Question

On June 30, 2021, the Esquire Company sold some merchandise to a customer for $40,000. In payment, Esquire agreed to accept a 5% note requiring the payment of interest and principal on March 31, 2022. The 5% rate is appropriate in this situation.
Required:
1. Prepare journal entries to record the sale of merchandise (omit any entry that might be required for the cost of the goods sold), the December 31, 2021 interest accrual, and the March 31, 2022 collection.
2. If the December 31 adjusting entry for the interest accrual is not prepared, by how much will income before income taxes be over-or understated in 2021 and 2022?

Answer 1

Answer:

Notes Receivables 40,000 debit

     Sales revenue            40,000 credit

-- to record the sale and the accepted promissory note--

interest receivables 1,000 debit

    interest revenue    1,000 credit

--to adjust for interest at year-end ---

Cash             41,500 credit

  Notes Receivables          40,000 credit

  Interest receivables           1,000 credit

 Interest revenue                    500 credit

--to record the maturity and honor of the note--

If we didn't make the adjusting entr. the 2021 income will be understated by 1,000 and the 2022 overstated by 1000

as we assing the 6 month of interest from 2021 into 2022 accounting period.

Explanation:

We record the sales reveneu for the nominal. over time we are going to accrue interest.

principal x rate x time = interest

we should express rate and time in the same metric, in this case as teh rate is annual we express time in portion of a year (X month / 12)

Adjusting entry at year-end

40,000 x 5% x  6 /12 = 1,000 interest revenue

At maturity:

40,000 x 5% x 3/12 = 500 interest revenue

And we have to write-of the note receivable and the interest receivables.