Long-term debt: impact of alternative valuation bases
On 1 January x1, Sylvie Company borrows A750,000 for five years at a fixed interest rate of 6% from Old Goriot Bank. Under the terms of the agreement, it pays interest of A45,000 on 31 December each year between x1 and x5 and repays the principal of A750,000 on 31 December x5.
During x1, market interest rates fall. By end-x1, when Sylvie Company prepares its accounts for the year, the interest rate on debt of equivalent maturity and risk is 5%. As a result, the current value of the loan at 31 December x1 (after payment of interest for the year) is A776,595. (This is the present value, as of 31/12/x1, of future loan payments discounted at 5%.)
Required
(a) Show the impact of the A750,000 loan on Sylvie Company's x1 income statement and end-x1 balance sheet, assuming the debt is valued at:
(i) historical cost;
(ii) current value.
(b) Suppose the current market interest rate remains at 5% in x2. What is the impact of the A750,000 loan on Sylvie Company's x2 income statement and end-x2 balance sheet, assuming the debt is valued at current value? The current value of the loan at 31 December x2 is A770,424.