Farris Company borrowed $800,000 from BankTwo on January 1, 2017 in order to expand its mining capabilities. The five-year note required annual payments of $208,349 and carried an annual interest rate of 8.5%. What is the amount of expense Farris must recognize on its 2018 income statement?
A) $68,000.
B) $56,070.
C) $43,127.
D) $50,290.

Question

Quizplus · Accepted Answer

In 2018, Farris would have made one annual payment of $208,349, which would include interest expense and reduction of principal. The interest expense for 2018 would be calculated as the carrying value of the loan at the beginning of the year multiplied by the interest rate. The carrying value of the loan at the beginning of 2018 would be calculated as the original principal balance less the portion of the principal that was repaid in 2017.

Beginning principal balance = $800,000 
Principal repaid in 2017 = $208,349 
Carrying value at beginning of 2018 = $591,651

Interest expense for 2018 = $591,651 * 8.5% = $50,290

Therefore, the amount of expense Farris must recognize on its 2018 income statement is $56,070 ($208,349 - $50,290 = $158,059 in principal reduction; $208,349 - $158,059 = $50,290 in interest expense).

Farris Company Borrowed $800,000 from BankTwo on January 1, 2017