Question

Ben Bradley started Bradley Company on January 1, Year 1. The company experienced the following events during its first year of operation: Earned $2,900 of cash revenue for performing services. Borrowed $4,400 cash from the bank. Adjusted the accounting records to recognize accrued interest expense on the bank note. The note, issued on August 1, Year 1, had a one-year term and a 6 percent annual interest rate. Required a. What is the amount of interest expense in Year 1? b. What amount of cash was paid for interest in Year 1? c. Use a horizontal financial statements model to show how each event affects the balance sheet, income statement, and statement of cash flows. Indicate whether the event increases (I) or decreases (D) each element of the financial statements model. Also, in the Statement of Cash Flows column, classify the cash flows as operating activities (OA), investing activities (IA), or financing activities (FA). The first transaction has been recorded as an example. (Note: Not all cells will require an input.)

Answer 1

Answer:

Bradley Company

a) Amount of interest expense in Year 1 = $110

b) Amount of cash paid for interest in Year 1 = $0

c) Horizontal Financial Statements Model:

Balance Sheet                                         Income Statement         Statement  

                                                                                                     of cash flows

Assets      = Liabilities  + Equity     Revenue - Expense = Profit

(I)+ $2,900 =  Liabilities + $2,900   +$2,900 - 0          = +2,900  $2,900 OA

(I)+ $4,400 =  +$4,400 + Equity          0        -   0          = Profit     $4,400 FA

Assets        =  (I)+$110 + (D) ($110)       0  -   ($110)        = ($110)      None

Explanation:

a) Data and Calculations:

Service Revenue in cash = $2,900

Bank Loan in cash = $4,400

Accrued Interest = $4,400 * 6% * 5/12 = $110

b) Each business transaction that Bradley undertakes has an effect on the accounting equation, but the equation is always in balance, if proper records are kept.  This is because of the duality of transactions as recorded by the double-entry system of accounting.  One transaction can increase an element of the equation and increase or decrease the other element as we have demonstrated above.