Problem 12 - Accounting

Question

On January 1, 2010, Zinn Company obtained a \(52,000, four-year, 6.5% installment note from Fidelity Bank. The note requires annual payments of \)15,179, beginning on December 31, 2011. a. Prepare an amortization table for this installment note, similar to the one presented in Exhibit 3. b. Journalize the entries for the issuance of the note and the four annual note payments.

Step-by-Step Solution

Answer

Amortization tables help manage loan repayments; summarize with journal entries.

Step 1: Understanding the Installment Note

The installment note is a 4-year loan for \(52,000\) with an annual interest rate of 6.5%. The loan requires annual payments of \(15,179\) starting from December 31, 2011.

Step 2: Calculate Interest for the First Year

To calculate the interest for the first year, multiply the principal (\(52,000\)) by the interest rate (6.5%). Interest = \( 52,000 \times 0.065 = 3,380 \)

Step 3: Calculate Principal Payment for the First Year

The total annual payment is \(15,179\). To find the principal payment, subtract the interest from the total payment:Principal Payment = \( 15,179 - 3,380 = 11,799 \)

Step 4: Update Principal Balance for the Second Year

Subtract the principal payment from the initial principal to find the new balance:New Principal Balance = \( 52,000 - 11,799 = 40,201 \)

Step 5: Construct the Amortization Table

Repeat the process of calculating interest, principal payment, and updating the principal balance for 4 years. Record each year in the amortization table with columns for Year, Beginning Balance, Payment, Interest, Principal, and Ending Balance.

Step 6: Prepare Journal Entry for Note Issuance

On January 1, 2010, record the receipt of cash by debiting Cash and crediting Notes Payable:- Debit Cash \(52,000\)- Credit Notes Payable \(52,000\)

Step 7: Journal Entry for First Annual Payment

For the first annual payment on December 31, 2011, record the interest expense and reduction of the note payable:- Debit Interest Expense \(3,380\)- Debit Notes Payable \(11,799\)- Credit Cash \(15,179\)

Step 8: Journal Entry for Subsequent Payments

Repeat the journal entry process for each of the next three annual payments using the interests and principal values from the amortization table.

Key Concepts

Installment Note

When a company borrows money and agrees to repay it over a set period, it often uses something called an "installment note." In this case, Zinn Company acquired a note from Fidelity Bank for $52,000 with a duration of four years, and an annual interest rate of 6.5%.
Importantly, this note does not only involve repaying the principal amount borrowed but also includes interest payments.
An installment note means the borrower will pay back the principal and the accumulated interest over time through yearly or monthly payments.

• Duration: This particular note is structured over four years.
• Interest: The rate of interest here is fixed at 6.5% annually.
• Payments: Zinn Company is required to make annual payments of $15,179 beginning from the end of the first year, December 31, 2011.

Understanding the installment note is crucial because it sets the stage for how the payments will reduce the overall debt over time.

Journal Entries

Journal entries are vital records that outline the insights of financial transactions. They are central to accounting and often reflect how a company manages its finances.
For Zinn Company, journalizing the transactions related to the installment note involves recording two key moments:

• Issuing the Note: When Zinn receives the $52,000 from Fidelity Bank, an entry is recorded to show this inflow of funds. This is done by making a Debit entry to the Cash account and a Credit entry to Notes Payable.
• Annual Payments: Each year, Zinn will document the financial transaction of making a payment. This includes interest paid and reduction in the note's principal. For example, after the first payment, they would Debit Interest Expense for the interest portion, Debit Notes Payable for the principal paid back, and Credit Cash for the total payment made.

This systematic documentation helps keep track of financial obligations and how they change over time.

Interest Calculation

Calculating interest is a crucial component of managing an installment note. It's how we determine the cost of borrowing the money over time.
In the first year, the interest for Zinn Company's note is calculated by multiplying the rate (6.5%) by the principal amount ($52,000):\[ Interest = 52,000 \times 0.065 = 3,380 \]This calculation is repeated yearly based on the outstanding principal after each payment.
This year's interest payment ensures the lender receives compensation for the time the money is borrowed. As payments are made, the principal decreases and hence, the interest payments also reduce over time.

Principal Payment

Paying off the principal is like chipping away at the main loan amount. It's the piece of each payment that reduces the outstanding balance on the note.
After determining how much of the annual payment goes to interest, the remaining amount is applied to reduce the principal. For Zinn Company, during the first year, $11,799 of the $15,179 total payment went toward reducing the principal.

• Total Payment: $15,179
• Interest Portion: $3,380
• Principal Payment: 15,179 - 3,380 = $11,799

With each subsequent payment, this principal reduction process continues, progressively lowering the borrowed amount and consequently reducing future interest payments. Over the loan's life, reducing the principal becomes key in minimizing interest expenses.