Chapter 14, Problem 13E

To determine

Prepare the journal entry to record issuance of notes.

Explanation of Solution

Notes payable: Notes Payable is a written promise to pay a certain amount on a future date, with the certain percentage of interest. Companies use to issue notes payable to meet short-term financing needs.

Prepare the journal entry to record issuance of notes as follows:

Date	Account titles and Explanation	Post ref.	Debit	Credit
January 1, 2019	Cash		$100,000
	Notes payable			$100,000
	(To record issuance of notes payable)

Table (1)

To record issuance of notes payable:

• Cash is a current asset, and it is increased. Therefore, debit cash account for $100,000.
• Notes payable is a short term liability, and it is increased. Therefore, credit notes payable account for $100,000.

Journalize the first note payment on December 31, 2019, as follows:

Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
December 31, 2019	Notes Payable		22,523 (2)
	Interest Expense		7,000 (1)
	Cash			29,523
	(To record the first payment of bonds payable with due interest)

Table (2)

To record the first payment of bonds payable with due interest:

• Notes Payable is a liability and it is decreased. Therefore, it is debited for $22,523.
• Interest expense is a component of stockholders’ equity and decreased it, so debit interest expense for $7,000.
• Cash is an asset and payment of interest expense decreases cash, so it is credited for $29,523.

Working Notes:

Interest expense for one year is computed as below:

$\begin{array}{l}\text{Interest expense = Notes payable}\times \text{Annual interest rate}\\ \text{ = \$100,000}\times 7\text{\%}\\ \text{ = \$7,000}\end{array}$ (1)

Calculate the portion of notes payable paid.

Interest expense = $7,000

Four equal payments = $29,523

$\begin{array}{c}\text{Portion of notes payable paid = Four equal payments}-\text{Interest expense}\\ \text{=}\text{\$29,523}-\$7,000\\ \text{= \$22,523}\end{array}$ (2)

Journalize the second note payment on December 31, 2020, as follows:

Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
December 31, 2020	Notes Payable		24,100 (4)
	Interest Expense		5,423 (3)
	Cash			29,523
	(To record the second payment of bonds payable with due interest)

Table (3)

To record the second payment of bonds payable with due interest:

• Notes Payable is a liability and it is decreased. Therefore, it is debited for $24,100.
• Interest expense is a component of stockholders’ equity and decreased it, so debit interest expense for $5,423.
• Cash is an asset and payment of interest expense decreases cash, so it is credited for $29,523.

Working Notes:

Interest expense for second year is computed as below:

$\begin{array}{c}\text{Interest expense = Net notes payable}\times \text{Annual interest rate}\\ \text{ = }\left(\text{\$100,000}-\$22,523\right)\times 7\text{\%}\\ \text{ = \$77,477}\times 7\text{\%}\\ =\$5,423\end{array}$ (3)

Calculate the portion of notes payable paid.

Interest expense = $5,423

Four equal payments = $29,523

$\begin{array}{c}\text{Portion of notes payable paid = Four equal payments}-\text{Interest expense}\\ \text{=}\text{\$29,523}-\$5,423\\ \text{= \$24,100}\end{array}$ (4)

Journalize the third note payment on December 31, 2021, as follows:

Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
December 31, 2021	Notes Payable		25,787 (6)
	Interest Expense		3,736 (5)
	Cash			29,523
	(To record the third payment of bonds payable with due interest)

Table (4)

To record the third payment of bonds payable with due interest:

• Notes Payable is a liability and it is decreased. Therefore, it is debited for $25,787.
• Interest expense is a component of stockholders’ equity and decreased it, so debit interest expense for $3,736.
• Cash is an asset and payment of interest expense decreases cash, so it is credited for $29,523.

Working Notes:

Interest expense for third year is computed as below:

$\begin{array}{c}\text{Interest expense = Net notes payable}\times \text{Annual interest rate}\\ \text{ = }\left(\text{\$100,000}-\$22,523-\$24,100\right)\times 7\text{\%}\\ \text{ = \$53,377}\times 7\text{\%}\\ \text{=}\text{\$3,736}\end{array}$ (5)

Calculate the portion of notes payable paid.

Interest expense = $3,736

Four equal payments = $29,523

$\begin{array}{c}\text{Portion of notes payable paid = Four equal payments}-\text{Interest expense}\\ \text{=}\text{\$29,523}-\$3,736\\ \text{= \$25,787}\end{array}$ (6)

Journalize the fourth note payment on December 31, 2022, as follows:

Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
December 31, 2022	Notes Payable		27,590 (8)
	Interest Expense		1,933 (7)
	Cash			29,523
	(To record the fourth payment of bonds payable with due interest)

Table (5)

To record the fourth payment of bonds payable with due interest:

• Notes Payable is a liability and it is decreased. Therefore, it is debited for $27,590.
• Interest expense is a component of stockholders’ equity and decreased it, so debit interest expense for $1,933.
• Cash is an asset and payment of interest expense decreases cash, so it is credited for $29,523.

Working Notes:

Interest expense for fourth year is computed as below:

$\begin{array}{c}\text{Interest expense = Net notes payable}\times \text{Annual interest rate}\\ \text{ = }\left(\text{\$100,000}-\$22,523-\$24,100-\$25,787\right)\times 7\text{\%}\\ \text{ = \$27,590}\times 7\text{\%}\\ \text{=}\text{\$1,931}\end{array}$ (7)

Calculate the portion of notes payable paid.

Interest expense = $1,933

Four equal payments = $29,523

$\begin{array}{c}\text{Portion of notes payable paid = Four equal payments}-\text{Interest expense}\\ \text{=}\text{\$29,523}-\$1,933\\ \text{= \$27,590}\end{array}$ (8)