a) the carrying value of liabilities,
(b) the amount of annual interest expense,
(c) the total amount of interest that will be paid over the life of the note, and
(d) the cash flow consequences.

Exercise 10-2B Amortization schedule for an installment note

On January 1, Year 1, Monroe Co. borrowed $80,000 cash from First Bank by issuing a four-year, 6 percent note. The principal and interest are to be paid by making annual payments in the amount of $23,087. Payments are to be made December 31 of each year, beginning December 31, Year 1.

Required
Prepare an amortization schedule for the interest and principal payments for the four-year period.

Exercise 10-3B Financial statement effects of an installment note

Lek Hood started a business by issuing a $70,000 face-value note to State National Bank on January 1, Year 1. The note had a 6 percent annual rate of interest and a 10-year term. Payments of $9,581 are to be made each December 31 for 10 years.

Required
a. What portion of the December 31, Year 1, payment is applied to:
(1) Interest expense?
(2) Principal?
b. What is the principal balance on January 1, Year 2?
c. What portion of the December 31, Year 2, payment is applied to:
(1) Interest expense?
(2) Principal?

Exercise 10-4B Financial statement effects of an installment note

A partial amortization schedule for a five-year note payable that Mercury Co. issued on January 1, Year 1, is shown next:

Required
a. What rate of interest is Mercury Co. paying on the note?
b. Using a financial statements model like the one shown next, record the appropriate amounts for the following two events:
(1) January 1, Year 1, issue of the note payable
(2) December 31, Year 2, payment on the note payable
c. If the company earned $75,000 cash revenue and paid $32,000 in cash expenses in addition to the interest in Year 1, what is the amount of each of the following?
(1) Net income for Year 1
(2) Cash flow from operating activities for Year 1
(3) Cash flow from financing activities for Year 1
d. What is the amount of interest expense on this loan for Year 3?