Problem 27 - Accounting

Question

Journalize the following transactions in the accounts of Zion Theater Productions: Mar. 1. Received a \(\$ 40,000,90\)-day, \(8 \%\) note dated March 1 from Gymboree Company on account. 31\. Discounted the note at Security Credit Bank at \(10 \%\). May 30. The note is dishonored by Gymboree Company; paid the bank the amount due on the note, plus a protest fee of \(\$ 200\). June 29. Received the amount due on the dishonored note plus interest for 30 days at \(12 \%\) on the total amount charged to Gymboree Company on May 30 .

Step-by-Step Solution

Answer

Journal entries record the conversion of a receivable to a note, discounting the note, handling a dishonored note with payment and protest fee, and eventually collecting the amount with additional interest.

Step 1: Received a Note on Account

On March 1, Zion Theater Productions receives a 90-day note from Gymboree Company with a face value of \( \\(40,000 \) and an 8% interest rate. This transaction is journalized as follows:- Debit: Notes Receivable \( \\)40,000 \)- Credit: Accounts Receivable \( \$40,000 \)This reflects the conversion of the account receivable into a notes receivable.

Step 2: Discounting the Note

On March 31, Zion Theater Productions discounts the note at Security Credit Bank at a 10% discount rate. First, we calculate the interest on the note:Interest = Principal × Rate × Time = \( 40,000 \times 0.08 \times \frac{90}{360} = \\(800 \). The maturity value of the note = Principal + Interest = \( \\)40,000 + \\(800 = \\)40,800 \). Next, calculate the amount received from the bank:Discount = Maturity Value × Discount Rate × Time Remaining = \( 40,800 \times 0.10 \times \frac{60}{360} = \\(680 \). Proceeds received = Maturity Value - Discount = \( \\)40,800 - \\(680 = \\)40,120 \). Journal entry:- Debit: Cash \( \\(40,120 \)- Debit: Interest Expense \( \\)680 \)- Credit: Notes Receivable \( \$40,800 \).

Step 3: Dishonored Note and Payment to Bank

On May 30, the note is dishonored by Gymboree Company. Zion Theater Productions owes the bank the maturity value plus a protest fee.Payment to bank = Maturity Value + Protest Fee = \( \\(40,800 + \\)200 = \\(41,000 \).Journal entry:- Debit: Accounts Receivable (Gymboree Company) \( \\)41,000 \)- Credit: Cash \( \$41,000 \).

Step 4: Collection on Dishonored Note

On June 29, Zion Theater Productions receives the amount due on the dishonored note plus additional interest for 30 days at 12%.Additional Interest = Amount Paid to Bank × Interest Rate × Time = \( 41,000 \times 0.12 \times \frac{30}{360} = \\(410 \).Total amount received = Amount Due + Additional Interest = \( \\)41,000 + \\(410 = \\)41,410 \).Journal entry:- Debit: Cash \( \\(41,410 \)- Credit: Accounts Receivable (Gymboree Company) \( \\)41,000 \)- Credit: Interest Income \( \$410 \).

Key Concepts

Accounts Receivable

Accounts Receivable is an important aspect of any business, as it represents money owed by customers for goods or services provided on credit. Essentially, when a company makes a sale on credit, it expects to receive payment from the customer at a future date. This expectation creates an 'Account Receivable'.
Understanding how to handle accounts receivable is crucial for managing cash flow and finances effectively.

• It is recorded as an asset on the balance sheet.
• Turning accounts receivable into cash quickly is important to ensure a healthy cash flow.
• When a note is issued to settle an account receivable, it gets converted into a 'Notes Receivable'. This can help stabilize cash flows and streamline collection processes.

In the context of the exercise, when Zion Theater Productions received a note from Gymboree Company, it converted its accounts receivable of $40,000 into a notes receivable, thus creating a formal agreement for repayment.

Interest Calculation

Interest calculation is a key financial concept crucial for understanding the cost of borrowing. When a company lends money or issues a note, interest is charged on the principal amount.
The interest calculation is typically based on three components:

• Principal: The original sum of money lent or borrowed.
• Rate: The percentage charged annually for the borrowing of money, expressed as a decimal.
• Time: Duration for which the money is borrowed.

For example, with the note from Gymboree Company, interest was calculated as follows:\(\text{Interest} = \text{Principal} \times \text{Rate} \times \frac{\text{Time}}{360} \)Replacing with values gives:\(\text{Interest} = 40,000 \times 0.08 \times \frac{90}{360} = 800\) This basis ensures accurate interest recognition, aiding in financial planning and profitability analysis.

Dishonored Note

A dishonored note happens when the maker of the note fails to pay upon maturity. This event requires adjustments in accounting records, as the expectation of payment is not met.
When this happens, the holder of the note will need to take certain steps:

• The note is reclassified back to an account receivable.
• A protest fee may be incurred and needs to be recorded.
• Increased diligence in collection efforts might be necessary.

In our exercise, Gymboree Company failed to honor the note by May 30, resulting in Zion Theater Productions having to pay the bank the maturity value and an additional protest fee of $200, impacting the company's cash flow and financial statements.

Notes Receivable

Notes Receivable represents a formal, often written, promise to pay a certain amount of money at a future date. This legal promise is stronger than an account receivable, providing greater assurance of collection.
Several characteristics define notes receivable:

• They may bear interest, offering the holder a return on investment.
• The maturity date is set when the note is issued, specifying when payment is due.
• It is recorded on the balance sheet as an asset and can be used as collateral.

In practice, Zion Theater Productions turned its account receivable from Gymboree Company into a notes receivable, thus formalizing the payment arrangement and gaining a legal advantage in collecting the owed amount.