A has an account payable of $7,700 due to B, Inc., one of its suppliers. The amo

Question

A has an account payable of $7,700 due to B, Inc., one of its suppliers. The amount was due to be paid on October 15, 2012. A only had enough cash on hand then to pay $1,700 of the amount due, so A's treasurer called B's treasurer and agreed to sign a note payable for the balance. The note was dated October 15, 2012, had an interest rate of 8% per annum, and was payable with interest on December 31, 2012. Write the journal entry, to show the effect of: a. The October 15, 2012 payment of $1,700 and the creation of a note payable for the balance owed. b. The October 31, 2012 accrual of interest expense for the month of October. c. The December 31, 2012 payment of the note and all of the interest due. Interest for November and December had not been accrued.

Explanation / Answer

A) Alright, well to first record the payment on the 15th of October, always ask yourself first what happened to cash. In this case we paid $1,700 cash so there is a credit to cash. Furthermore, we signed a note for the remaining, balance, which means we have a credit for a notes payable of $6,000(7,700-1,700) as well. Thus we have a credit for this transaction of 7,700, and need an equal and opposite debit entry for 7,700. In this case, we got rid of our accounts payable through the use of cash and a note payable, (the difference between an accounts payable and a notes payable is accounts payable is a verbal agreement whereas notes payable is an actual physical manifestation that shows an obligation to pay, in this case a note). Since we got rid of our accounts payable, that means we reduced a liability, which has a natural credit balance, thus to reduce it we must debit it. So, your final entry is a debit to accounts payable for $7,700 and a credit to notes payable for $6,000 and a credit to cash for $1,700. b) For b, we are recording the accrual of interest for the month of October. Usually, proper accounting requires a present value calculation, however, that is not necessary for transactions that are fulfilled quicker than a year. So, we simply compute the interest for October. We know that our interest rate is 8% and the cost of the note payable is $6,000. So, we use the equation i=prt, where i is interest, p is principal or 6,000 in this case, r is rate or 8%, and t is time, or the total time that the interest was computed. Thus i=6000*0.08*(1/12)(1/2), now to explain the 1/12 and 1/2 since the interest is per annum, or on a yearly basis, we need to divide it by 12 to see the interest for a single month, furthermore, the note for this month was only in existence for half the month, so we cut the cost in half. So total interest expense=$20 So we debit interest expense for 20, since to increase ADE (assets, dividends, expense) we debit them. Our credit will go to interest payable for 20 since we have not paid the interest yet. c) On December 31,2012 we must pay what we owe. First thing we know is that the note payable will no longer exist, so we will write it off for $6,000 by debiting it. We also will no longer have any interest payable since we are paying it off, so we will debit interest payable for $20. We do not include the interest for November or December as a payable since we never accrued it as said in the problem; however, we must still need to account for the interest during November and December, so, finding the interest expense again using the equation i=prt i=6000*0.08*2/12, since this is 2 months out of the year, we get i=$80. So we will debit interest expense for $80. Thus our total debits are note payable debit for $6,000 interest payable debit for $20 and interest expense for $80. Remember, always ask what happened to cash; we used cash to pay for the note and the interest, so we will credit cash for $6,100 (6000+20+80). DONE. Hope this helped. Go ahead and message me if you need anything else explained or something was unclear. Good luck and study hard.

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