This one confused me a bit…
On December 30, 2005, Bart, Inc. purchased a machine from Fell Corp. in exchange for a non-interest bearing note requiring eight payments of $20,000. The first payment was made on December 30, 2005, and the others are due annually on December 30. At date of issuance, the prevailing rate of interest for this type of note was 11%. Present value factors are as follows:
PVOA for 7 periods is 4.712, 8 periods is 5.146
PVOAD for 7 periods is 5.231, 8 periods is 5.712
On Bart's December 31, 2005 balance sheet, the note payable to Fell was:
a. $94,240
b. $102,920
c. $104,620
d. $114,240
The answer is A. I chose D. I treated it as an annuity due…I understand the difference (or I thought I did) but now I'm confused. I mean, if it was recorded as an annuity due for 8 periods then it would be 5.712 * 20,000 = 114,240. Then less the 20,000 payment due right away and then in that case it would be A. I'm just not sure why it is treated as an ordinary annuity right away I guess?
Explanation
The note payable balance at the end of 2005 is the present value of a $20,000 ordinary annuity for seven periods.
The first payment reduced the liability immediately by the amount of the payment because it was due at the date the liability originated. The remaining seven payments begin one year from the December 31, 2005 balance sheet, making the annuity an ordinary annuity. Thus, the liability balance on that date is: $20,000(4.712) = $94,240.
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