Generous Inc.lends Blue Inc.$40,000 on April 1,accepting a four-month,4.5% interest-bearing note.Generous Inc.prepares financial statements on April 30.What adjusting entry should be made by Generous Inc.before its financial statements are prepared?
A)Option A
B)Option B
C)Option C
D)Option D

Question

Generous Inc.lends Blue Inc.$40,000 on April 1,accepting a four-month,4.5% interest-bearing note.Generous Inc.prepares financial statements on April 30.What adjusting entry should be made by Generous Inc.before its financial statements are prepared? 
A)Option A 
B)Option B 
C)Option C 
D)Option D

Quizplus · Accepted Answer

The adjusting entry that should be made by Generous Inc. before its financial statements are prepared is to accrue interest expense for the month of April, since the financial statements are being prepared on April 30.

Option A - Debit Interest Receivable, credit Interest Revenue: This entry is incorrect, as it assumes that interest revenue has already been earned and recorded. However, interest revenue is only recorded when it is earned, and since only one month has passed in this scenario, no interest revenue has been earned yet.

Option B - Debit Interest Expense, credit Interest Payable: This entry is correct. It recognizes that interest expense needs to be accrued for the month of April, and that the company has not yet paid the interest owed on the note.

Option C - Debit Interest Expense, credit Interest Receivable: This entry is incorrect, as it incorrectly assumes that the company has already received the interest revenue.

Option D - No adjusting entry is necessary: This option is incorrect, as an adjusting entry is necessary to recognize interest expense for the month of April. Failing to make this adjusting entry would result in an understatement of expenses and an overstatement of net income in the financial statements.