Chapter 17, Problem 1MP

Eddie Edwards and Phil Bell own and operate The Second Hand Equipment Shop. The following transactions involving notes and interest were completed during the last three months or 20--:

REQUIRED

1. 1. Prepare general journal entries for the transactions.
2. 2. Prepare necessary adjusting entries for the notes outstanding on December 31.

To determine

Prepare journal entry to record the following transactions.

Explanation of Solution

Note receivable:

Note receivable refers to a written promise for the amounts to be received within a stipulated period of time. This written promise is issued by a debtor or, borrower to the lender or creditor. Notes receivable is an asset of a business.

Prepare journal entry to record the following transactions.

Date	Account titles and Explanation	Debit	Credit
October 1	Purchases	$6,800
	Notes payable		$6,800
	(To record note issued for inventory purchases)
October 15	Notes receivable	$2,000
	Sales		$2,000
	(To record note received for merchandise for sale)
November 1	Cash (1)	$2,003.11
	Notes receivable		$2,000
	Interest revenue (2)		$3.11
	(To record discount on notes receivable)
November 1	Cash (4)	$4,925
	Discount on notes payable (3)	$75
	Notes payable		$5,000
	(To record issued note for bank loan)
November 20	Notes receivable	$4,000
	Accounts receivable - L.R		$4,000
	(To record received note to settle account)
November 30	Notes payable	$6,800
	Interest expense (5)	$56.67
	Cash		$6,856.67
	(To record paid note with interest at maturity)
December 10	Accounts payable - RT	$3,000
	Notes payable		$3,000
	(To record issued note to settle account)
December 16	Accounts receivable - R.C (6)	$2,040
	Cash		$2,040
	(To record paid bank for dishonoured note)

Table (1)

Working notes:

(1) Calculate cash proceeds.

$\begin{array}{c}\text{Cash proceeds =}\text{Maturity value }-\text{Discount amount (Difference in time period)}\\ \text{=}\left(\$2,000+\left(\$2,000\times 6\%\times \frac{60}{360}\right)\right)-\left(\$2,020\times 7\%\times \frac{43}{360}\right)\\ =\$2,020-\$16.89\\ =\$2,003.11\end{array}$

(2) Calculate interest expense.

$\begin{array}{c}\text{Interest revenue =}\text{Cash proceeds}-\text{Notes receivable}\\ \text{= \$2,003}\text{.11}-\$2,000\\ =\$3.11\end{array}$

(3) Calculate discount on notes payable.

$\begin{array}{c}\text{Discount on notes payable =}\text{Notes payable}\times \text{Interest rate }\times \text{Time period}\\ \text{=}\text{\$5,000}\times 6\%\times \frac{90}{360}\\ =\$75\end{array}$

 (4) Calculate cash proceeds.

$\begin{array}{c}\text{Cash proceeds =}\text{Notes payable }-\text{Discount on notes payable}\\ \text{=}\text{\$5,000}-\$75\\ =\$4,925\end{array}$

(5) Calculate interest expenses.

$\begin{array}{c}\text{Interest expenses =}\text{Notes payable}\times \text{Interest rate}\times \text{Time period}\\ \text{=}\text{\$6,800}\times \text{5\%}\times \frac{60}{360}\\ =\$56.67\end{array}$

(6) Calculate accounts receivable.

$\begin{array}{c}\text{Accounts receivable =}\text{Issued value of notes receivable + Interest revenue + Bank fee}\\ \text{=}\$2,000+\left(\text{\$2,000}\times \text{6\%}\times \frac{60}{360}\right)+\$20\\ =\$2,040\end{array}$

To determine

Prepare adjusting entries for the notes outstanding on 31^st December.

Explanation of Solution

Adjusting entries: Adjusting entries are those entries which are recorded at the end of the year, to update the income statement accounts (revenue and expenses) and balance sheet accounts (assets, liabilities, and stockholders’ equity) to maintain the records according to accrual basis principle.

Prepare adjusting entries for the notes outstanding on 31^st December.

Date	Account titles and Explanation	Debit	Credit
December 31	Interest expense (7)	$50
	Discount on notes payable		$50
	(To record adjusting entry for interest expense)
December 31	Interest expense (8)	$10.50
	Accrued interest payable		$10.50
	(Record adjusting entry for interest expense)
December 31	Accrued interest receivable	$29.61
	Interest revenue (9)		$29.61
	(To record adjusting entry for interest revenue)

Table (2)

Working notes:

(7) Calculate interest expense.

$\begin{array}{c}\text{Interest expenses =}\text{Notes payable}\times \text{Interest rate}\times \text{Time period}\\ \text{=}\text{\$5,000}\times 6\text{\%}\times \frac{60}{360}\\ =\$50\end{array}$

(8) Calculate interest expense.

$\begin{array}{c}\text{Interest expenses =}\text{Notes payable}\times \text{Interest rate}\times \text{Time period}\\ \text{=}\text{\$3,000}\times 6\text{\%}\times \frac{21}{360}\\ =\$10.50\end{array}$

(9) Calculate interest revenue.

$\begin{array}{c}\text{Interest revenue =}\text{Notes receivable}\times \text{Interest rate}\times \text{Time period}\\ \text{=}\text{\$4,000}\times 6.5\text{\%}\times \frac{41}{360}\\ =\$29.61\end{array}$