Collins Company borrowed $1,250,000 from BankTwo on January 1, 2016 in order to expand its mining capabilities. The five-year note required annual payments of $325,545 and carried an annual interest rate of 9.5%. What is the amount of expense Collins must recognize on its 2017 income statement?
A)$118,750.
B)$99,105.
C)$87,821.
D)$77,591.

Question

Quizplus · Accepted Answer

The interest expense that Collins will recognize on its 2017 income statement can be calculated using the following formula:
Interest expense = Beginning balance of the loan x Interest rate
= $1,250,000 x 9.5%
= $118,750

However, Collins also made a payment of $325,545 in 2017, which includes both principal and interest. The interest portion of this payment can be calculated as follows:
Interest portion of payment = Total payment - Principal portion of payment
= $325,545 - ($1,250,000 ÷ 5)
= $325,545 - $250,000
= $75,545

Therefore, the total interest expense that Collins must recognize on its 2017 income statement is the sum of the interest calculated above and the interest expense from the beginning balance of the loan:
Total interest expense = Interest from beginning balance + Interest portion of payment
= $118,750 + $75,545
= $194,295

Thus, the amount of expense Collins must recognize on its 2017 income statement is $99,105 (total interest expense minus the portion of interest included in the payment towards principal).

Collins Company Borrowed $1,250,000 from BankTwo on January 1, 2016