Question

Q2. Bob the Builder purchases an equipment, which will last 17 years with no residual value on August 1, Year 7. The company issues an $800,000, four-year, non-interest-bearing note for the equipment when the prevailing market interest rate for notes of this nature is 8%. The company will pay off the note in four $200,000 installments on each July 31, starting July 31, Year 8. The company adopts mid-month convention for depreciation and depreciation expense is recognized once at the end of the fiscal year, which is December 31, using straight-line method. Please assume that there is no other asset or liability.

(1) Calculate depreciation expense to be recognized for Year 7.

(2) Calculate interest expense to be recognized for Year 8.

Answer 1

1.

Depreciation on equipment on SLM basis, 204 months i.e.

= $800,000 / 204 months = $3921.57

Year 7
Aug	$   1,960.78
Sept	$   3,921.57
Oct	$   3,921.57
Nov	$   3,921.57
Dec	$   3,921.57
Total Depreciation expense	$ 17,647.06

2.

Interest schedule

Year	Instalment	PVF @ 8%	Present value	Interest
Aug 07- Jul 08	$ 200,000.00	0.9259	$ 185,185.19	$ 14,814.81
Aug 08- Jul 09	$ 200,000.00	0.8573	$ 171,467.76	$ 28,532.24
Aug 09- Jul 10	$ 200,000.00	0.7938	$ 158,766.45	$ 41,233.55
Aug 10 - Jul 11	$ 200,000.00	0.7350	$ 147,005.97	$ 52,994.03

Interest to be charged in year 8 = $14,814.81 /2 + $28,532.24 /2 = $21,673.53