Chapter 8, Problem 3CP

Recording Notes Receivable Transactions

Jung & Newbicalm Advertising (JNA) recently hired a new creative director, Howard Rachell, for its Madison Avenue office in New York. To persuade Howard to move from San Francisco, JNA agreed to advance him $100,000 on April 30, 2018, on a one-year, 10 percent note, with interest payments required on October 31, 2018, and April 30, 2019. JNA issues quarterly financial statements on March 31, June 30, September 30, and December 31.

Required:

1. 1. Prepare the journal entry that JNA will make to record the promissory note created on April 30, 2018.

   TIP: See Demonstration Case B for a similar problem.

2. 2. Prepare the journal entries that JNA will make to record the interest accruals at each quarter-end and interest payments at each payment date.

   TIP: Interest receivable will be accrued at the end of each quarter, and then will be reduced when the interest payment is received.

3. 3. Prepare the journal entry that JNA will make to record the principal payment at the maturity date.

To determine

Prepare the journal entry in the books of JN Advertising to record the promissory note received on April 30, 2018.

Explanation of Solution

Note Receivable:

Note receivable refers to a written promise by the debtor for the amounts to be received within a stipulated period of 60-90 days or longer time. This written promise is issued by a debtor or, a borrower to the lender or, creditor. Notes receivable is an asset of a business.

Prepare journal entry in the books of JN Advertising to record the promissory note received on April 30, 2018.

Date	Account Title and Explanation	Debit ($)	Credit ($)
April 30, 2018	Notes receivable	100,000
	Cash		100,000
	(To record the acceptance of the note receivable)

Table (1)

• Note Receivable is an asset account, and acceptance of note has increased the value of the asset, so debit it.
• Cash is an asset account, and it has decreased the value of the asset, so credit it.

To determine

Prepare the journal entry in the books of JN Advertising to record the interest accruals at the end of each quarter and the interest received at the each payment date.

Explanation of Solution

Prepare journal entry to record the interest accruals at the end of 2^nd quarter (June 30):

Date	Account Title and Explanation	Debit ($)	Credit ($)
June 30, 2018	Interest Receivable (1)	1,667
	Interest Revenue		1,667
	(To record the interest revenue accrued at the end of the 2nd quarter)

Table (2)

• Interest receivable is an asset and it increases the value of the asset, so debit interest receivable account.
• Interest revenue is a component of stockholder’s equity and it is increased, which in turn has increased the stockholder’s equity, so credit interest revenue account.

Working note 1:

Calculate the amount of interest revenue earned on note, as on June 30, 2018.

$\begin{array}{c}\text{Interest Receivable = }\left[\begin{array}{c}\text{Notes Receivable}\times \text{ Interest Percentage}\times \\ \left(\frac{\text{May 1, 2018 to June 30, 2018}}{12\text{ months}}\right)\end{array}\right]\\ \text{= \$100,000}\times \frac{10}{100}\times \frac{2\text{months}}{12}\\ =\text{\$1,667}\end{array}$

Prepare journal entry to record the interest accruals at the end of 3^rd quarter (September 30):

Date	Account Title and Explanation	Debit ($)	Credit ($)
September 30, 2018	Interest Receivable (2)	2,500
	Interest Revenue		2,500
	(To record the interest revenue accrued at the end of the 3rd quarter)

Table (3)

• Interest receivable is an asset and it increases the value of the asset, so debit interest receivable account.
• Interest revenue is a component of stockholder’s equity and it is increased, which in turn has increased the stockholder’s equity, so credit interest revenue account.

Working note 2:

Calculate the amount of interest revenue earned on note, as on September 30, 2018.

$\begin{array}{c}\text{Interest Receivable = }\left[\begin{array}{c}\text{Notes Receivable}\times \text{ Interest Percentage}\times \\ \left(\frac{\text{July 1, 2018 to September 30, 2018}}{12\text{ months}}\right)\end{array}\right]\\ \text{= \$100,000}\times \frac{10}{100}\times \frac{\text{3months}}{12}\\ =\text{\$2,500}\end{array}$

Journal entry to record the interest payment received on October 31, 2018:

Date	Account Title and Explanation	Debit ($)	Credit ($)
October 31, 2018	Cash	5,000
	Interest Receivable $\left(\$1,667+\$2,500\right)$		4,167
	Interest Revenue (3)		833
	(To record collection of interest)

Table (4)

Collection of interest on note to be recorded by increasing cash, eliminating interest receivable, and recording interest revenue.

• An increase in cash (asset account) is debited with $5,000,
• A decrease in interest receivable (asset account) is credited with $\left(\$1,667+\$2,500\right)$$4,167, and
• An increase in interest revenue (stockholders’ equity account) is credited with $833.

Working note 3:

Calculate the amount of interest revenue earned on note, from October 1 to 31.

$\begin{array}{c}\text{Interest Revenue = }\left[\begin{array}{c}\text{Notes Receivable}\times \text{ Interest Percentage}\times \\ \left(\frac{\text{October 1, 2018 to October 31, 2018}}{12\text{ months}}\right)\end{array}\right]\\ \text{= \$100,000}\times \frac{10}{100}\times \frac{\text{1month}}{12}\\ =\text{\$833}\end{array}$

Prepare journal entry to record the interest accruals at the end of 4^th quarter (December 31, 2018):

Date	Account Title and Explanation	Debit ($)	Credit ($)
December 31, 2018	Interest Receivable (4)	1,667
	Interest Revenue		1,667
	(To record the interest revenue accrued at the end of the 4th quarter)

Table (5)

Working note 4:

Calculate the amount of interest revenue earned on note, as on December 31, 2018.

$\begin{array}{c}\text{Interest Receivable = }\left[\begin{array}{c}\text{Notes Receivable}\times \text{ Interest Percentage}\times \\ \left(\frac{\text{November 1, 2018 to December 31, 2018}}{12\text{ months}}\right)\end{array}\right]\\ \text{= \$100,000}\times \frac{10}{100}\times \frac{2\text{months}}{12}\\ =\text{\$1,667}\end{array}$

• Interest receivable is an asset and it increases the value of the asset, so debit interest receivable account.
• Interest revenue is a component of stockholder’s equity and it is increased, which in turn has increased the stockholder’s equity, so credit interest revenue account.

Prepare journal entry to record the interest accruals at the end of 1^st quarter of 2019 (March 31, 2019)

Date	Account Title and Explanation	Debit ($)	Credit ($)
March 31, 2019	Interest Receivable (5)	2,500
	Interest Revenue		2,500
	(To record the interest revenue accrued at the end of the 1st quarter in 2019)

Table (6)

• Interest receivable is an asset and it increases the value of the asset, so debit interest receivable account.
• Interest revenue is a component of stockholder’s equity and it is increased, which in turn has increased the stockholder’s equity, so credit interest revenue account.

Working note 5:

Calculate the amount of interest revenue earned on note, as on March 31, 2019.

$\begin{array}{c}\text{Interest Receivable = }\left[\begin{array}{c}\text{Notes Receivable}\times \text{ Interest Percentage}\times \\ \left(\frac{\text{January 1, 2019 to March 31, 2019}}{12\text{ months}}\right)\end{array}\right]\\ \text{= \$100,000}\times \frac{10}{100}\times \frac{\text{3months}}{12}\\ =\text{\$2,500}\end{array}$

Prepare journal entry to record the interest payment received on April 30, 2019.

Date	Account Title and Explanation	Debit ($)	Credit ($)
April 30, 2019	Cash	5,000
	Interest Receivable $\left(\$1,667+\$2,500\right)$		4,167
	Interest Revenue (6)		833
	(To record collection of interest)

Table (7)

Collection of interest on note to be recorded by increasing cash, eliminating interest receivable, and recording interest revenue.

• An increase in cash (asset account) is debited with $5,000,
• A decrease in interest receivable (asset account) is credited with $\left(\$1,667+\$2,500\right)$$4,167 and
• An increase in interest revenue (stockholders’ equity account) is credited with (6) $833.

Working note 6:

Calculate the amount of interest revenue earned on note, from April 1 to April 30, 2019.

$\begin{array}{c}\text{Interest Revenue = }\left[\begin{array}{c}\text{Notes Receivable}\times \text{ Interest Percentage}\times \\ \left(\frac{\text{April 1, 2019 to April 31, 2019}}{12\text{ months}}\right)\end{array}\right]\\ \text{= \$100,000}\times \frac{10}{100}\times \frac{\text{1month}}{12}\\ =\text{\$833}\end{array}$

To determine

Prepare the journal entry in the books of JN Advertising to record the collection of principal on note at maturity.

Explanation of Solution

Prepare journal entry to record the collection of principal on the note at maturity.

Date	Account Title and Explanation	Debit ($)	Credit ($)
April 30, 2019	Cash	100,000
	Notes Receivable		100,000
	(To record the collection of principal on note)

Table (8)

Collection of principal must be recorded by increasing cash and eliminating notes receivable account by $100,000. Hence,

• An increase in cash (asset account) is debited with $100,000, and
• A decrease in notes receivable (asset account) is credited with $100,000.