Question

9. A bank loaned York Construction Company $35,000 on a 1-year, 6% note, but deducted the interest in advance. The journal entry made by York to record receipt of the cash would include an a. increase in Cash for $35,000. b. decrease in Notes Payable for $32,900. c. increase in Discount on Notes Payable for $2,100. d. increase in Interest Revenue for $2,100.

Answer 1

Answer: The correct answer is c. increase in Discount on Notes Payable for $2,100.

Explanation: 6% of $35,000 for a year is $2,100. From the facts in the question, the Bank deducted the interest in advance, this means the net cash York Construction Company got was $35,000 - 2,100 = $32,900 but note that this does not change the principal amount obligation the Company is obliged to pay the bank, which remains $35,000. What the Company needs to do is to recognize the $35,000 as Notes Payable (Debit Cash and Credit Notes Payable) and recognize a Discount on Notes Payable of $2100 (Debit Discount on Notes Payable and Credit to Cash). Subsequently, based on the 1-year tenor, the Company would unwind the discount to finance charge / interest expense as $2,100 / 12 = $175 monthly (Debit Interest expense; Credit Discount on Notes Payable).