On October 1 st the company borrows $500,000 from a local bank for nine months.

Question

On October 1st the company borrows $500,000 from a local bank for nine months. A note is signed with principal and 6% interest to be paid when the note matures next year. A note payable was recognized on October 1st and no other entries regarding this transaction were made until December 31st.

$__________ In the adjusting entry recorded on December 31st determine the amount of interest expense that should be reported.

What effect would failure to record the adjusting entry for this note payable have on the financial statement items?

A. would cause it to be overstated

B. would cause it to be understated

C. would have no effect

Assets

Liabilities

Stockholders’ Equity

Revenue

Expenses

Net income

Assets

Liabilities

Stockholders’ Equity

Revenue

Expenses

Net income

Explanation / Answer

$7,500

In the adjusting entry recorded on december 31st the amount of interest expense that should be reported is $7,500.

working:

interest for 3 months from october 1st to december 31st = note payable * interest rate * 3 months / 12 months

=>$500,000 * 6%* 3 /12

=>$7,500.

2nd part:

working : the adjusting entry should have been:

the following table shows the effect of failure to record the adjusting entry:

dec 31 interest expense a/c 7,500 .................To Interest payable a/c 7,500

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