Problem 26 - Accounting

Question

D. Stoner Co., a building construction company, holds a 120 -day, \(9 \%\) note for \(\$ 60,000\), dated August 7, which was received from a customer on account. On October 6, the note is discounted at the bank at the rate of \(12 \%\). a. Determine the maturity value of the note. b. Determine the number of days in the discount period. c. Determine the amount of the discount. d. Determine the amount of the proceeds. e. Journalize the entry to record the discounting of the note on October \(6 .\)

Step-by-Step Solution

Answer

a) \$61,800; b) 60 days; c) \$1,236; d) \$60,564; e) Debit Cash \(60,564\), Debit Interest Expense \(1,236\), Credit Notes Receivable \(61,800\).

Step 1: Calculate the Maturity Value of the Note

The maturity value of the note is equal to the principal amount plus the interest accrued over the period. The interest can be calculated using the formula: \[ \text{Interest} = \frac{\text{Principal} \times \text{Rate} \times \text{Time}}{360} \] where Principal = \\(60,000, Rate = 9\%, and Time = 120 \text{ days}. Substitute the values into the formula: \[ \text{Interest} = \frac{60,000 \times 0.09 \times 120}{360} = 1,800 \] Therefore, the maturity value is: \[ \text{Maturity Value} = 60,000 + 1,800 = \\)61,800 \]

Step 2: Determine the Number of Days in the Discount Period

The discount period is the time between the date the note is discounted and its maturity date. The note is dated August 7 and has a term of 120 days, meaning it matures on December 5. Since it is discounted on October 6, we calculate the days from October 6 to December 5. From October 6 to November 6 is 31 days, and from November 6 to December 5 is another 29 days. Therefore, the discount period is: \[ 31 + 29 = 60 \text{ days} \]

Step 3: Calculate the Discount Amount

The discount amount is the interest the bank charges for the discount period. It is calculated using the formula: \[ \text{Discount Amount} = \frac{\text{Maturity Value} \times \text{Bank Rate} \times \text{Discount Period}}{360} \] where Maturity Value = \$61,800, Bank Rate = 12\%, and Discount Period = 60 \text{ days}. Substitute the values into the formula: \[ \text{Discount Amount} = \frac{61,800 \times 0.12 \times 60}{360} = 1,236 \]

Step 4: Calculate the Proceeds from Discounting

The proceeds are the amount received from the bank after discounting the note. This is calculated by subtracting the discount amount from the maturity value. Substitute the values: \[ \text{Proceeds} = 61,800 - 1,236 = \$60,564 \]

Step 5: Journalize the Entry for Discounting the Note

The journal entry to record the discounting of the note on October 6 will include a debit to cash for the proceeds amount and a debit to interest expense for the discount amount. Credit notes receivable for the maturity value:- Debit: Cash \(60,564\)- Debit: Interest Expense \(1,236\)- Credit: Notes Receivable \(61,800\)

Key Concepts

Note Receivable

A note receivable is essentially a documented promise that a customer will pay a certain amount of money at a future date. Notes receivable are a common component of financial accounting, allowing businesses to track and control amounts owed to them.

• Principal Amount: This is the initial amount of money loaned and recorded on the note. In our exercise, it is $60,000.
• Interest Rate: This is the percentage of the principal amount charged as interest. The interest rate for D. Stoner Co.'s note is 9%.
• Term: This refers to the period during which the note is expected to be paid back. For this exercise, the term of the note is 120 days.

Notes receivable differ from accounts receivable as they usually involve interest, making them more formal and rigid. They're often used in professional business transactions that span over longer terms.

Interest Calculation

Interest calculation is a crucial step in financial accounting to determine the cost of borrowing or the earnings on investments. When a company like D. Stoner Co. holds a note receivable, it expects to earn interest over the note's term.To calculate interest, use the formula:\[ \text{Interest} = \frac{\text{Principal} \times \text{Rate} \times \text{Time}}{360} \]

• Principal: The original amount of \(60,000.
• Rate: At 9%, though you need to express this as a decimal when calculating (0.09).
• Time: The duration for which the interest is calculated (120 days).

In our exercise, the interest ends up being \)1,800, highlighting the importance of accurate calculations in managing financial resources effectively.

Journal Entries

Journal entries are the backbone of capturing all financial transactions in accounting. They record every instance of receiving or paying money in a business, providing a clear and systematic record of all business events. For instance, the discounting of the note on October 6 results in the following entries:

• Cash (Debited): $60,564 is recorded as the cash received from the bank.
• Interest Expense (Debited): $1,236 represents the cost or discount amount the bank charges.
• Notes Receivable (Credited): $61,800 is removed from the asset account when the note is discounted.

These entries ensure that financial statements reflect accurate information, showing not only the amounts involved but also the reasoning behind them.

Discount Period

The discount period is the time span leading up to the maturity of a note, during which it might be discounted or "sold" to the bank. Calculating this period precisely is important for understanding how long the bank will hold the note until its maturity. In our example:

• The note matures 120 days after August 7, which is December 5.
• The discount period starts when the note is given to the bank on October 6 and ends on the maturity date.
• This results in a discount period of 60 days, from October 6 to December 5.

Understanding the discount period allows companies to predict when they'll need to adjust their cash flows. It assures them of the financial implications of using bank resources to monetize notes before they're naturally due.