2. One of the customers at Faith Company has contacted management and explained

Question

2. One of the customers at Faith Company has contacted management and explained to the company that they have a cash flow issue. The cash flow issue will last eight months and they will like not be able to pay their balance due of $10,400 until the end of eight months. Both companies agree they should create a promissory note, which they signed on March 1.

a. Each student will create the annual interest rate that was assigned to the note.

b. Record the journal entry for Faith Company when the note was signed.

c. Prepare the journal entry for Faith Company when the note matures.

d. Explain how the journal entry in ‘c’ affected the Balance Sheet for Faith Company, be specific.

Explanation / Answer

a. Let the annual interest be 6%, 240 days.

b When the note is signed on March 1, the following entry is passed.

Note receivable account debit 10,400 Account receivable credit 10,400

c.When the note matures on November 1, and payment is received of the principal outstanding plus interest,

the following journal entry is passed:

d.The journal entry in 'c' firstly caused one asset, i.e note receivable to be replaced by another,i.e cash. In other words the transaction leads to a change in the asset portfolio. Note receivable of $ 10,400 goes out, and in its place, a like amount is added to cash account.But this does not lead to balance sheet growth. But the interest revenue of $ 416 leads to balance sheet growth, as it increases cash on the one hand, and leads to an increase in retained earnings on the other.

Therefore the net effect on the balance sheet is the $416 increase to balance sheet total.

Account Title Debit Credit Nov 1 Cash 10,816 Note receivable 10,400 Interest revenue 416

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