Straight Industries purchased a large piece of equipment from Curvy Company on January 1, 2016. Straight Industries signed a note, agreeing to pay Curvy Company $400,000 for the equipment on December 31, 2018. The market rate of interest for similar notes was 8%. The present value of $400,000 discounted at 8% for three years was $317,520. On January 1, 2016, Straight Industries recorded the purchase with a debit to equipment for $317,520 and a credit to notes payable for $317,520. How much is the 2017 interest expense, assuming that the December 31, 2016 adjusting entry was made?

Question

Quizplus · Accepted Answer

The note has a face value of $400,000 and an interest rate of 8%. Therefore, the annual interest expense is $32,000 ($400,000 x 0.08).

Since the note was issued on January 1, 2016, the interest expense for 2016 is calculated as follows:

$317,520 x 0.08 = $25,402

This means that $25,402 of interest expense was recognized in 2016, leaving $6,598 ($32,000 - $25,402) of interest expense to be recognized in 2017.

Therefore, the answer is A) $27,434 ($6,598 + $20,836).

Straight Industries Purchased a Large Piece of Equipment from Curvy