A corporation borrowed $125,000 cash by signing a 5-year, 9% installment note requiring equal annual payments each December 31 of $32,136. What journal entry would the issuer record for the first payment?
A) Debit Interest Expense $7,136; debit Notes Payable $25,000; credit Cash $32,136.
B) Debit Notes Payable $32,136; debit Interest Payable $11,250; credit Cash $43,386.
C) Debit Interest Expense $11,250; debit Notes Payable $20,886; credit Cash $32,136.
D) Debit Notes Payable $32,136; credit Cash $32,136.
E) Debit Notes Payable $11,250; credit Cash $11,250.

Question

Quizplus · Accepted Answer

The first payment on an installment note consists of both principal and interest.
The principal payment is calculated as the total amount borrowed divided by the number of payments, which in this case is $125,000/5 = $25,000.
The interest portion of the payment is calculated as the current outstanding balance of the loan multiplied by the interest rate, which in this case is ($125,000 - $25,000) x 9% = $9,000 per year. 
Since the payments are equal amounts of $32,136, the interest portion of the payment must decrease each year as the outstanding balance of the loan is reduced by the amount of the principal payment.

Therefore, the journal entry for the first payment on December 31 should be:

Debit Interest Expense $11,250 ($9,000 for interest + ($125,000-$25,000)/5 x 9% for first year amortization)
Debit Notes Payable $20,886 ($32,136-$11,250)
Credit Cash $32,136

A Corporation Borrowed $125,000 Cash by Signing a 5-Year, 9