A company lends a major client $90,000 for one year at a 7% annual interest rate. Interest payments are t o be made twice a year but the company wants to recognize interest earned on a monthly basis. On a month in which the company does not receive any interest payments, interest is recorded with:
A) a debit to Cash of $525 and a credit to Interest Revenue of $525.
B) a debit to Notes Receivable of $525 and a credit to Cash of $525.
C) a debit to Interest Receivable of $525 and a credit to Interest Revenue of $525.
D) no adjusting entry, since no transaction has occurred.

Question

Quizplus · Accepted Answer

Since the company wants to recognize interest earned on a monthly basis, it needs to make an adjusting entry at the end of each month in order to show the revenue earned. Therefore, on a month in which the company does not receive any interest payments (such as the first and last months of the loan), an adjusting entry should be made to recognize the interest revenue earned during that month. The adjusting entry should debit Interest Receivable (to record the amount of interest earned but not yet received) and credit Interest Revenue (to recognize the revenue earned). The amount of this adjusting entry is calculated as follows:

($90,000 * 0.07 / 2) / 12 = $525

This is the amount of interest earned in one month, based on an annual rate of 7% and semi-annual payments. Therefore, the correct answer is C.

A Company Lends a Major Client $90,000 for One Year