Be14 13samson Corporation Issued A 5year 81500 Zero Interest
Be14 13samson Corporation Issued A 5year 81500 Zero Interest
Prepare journal entries for Samson Corporation related to the issuance of a zero-interest-bearing note and the recognition of interest over the note’s life. Specifically, record the journal entry on January 1, 2014, at issuance, and the journal entry on December 31 to recognize interest expense for the year.
Samson Corporation issued a five-year, \$81,500 zero-interest-bearing note to Brown Company on January 1, 2014. The cash received was \$48,366, and the implicit interest rate is 11%. The accounting treatment for this type of note involves recognizing the discount on Notes Payable and amortizing interest expense over the life of the note. This process aligns with the effective interest method of accounting for bonds and notes payable with discounts.
Introduction
In managing its financial liabilities, companies often utilize zero-interest-bearing notes, which do not pay periodic interest but are issued at a discount to face value. The discount reflects the imputed interest, and the carrying amount of the note increases over time as interest expense is recognized. This paper discusses the journal entries necessary to account for such a note issued by Samson Corporation, considering the terms provided and applying appropriate accounting principles.
1, 2014)
On January 1, 2014, Samson Corporation issued the note with a face value of \$81,500. Since the cash received was \$48,366, the difference between face value and cash received represents the discount on the note, which is an implicit interest component. The journal entry records the receipt of cash, the note payable at its face value, and the discount:
Debit: Cash .................................... 48,366
Debit: Discount on Notes Payable ............ 33,134
Credit: Notes Payable ....................... 81,500
This entry reflects the obligation undertaken and the discount that will be amortized over the note's life.
At the end of each accounting period, interest expense must be recognized based on the effective interest rate of 11%. The amortized discount increases the carrying amount of the note, and the total interest expense for the year is calculated as the book value at the beginning of the period times the effective interest rate.
Initial book value of the note (issue date): \$48,366 + amortized portion of discount
First, determine the amortized discount for the year:
Interest Expense = Carrying amount * Effective interest rate
= \$48,366 * 11% = \$5,320
The amortization of the discount (or increase in carrying amount) is then:
Amortization = Interest Expense - cash interest (which is zero in zero-interest notes)
Since it is a zero-interest note, no cash interest is paid; however, for reporting, the interest expense is recognized as the amortization of the discount.
The amortized discount increases the carrying amount of the note, so the new book value at year-end becomes:
Book value at 12/31/2014 = Previous book value + Amortized interest
= \$48,366 + \$5,320 = \$53,686
Thus, the journal entry to recognize interest expense on December 31, 2014, is:
Debit: Interest Expense ...................... 5,320
Credit: Discount on Notes Payable .......... 5,320
This process repeats annually, with the interest expense increasing the carrying amount until it equals the face amount at maturity.
Conclusion
Accounting for zero-interest-bearing notes involves recognizing the discount upon issuance and systematically amortizing it over the note's life, reflecting the accrued interest expense. The effective
interest method ensures that interest expense closely aligns with the implicit interest rate, providing a realistic picture of the company's financial obligations and costs.
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