Chapter 14, Problem 1QC

To determine

Notes:

• They are long term negotiable instruments of debt issued by corporate entities to secure funds from the public. These funds are used to either fund long term capital expenditure or similar long-term investment opportunities.
• They represent steady income for the investor in the form of periodic interest payments by the entity issuing the bond. Notes are issued at par, at premium or at a discount.
• Journal entries are the first step in recording financial transactions and preparation of financial statements. These represent the impact of the financial transaction and demonstrate the effect on the accounts impacted in the form of debits and credits.
• Assets and expenses have debit balances and Liabilities and Incomes have credit balances.

Journal Entry for the annual payment of interest and principal on December 31, 2019.

Answer to Problem 1QC

Solution:

The correct answer is Option D.

Explanation of Solution

The Journal Entry for the annual payment of interest and principal on December 31, 2019 is as follows:

Journal Entries
Date	Particulars	Debit ($)	Credit ($)
31.12.2019	Notes Payable	80,000
	Interest on Notes	40,000
	To Cash		1,20,000
	(Being Annual interest and principal payment on 5% Notes made)

• Formula Used:

$\text{Interest = Face Value x Rate of Interest}$

• Calculation:

$\text{Interest = \$800,000 x 5\% = \$40,000}$

• Notes Payable is a liability and must therefore have a credit balance. In order to reduce the balance due to principal repayment, it must be debited.

• Interest will be calculated on face value of bond i.e. $800,000.

• Interest on Notes A/c is an expense account and therefore has a debit balance. In order to create the expense account, it is debited.

• Bank Account balance is an asset and is reduced at the time of payment of interest on Notes and hence must be credited to indicate decrease.

• The interest is calculated on the difference of the Bond Repayable after deduction of principal repayment of $80,000.

Conclusion

Hence the correct option is Option D.