On January 1, 2010, Crown Company sold property to Leary Company.There was no established exchange price for the property, and Leary gave Crown a $2,000,000 zero-interest-bearing note payable in 5 equal annual installments of $400,000, with the first payment due December 31, 2010.The prevailing rate of interest for a note of this type is 9%.The present value of the note at 9% was $1,442,000 at January 1, 2010.What should be the balance of the Notes Payable account on the books of Leary at December 31, 2010 after adjusting entries are made, assuming that the effective-interest method is used?

Question

Quizplus · Accepted Answer

The effective-interest method allocates the interest expense and reduces the carrying value of the note over the life of the note. The interest expense for the year is $1,442,000 x 9% = $129,780. The carrying value of the note is reduced by the amount of the interest expense, so the balance of the Notes Payable account on the books of Leary at December 31, 2010 is $1,571,780 ($1,442,000 + $129,780).

On January 1, 2010, Crown Company Sold Property to Leary