Question

Sand Castle Co. borrowed $40,000 by issuing a four-year non-interest-bearing note to a customer. In addition, Sand Castle agreed to sell inventory to the same customer at reduced prices over the four-year period. Sand Castle’s incremental borrowing rate was 8%, so the present value of the note was $29,400. The customer agreed to purchase an equal amount of inventory each year over the four-year period.

Required:

Prepare journal entries to:

a.	Issue the note
b.	Adjust at the end of the first year
c.	Adjust at the end of the second year

Answer 1

No.	Accounts Titles & Explanation	Debit ($)	Credit ($)
a.	Issue the note
	Cash	40,000
	Discount on Note [$40,000 - $29,400]	10,600
	Notes Payable		$40,000
	Unearned Revenue [$40,000 - $29,400]		10,600
b.	Adjust at the end of the first year
	Interest Expense [ $29,400 * 8 %]	2,352
	Discount on Note		2,352
	Unearned Revenue [ $10,600 /4 years]	2,650
	Sales Revenue		2,650
c	Adjust at the end of the second year
	Interest Expense [ ($29,400 + $2,352) * 8 %]	2,540.16
	Discount on Note		2,540.16
	Unearned Revenue [ $10,600 /4 years]	2,650
	Sales Revenue		2,650