Question
Problem Rent A Car, Inc. (RAC) purchased 100 vehicles on January 1, 2020, spending $2 million plus 11 percent total sales tax for a total
Problem
Rent A Car, Inc. (RAC) purchased 100 vehicles on January 1, 2020, spending $2 million plus 11 percent total sales tax for a total cost of $2,220,000. RAC expects to use the vehicles for five years and then sell them for approximately $360,000. RAC anticipates the following average vehicle use over each year ended December 31:
| 2020 | 2021 | 2022 | 2023 | 2024 | |
| Kilometers per year | 15,000 | 20,000 | 10,000 | 10,000 | 5,000 |
To finance the purchase, RAC borrowed $1.8 million by signing a 6% promissory note. The note is to be repaid in full by December 31, 2024. On December 31 of each year, RAC makes one payment on the installment note comprising blended interest and principal components. The amortization schedule for the note is presented below. RAC has a December 31 year-end. The company does not make monthly adjustments, but rather makes adjusting entries every quarter.
| Year | Beginning Note Payable | Interest Expense (6%) | Repaid Principle on Note Payable | Ending Note Payable |
|---|---|---|---|---|
| 2020 | 1,800,000 | 108,000 | 319,314 | 1,480,686 |
| 2021 | 1,480,686 | 88,841 | 338,473 | 1,142,213 |
| 2022 | 1,142,213 | 68,533 | 358,781 | 783,432 |
| 2023 | 783,432 | 47,006 | 380,308 | 403,124 |
| 2024 | 403,124 | 24,187 | 403,124 | 0 |
The note carries loan covenants that require RAC to maintain a minimum times interest earned ratio of 3.0. RAC forecasts that the company will generate the following sales and preliminary earnings (prior to recording depreciation on the vehicles and interest on the note). For purposes of this question, ignore income tax.
| 2020 | 2021 | 2022 | 2023 | 2024 | |
| Sales Revenue | $2,000,000 | $2,500,000 | $2,800,000 | $2,900,000 | $3,000,000 |
| Income before depreciation and interest expense | 1,000,000 | 800,000 | 900,000 | 1,200,000 | 1,100,000 |
Required:
- Assuming the company makes the required annual payments on December 31, use the amortization schedule to determine:
- The amount of the annual payment
- The total interest and principal paid over the notes life
- What portion of the Note Payable balance would be reported as current versus noncurrent on the December 31, 2021, balance sheet? Fill-in the two blanks below.
Note Payable, Current $
Note Payable, Noncurrent
- Calculate the depreciation expense that would be recorded in 2020 and 2021, using the (a) straight-line, (b) double-declining balance, and (c) units-of-production depreciation method.
2020 2021
a) straight line:
b) double-declining balance:
c) units-of-production:
- Using the information provided and your answers to requirement 3, determine net income and the loan covenant ratio in 2020 and 2021, assuming the company chooses the (a) straight-line, (b) double-declining-balance, and (c) units-of-production depreciation method.
2020 2021
a) straight line:
Net Income =
Times Interest Earned Ratio =
b) double-declining balance:
Net Income =
Times Interest Earned Ratio =
c) units-of-production:
Net Income =
Times Interest Earned Ratio =
- Using your answers to requirement 4, indicate whether the loan covenant would be violated under the (a) straight-line, (b) double-declining-balance, and (c) units-of-production depreciation method.
- If the loan covenant is violated at any point in requirement 5, what can the company do to make sure they are not offside?
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Survey of Accounting
Authors: Thomas P. Edmonds, Frances M. McNair, Philip R. Olds, Bor Yi
3rd Edition
978-1259683794, 77490835, 1259683796, 9780077490836, 978-0078110856
