Question

Hornet Motors purchased a custom-made metal press for use in repairing wrecked cars.  The press had no known market value.  Hornet agreed to pay $300,000 at the end of three years and asked for a 3% interest rate.  At the time, Hornet's incremental borrowing rate was 7%. How should the seller and buyer record the transaction?

A) Each should record the sale/purchase at $300,000.

B) The seller should record the sale at $300,000 and Hornet at the present value of $300,000.

C) Each should record the transaction at the present value of the note payable.

D) Hornet should record the sale at $300,000 and the seller at the present value of $300,000.

Please explain your answer so I will get a better understanding of this question. Thanks!

Answer 1

The transaction is like financing arrangement and the payment is to be made at end of three years, it can be referred to as notes payable by Hornet Company

Since the payment is to be made over three years period, there would be financing element in this case purchase transaction for both Hornet Motors and wrecked cars

Hornet motor should record the liability as note payable under non-current liability at the present value of the notes payable that is present value of $ 300000

Similarly, Wrecked cars should the record the asset as note receivable under non-current asset at the present value of the notes receivable that is present value of $ 300000

Since the payment is made after 3 years period, the asset or liability should be recorded at the present value The current answer is option C)