Problem 10-26A: Effect of an Installment Note on Financial Statements

Accounting for Long-Term Debt

Problem 10-26A: Effect of an Installment Note on Financial Statements

On January 1, Year 1, Brown Co. borrowed cash from First Bank by issuing a $100,000 face-value, four-year term note with an 8 percent annual interest rate. The note requires annual cash payments of $30,192, which include both interest and principal, to be made on December 31 of each year. Brown Co. used the loan proceeds to purchase land that generates $52,000 in rental revenues annually.

Required

a. Prepare an amortization schedule for the four-year period.
b. Prepare an income statement, balance sheet, and statement of cash flows for each of the four years. (Hint: Record the transactions for each year in T-accounts before preparing the financial statements.)
c. Given that revenue remains constant over the four years, explain why net income increases each year.

Problem 10-27A: Effect of a Line of Credit on Financial Statements

Boyd Company has a line of credit with State Bank, allowing borrowing of up to $400,000 during the Year 1 calendar year. The following table summarizes the prime rate (as an annual percentage) and the amounts borrowed or repaid each month in Year 1. Boyd agreed to an interest rate that is 2 percent higher than the bank’s prime rate. Funds are borrowed or repaid at the start of the month, and interest on the outstanding balance is paid in cash at the end of the month. For example, in January, Boyd pays 7 percent annual interest (5 percent prime + 2 percent) on $100,000.

Boyd earned $45,000 in cash revenue during Year 1.

Required

a. Prepare an income statement, balance sheet, and statement of cash flows for Year 1. (Round all computations to the nearest dollar.)
b. Write a memo explaining how the business generated retained earnings despite the owner contributing no assets to the business.