Problem Solving Survival Guide to accompany Financial Accounting, 8th Edition

SOLUTION TO EXERCISE 10-10

Explanation to part (a): The cost of the building is determined by the fair market value of the consideration given which is the $80,000 cash plus the $400,000 present value of the note payable.

Explanation to parts (b) and (c): The mortgage note payable is recorded initially at its face value [see part (a)], which is often referred to as the note's beginning principal, and each installment payment reduces the outstanding principal amount. The installment payments are an equal amount each interest period; however, the portion of the payment going to cover interest charges and the portion going to reduce the outstanding principal varies each period. In this exercise, the installment payments are due semiannually; thus, the length of an interest period is six months and the annual interest rate (10%) must be expressed on a semiannual basis (5%) to perform the interest computation. Interest is a function of outstanding balance, interest rate, and time. Thus, the interest sustained for the first six months is determined by the note's initial carrying value (the face value of $400,000), the annual rate of 10%, and a six-month time period. The interest sustained for the second six months cannot be determined until the outstanding principal balance is updated ...