Chapter 13, Problem 13.3E

Short-term notes

• LO13–2

The following selected transactions relate to liabilities of United Insulation Corporation. United’s fiscal year ends on December 31.

Required:

Prepare the appropriate journal entries through the maturity of each liability.

2018
Jan. 13	Negotiated a revolving credit agreement with Parish Bank that can be renewed annually upon bank approval. The amount available under the line of credit is $20 million at the bank’s prime rate.
Feb. 1	Arranged a three-month bank loan of $5 million with Parish Bank under the line of credit agreement. Interest at the prime rate of 10% was payable at maturity.
May 1	Paid the 10% note at maturity.
Dec. 1	Supported by the credit line, issued $10 million of commercial paper on a nine-month note. Interest was discounted at issuance at a 9% discount rate.
31	Recorded any necessary adjusting entry(s).
2019
Sept. 1	Paid the commercial paper at maturity.

To determine

Long-term notes payable: Long-term notes payable represent a legal and written promise made by the business to pay a debt with interest over a period of more than a year. It is reported under the long-term liability section of the balance sheet.

Current portion of long-term notes payable: The principal amount of notes payable which would be paid within one year is called as current portion of long-term notes payable. The current portion of long-term notes payable is reported as a current liability.

To prepare: Necessary journal entries through the maturity of each liability.

Explanation of Solution

On January 13, 2016, there is no entry to be made because the loan is not made from the line of credit.

Record borrowing of cash on 10% notes payable.

Date		Accounts and Explanation			Post Ref	Debit ($)	Credit ($)
2016		Cash				5,000,000
February	1		Short-Term Notes Payable				5,000,000
				(To record the borrowed of cash on 10% notes payable.)

Table (1)

• Cash is an asset and is increased by $5,000,000 due to borrowing of cash on 10% notes payable. Thus, debit cash with $5,000,000.
• Short-term notes payable is a liability and is increased by $5,000,000 as borrowed cash on notes payable. Thus, credit short-term notes payable with $5,000,000.

Record payment of 10% notes payable at maturity.

Date		Accounts and Explanation			Post Ref	Debit ($)	Credit ($)
2016		Interest Expense				125,000
May	1	Short-Term Notes Payable				5,000,000
			Cash				5,125,000
				(To record the payment of 10% notes payable at maturity.)

• Interest expense is an expense and decreases the stockholders’ equity. Thus, debit Interest expense with $125,000.
• Short-term notes payable is a liability and is decreased by $5,000,000 due to payment made. Thus, debit short-term notes payable with $5,000,000.
• Cash is an asset and decreased due to payment made. Thus, credit Cash with $5,125,000.

Working notes:

Calculate interest expense for 3 months (February to April) on 10% note.

$\begin{array}{c}\text{Interest}\text{expense}=\text{Principal}\text{amount}\times \text{Rate}\text{of interest}\times \text{Time}\\ =\$5,000,000\times 10\%\times \frac{3}{12}\\ =\$125,000\end{array}$

Record the payment of 10% notes payable at maturity.

Date		Accounts and Explanation			Post Ref	Debit ($)	Credit ($)
2016		Cash				9,325,000
December	1	Discount on Notes Payable				675,000
			Notes payable				10,000,000
				(To record the notes issuance at 9% discounted rate.)

• Cash is an asset and is increased due to issuance of note. Thus, debit cash account with $9,325,000.
• Discount on notes payable is a contra liability and is increased. Thus, debit discount on notes payable account with $675,000.
• Notes payable is a liability and is increased by $10,000,000 as borrowed cash on notes payable. Thus, credit notes payable with $10,000,000.

Working note

Calculate the amount of discount on notes payable (commercial paper).

$\begin{array}{c}\text{Discount on notes payable}=\text{Principal amount}\times \text{Rate of discount}\times \text{Time}\\ =\text{\$10,000,000}\times \text{9\%}\times \frac{9}{12}\\ =\$675,000\end{array}$

Record the interest expense for 1 month.

Date		Accounts and Explanation			Post Ref	Debit ($)	Credit ($)
2016
December	1	Interest expense				75,000
			Discount on Notes Payable				75,000
				(To record the interest expense for 1 month.)

• Interest expense is an expense and decreases the stockholders’ equity. Thus, debit Interest expense with $75,000
• Discount on notes payable is a contra liability and is decreased due to payment of interest expense. Thus, credit discount on notes payable account with $75,000.

Working note

Calculate the interest expense for 1 month (December) on commercial paper.

$\begin{array}{c}\text{Interest expense}=\text{Principal}\text{amount}\times \text{Rate}\text{of interest}\times \text{Time }\\ =\text{\$10,000,000}\times \text{9\%}\times \frac{1}{12}\\ =\$75,000\end{array}$

Record the interest expense for 8 months.

Date		Accounts and Explanation			Post Ref	Debit ($)	Credit ($)
2017
September	1	Interest expense				600,000
			Discount on Notes Payable				600,000
				(To record the interest expense for 1 month.)

• Interest expense is an expense and decreases the stockholders’ equity. Thus, debit Interest expense with $600,000
• Discount on notes payable is a contra liability and is decreased due to payment of interest expense. Thus, credit discount on notes payable account with $600,000.

Working note

Calculate the interest expense for 8 months (January to August) on commercial paper.

$\begin{array}{c}\text{Interest expense}=\text{Principal}\text{amount}\times \text{Rate}\text{of interest}\times \text{Time }\\ =\text{\$10,000,000}\times \text{9\%}\times \frac{8}{12}\\ =\$600,000\end{array}$

Record the payment of commercial paper at maturity.

Date		Accounts and Explanation			Post Ref	Debit ($)	Credit ($)
2017
September	1	Notes payable				10,000,000
			Cash				10,000,000
				(To record payment of commercial paper at maturity.)

• Notes payable is a liability and is decreased by $10,000,000 as payment is made at maturity. Thus, debit notes payable with $10,000,000.
• Cash is an asset and decreased due to payment made. Thus, credit cash accounts with $10,000,000