Tokyo Imports received a six-month, noninterest-bearing note for $100,000 from Tall Mart in exchange for goods that have a fair value of $95,000. Tokyo uses a periodic inventory system, and views the financing component of this transaction to be significant.
Required:
Prepare the journal entry to record the sale.
Compute the effective annual rate of interest.
The journal entry to record the sale is as follows:
Accounts Receivable - Tall Mart $100,000
Sales Revenue $95,000
Sales Discount $5,000
Explanation:
Accounts Receivable - Tall Mart is debited for the full amount of $100,000, representing the amount the company expects to receive from Tall Mart.
Sales Revenue is credited for the fair value of the goods sold, which is $95,000.
Sales Discount is credited for the difference between the face value of the note ($100,000) and the fair value of the goods sold ($95,000), which is $5,000. This represents the financing component of the transaction.
To compute the effective annual rate of interest, we need to calculate the implied interest amount, which is the difference between the face value of the note and the fair value of the goods sold.
Implied interest amount = Face value of note - Fair value of goods sold
= $100,000 - $95,000
= $5,000
Next, we need to determine the time period for which the note is outstanding. Since it is a six-month note, the time period is 0.5 years.
Finally, we can calculate the effective annual rate of interest using the formula:
Effective Annual Rate of Interest = (Implied interest amount / Fair value of goods sold) / Time period
Effective Annual Rate of Interest = ($5,000 / $95,000) / 0.5
= 0.05263
Thus, the effective annual rate of interest is approximately 5.26%.