Great Adventures obtains a $42,000 low-interest loan for the company from the ci
ID: 2539326 • Letter: G
Question
Great Adventures obtains a $42,000 low-interest loan for the company from the city council, which has recently passed an initiative encouraging business development related to outdoor activities. The loan is due in three years, and 6% annual interest is due each year on July 31. Record adjusting entries as of December 31, 2018.
Assume the following ending balances for the month of July.
Cash $ 27,250 Prepaid insurance 5,640 Supplies (Office) 1,800 Equipment (Bikes) 15,700 Accounts payable 1,800 Deferred revenue 6,500 Common stock 39,000 Service revenue (Clinic) 5,350 Advertising expense 1,060 Legal fees expense 1,200
Explanation / Answer
The balance sheet for the last July is as below.
Assets
$
Liabilities & Capital
$
Current assets:
Current liabilities:
Cash
27,250
Accounts payable
1,800
Prepaid insurance
5,640
Deferred revenue
6,500
Supplies
1,800
Total current liabilities
8,300
Total current assets
34,690
Capital:
Fixed assets:
Common stock
39,000
Equipment
15,700
Retained earnings (Note 1)
3,090
Total assets
50,390
Total liabilities & capital
50,390
Note 1: Retained earnings = Net income = Service revenue – Advertising expense – Legal fees
= 5,350 – 1,060 – 1,200
= 3,090
There is no loan amount in the above balance sheet, since it is taken on 31st July.
Therefore, the adjustment entry for interest amount should be made for 31st July to 31st December (the gap of 5 months).
Interest amount = Loan amount × Annual interest rate × (Number of months / Months is a year)
= $42,000 × 6% × (5 / 12)
= $42,000 × 0.06 × 0.416666
= $1,050
Interest expense is debited, since it is chargeable during the year; interest payable is credited, since it becomes due to be paid.
Adjusting entry
Date
Accounts titles & explanations
P.ref
Debit
Credit
31/12/18
Interest expense
$1,050
Interest payable
$1,050
To record adjusting entry at the year end
Assets
$
Liabilities & Capital
$
Current assets:
Current liabilities:
Cash
27,250
Accounts payable
1,800
Prepaid insurance
5,640
Deferred revenue
6,500
Supplies
1,800
Total current liabilities
8,300
Total current assets
34,690
Capital:
Fixed assets:
Common stock
39,000
Equipment
15,700
Retained earnings (Note 1)
3,090
Total assets
50,390
Total liabilities & capital
50,390
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