On January 1, 20X1, Wade Crimbring, Inc., a dealer in used manufacturing equipment, sold a CNC milling machine to Fletcher Bros., a new business that plans to fabricate utility trailers. To conserve cash, Fletcher paid for the machine by issuing a $200,000 note, payable in five years. Interest at 5% is payable annually with the first payment due on December 31, 20X1. The going rate for loans of this type is 10%.

Required:

1. Record Crimbring’s sale of the machine on January 1, 20X1.

2. Prepare the entry that Crimbring would make on December 31, 20X1, to record the receipt of the first interest payment.

3. What is the nature of the account that arises as a consequence of the difference between the 5% cash interest and the effective yield of 10%?

4. Assume that Crimbring opted to carry this note at its fair value. What should be the value of the note on Crimbring’s December 31, 20X1, balance sheet if the market interest rate is then 12%? Assume that the December 31, 20X1, payment has been made.

5. Prepare the entry that Crimbring would make on December 31, 20X1, to record the note at its fair value.