Problem 20 - Accounting

Question

South Bay Interior Decorators issued a 90 -day, \(6 \%\) note for \(\$ 40,000\), dated April 15 , to Miami Furniture Company on account. a. Determine the due date of the note. b. Determine the maturity value of the note. c. Journalize the entries to record the following: (1) receipt of the note by Miami Furniture and (2) receipt of payment of the note at maturity.

Step-by-Step Solution

Answer

The note's due date is July 14, with a maturity value of \$40,600. Upon issue, debit Notes Receivable \$40,000 and credit Accounts Receivable \$40,000. Upon payment, debit Cash \$40,600, credit Notes Receivable \$40,000, and credit Interest Revenue \$600.

Step 1: Calculate the Due Date

To calculate the due date of the 90-day note, start counting from the date of the issuance, which is April 15. - April has 30 days. Therefore, the remaining days from April 15 to the end of April is 15 days. - Since May has 31 days, subtracting the 15 days leaves us needing 75 more days. All of May counts towards this as it contributes 31 days. - June has 30 days, so it adds 30 more days (31 from May + 30 from June, totaling 61 days). - July will supply the remaining days. Since we need 29 more days to reach 90, July 14 is when the 90 days are completed. Thus, the due date is July 14.

Step 2: Determine the Maturity Value

To find the maturity value of the note, calculate the interest first and then add it to the principal.- The interest is calculated using the formula: \[ \text{Interest} = \frac{\text{Principal} \times \text{Rate} \times \text{Time}}{360} \] Here, the principal is \\(40,000, the rate is \(6\%\), and the time is 90 days.- Plug in the values: \[ \text{Interest} = \frac{40,000 \times 0.06 \times 90}{360} = 600 \]- The maturity value is the sum of the principal and the interest, \[ \text{Maturity Value} = 40,000 + 600 = 40,600 \].Thus, the maturity value is \\)40,600.

Step 3: Journalize Receipt of the Note

When Miami Furniture receives the note, it should be recorded as a Notes Receivable. The entry for the receipt of the note is:- Debit "Notes Receivable" for \\(40,000.- Credit "Accounts Receivable" for \\)40,000 (This reflects the conversion of the account receivable into a note receivable).

Step 4: Journalize Receipt of Payment at Maturity

On July 14, when the payment is received, Miami Furniture records the following:- Debit "Cash" for \\(40,600 (sum of the principal and interest, the maturity value).- Credit "Notes Receivable" for \\)40,000 (payment of the principal).- Credit "Interest Revenue" for \$600 (payment of the interest).

Key Concepts

Interest Calculation

When a company issues a note payable, one key component they need to determine is the interest that will accumulate over the note's term. Interest on a note is essentially the cost of borrowing money and is usually expressed as a yearly percentage rate. Let's look at how you can calculate it using a clear formula.

The formula for calculating interest is given by:
\[\text{Interest} = \frac{\text{Principal} \times \text{Rate} \times \text{Time}}{360}\]

• Principal: This is the original amount of the note. In our example, this is \\(40,000.
• Rate: This is the annual interest rate expressed as a decimal. For a 6% rate, you would use 0.06.
• Time: This is the duration for which the interest is calculated. Note that the time is based on a 360-day year in most exercises for simplicity.

In the example, replacing the values gives:\[\text{Interest} = \frac{40,000 \times 0.06 \times 90}{360} = 600\]
Thus, the interest for a 90-day period is \\)600. This means that by the end of the note's term, an additional \$600 will need to be paid as interest along with the principal.

Maturity Date

The maturity date is essentially the calendar date on which the note payable is due to be paid. Calculating it correctly requires knowing the starting point and the term's length. For a note issued for a specific number of days, such as 90 days, you simply count forward those 90 days from the issue date.

For instance, with an issue date of April 15, here's how to determine the maturity date:

• April: Start by counting the days from the issuance date. From April 15 to April 30 equals 15 days.
• May: Add the full 31 days for May.
• June: Include all 30 days of June.
• July: Continue counting until reaching the total 90 days. In this example, that happens by July 14.

So, the maturity date is July 14. On or before this date, the borrower must pay the principal plus any accumulated interest.

Journal Entries

Journal entries provide a record of all financial transactions in accounting. For a note payable, particularly the ones related to the receiving and repayment of the note, proper journal entries are crucial.

When receiving a note, the corresponding journal entry ensures that the amount is transferred correctly in the ledger:

• Debit "Notes Receivable": For the principal value of the note (\\(40,000). This action indicates that the company expects to receive this amount in the future as it is a receivable.
• Credit "Accounts Receivable": For the same amount (\\)40,000). This reflects that an outstanding receivable from credit sales is being converted into a formal promissory note.

When the note reaches maturity and payment is received, another set of journal entries records the receipt:

• Debit "Cash": For the maturity value, which is the principal plus interest (\\(40,600).
• Credit "Notes Receivable": Again for the principal amount (\\)40,000).
• Credit "Interest Revenue": For the interest earned over the note's term (\$600).

Journal entries like these help track financial progress and ensure accuracy in financial statements. They are fundamental parts of accounting practices in handling payables and receivables.