On 1/1/16,Lantana Loan Co.,a calendar-year company,accepts a 5%,$500,000 three-year loan that pays interest semi-annually on 6/30 and 12/31 from Diamond Distributors,when the market rate of interest was 10%.In exchange for the note,Diamond agrees to make semi-annual interest payment and repay the full $500,000 at maturity.What is the amount of discount amortized and the amount of Interest Revenue recorded on 6/30/16,the date of the first interest payment?

Question

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The first step is to calculate the present value of the loan, using the market rate of 10% and the semi-annual payments:

PV = $500,000 / (1 + 0.05/2) + $500,000 / (1 + 0.05/2)^2 + $500,000 / (1 + 0.05/2)^3
PV = $500,000 / 1.025 + $500,000 / 1.025^2 + $500,000 / 1.025^3
PV = $1,429,805.41

The difference between the face value and the present value of the loan is the discount, which is $1,429,805.41 - $500,000 = $929,805.41. This discount needs to be amortized over the life of the loan, so for the first six months, the discount amortization is:

Discount amortized = $929,805.41 * 0.05/2 = $23,245.14 (rounded to the nearest dollar)

The interest revenue is calculated as the difference between the cash received and the interest expense:

Interest revenue = $500,000 * 0.05/2 = $12,500
Interest expense = $1,429,805.41 * 0.10/2 = $71,490.27
Net interest expense = $71,490.27 - $12,500 = $58,990.27

Therefore, the journal entry on 6/30/16 would be:

Debit: Cash $12,500
Debit: Discount Amortization $9,328
Credit: Interest Revenue $21,828
Credit: Interest Payable $12,500
Credit: Discount on Notes Payable $9,328