Many businesses borrow money during periods of increased business activity to fi
ID: 2513825 • Letter: M
Question
Many businesses borrow money during periods of increased business activity to finance inventory and accounts receivable. General Harbor Corporation is one of America’s largest general merchandise retailers. Each Christmas, General Harbor builds up its inventory to meet the needs of Christmas shoppers. A large portion of Christmas sales are on credit. As a result, General Harbor often collects cash from the sales several months after Christmas. Assume that on November 1, 2015, General Harbor borrowed $6.9 million cash from Metropolitan Bank and signed a promissory note that matures in six months. The interest rate was 8.00 percent payable at maturity. The accounting period ends December 31.
Indicate the accounts, amounts, and effects of the (a) issuance of the note on November 1; (b) impact of the adjusting entry on December 31, 2015; and (c) the payment of the note and interest on April 30, 2016, on the accounting equation. (Do not round intermediate calculations. Enter your answers in whole dollars. Enter any decreases to account balances with a minus sign.)
Many businesses borrow money during periods of increased business activity to finance inventory and accounts receivable. General Harbor Corporation is one of America’s largest general merchandise retailers. Each Christmas, General Harbor builds up its inventory to meet the needs of Christmas shoppers. A large portion of Christmas sales are on credit. As a result, General Harbor often collects cash from the sales several months after Christmas. Assume that on November 1, 2015, General Harbor borrowed $6.9 million cash from Metropolitan Bank and signed a promissory note that matures in six months. The interest rate was 8.00 percent payable at maturity. The accounting period ends December 31.
Explanation / Answer
Accounting equation is as below:
Assets = Liabilities + Capital
a.
In this case cash increases because of incoming of cash; this is an asset; therefore, asset increases. The corresponding increasing is liability, since note payable increases and it is a part of liability. The amount is $6,900,000.
b.
Interest amount would be adjusted at the year-end, 31st December. Since the loan is taken on 1st November, the adjustment should be made for 2 months, November and December.
Interest amount at the year-end = Note amount × Rate of interest × (2 months / Number of months in a year)
= $6,900,000 × 8% × (2 / 12)
= $552,000 × (1/6)
= $92,000
This is the interest expense at the year-end; it decreases capital account by way of retained earnings. It also increases liability, because the interest payable account increases.
c.
At the time of payment, the remaining interest amount (for 4 months) should be calculated.
Remaining interest amount (from January to April) = Note amount × Rate of interest × (4 months / Number of months in a year)
= $6,900,000 × 8% × (4/12)
= $552,000 × (1/3)
= $184,000
It increases interest expense; therefore, capital account should be decreased. Liability decreases by the amount of notes payable ($6,900,000) and interest payable ($92,000), since these are met at maturity. Asset decreases because of the payment of cash; cash includes notes amount, interest payable amount, and interest expense amount; (6,900,000 + 92,000 + 184,000 = $7,176,000)
Accounting equation
Assets
=
Liabilities
+
Capital
a.
Cash = $6,900,000
=
Notes payable = $6,900,000
+
0
Balance
$6,900,000
=
$6,900,000
+
0
b.
0
=
Interest payable = $92,000
+
Retained earnings = - $92,000
Balance
$6,900,000
=
$6,992,000
+
-$92,000
c.
Cash = - $7,176,000
=
Notes payable = - $6,900,000
Interest payable = - $92,000
+
Retained earnings = - $184,000
Balance
-$276,000
=
0
+
-$276,000
Assets
=
Liabilities
+
Capital
a.
Cash = $6,900,000
=
Notes payable = $6,900,000
+
0
Balance
$6,900,000
=
$6,900,000
+
0
b.
0
=
Interest payable = $92,000
+
Retained earnings = - $92,000
Balance
$6,900,000
=
$6,992,000
+
-$92,000
c.
Cash = - $7,176,000
=
Notes payable = - $6,900,000
Interest payable = - $92,000
+
Retained earnings = - $184,000
Balance
-$276,000
=
0
+
-$276,000
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