Many businesses borrow money during periods of increased business activity to fi

Question

Many businesses borrow money during periods of increased business activity to finance inventory and accounts receivable. Target Corporation is one of America's largest general merchandise retailers. Each Christmas, Target builds up its inventory to meet the needs of Christmas shoppers. A large portion of Christmas sales are on credit. As a result, Target often collects cash from the sales several months after Christmas. Assume that on November 1, 2010, Target borrowed $6 million cash from Metropolitan Bank and signed a promissory note that matures in six months. The interest rate was 7.5 percent payable at maturity. The accounting period ends December 31. Requirement 1: Indicate the accounts, amounts, and effects (+ for increase, - for decrease, and NE for no effect) of the (a) issuance of the note on November 1, (b) impact of the adjusting entry on December 31, 2010, and (c) the payment of the note and interest on April 30, 2011, on the accounting equation.

Explanation / Answer

a. assets +6 million; liabilities +6 millions; stock holders equity no effect. b. interest expense = 6 million * 0.075 * 2/12 = 75,000 assets no effect; liabilities +75,000 ; stock holders equity -75,000. c. total interest would be 6 million * 0.075 * 6/12 = 225,000 cash payment 6 million + 225,000 = 6,225,000; the rest of the interest expense (150,000) is recognized. The previously recorded liabilities are paid off. assets –6,225,000; liabilities –6,075,000; stock holders equity -150,000

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