Melton Company sold some machinery to Addison Company on January 1, 2014. The cash selling price would have been $947,700. Addison entered into an installment sales contract which required annual payments of $250,000, including interest at 10%, over five years. The first payment was due on December 31, 2014. What amount of interest income should be included in Melton's 2015 income statement (the second year of the contract)?

Question

Quizplus · Accepted Answer

To calculate the interest income for the second year of the contract, we need to first calculate the carrying amount of the installment sales contract at the end of the first year.

Carrying amount at the end of year 1:
PV of the remaining payments = $250,000 x 4.16986 (PVIFA of 10% for 5 periods) = $1,042,465. 
The carrying amount of the installment sales contract at the end of year 1 would be $1,042,465.

The interest income for the second year of the contract would be the difference between the cash received ($250,000) and the interest portion of the payment. The interest portion can be calculated as the carrying amount at the beginning of the year multiplied by the interest rate.

Interest portion of second payment:
Carrying amount at beginning of year 2 = $1,042,465
Interest rate = 10%
Interest portion of second payment = $1,042,465 x 10% = $104,247

Therefore, the interest income for the second year of the contract would be $250,000 - $104,247 = $145,753. However, the question asked for the amount to be included in Melton's income statement, which would be the interest portion only, i.e. $104,247.

The option closest to this amount is B ($79,247) which could be an approximation error or a mistake in calculation.

Melton Company Sold Some Machinery to Addison Company on January