RockNRoll Music Store borrowed $24000 from the bank signing a 5% 3-month note on September 1. Principal and interest are payable to the bank on December 1. If the company prepares monthly financial statements the adjusting entry that the company should make for interest on September 30 would be
A) Debit Interest Expense $1200; Credit Interest Payable $1200.
B) Debit Interest Expense $100; Credit Interest Payable $100.
C) Debit Notes Payable $1200; Credit Cash $1200.
D) Debit Cash $300; Credit Interest Payable $300.

Question

Quizplus · Accepted Answer

The company signed a 5% 3-month note which means the annual interest rate is 5% and the note has a maturity of three months. To calculate the interest for September, we need to use the following formula:

Interest = Principal x Rate x Time

Time = Number of days the note is outstanding / Number of days in a year

For September, the note is outstanding for 30 days (from September 1 to September 30), and there are 365 days in a year. Therefore, Time = 30/365 = 0.0822.

Interest = $24,000 x 0.05 x 0.0822 = $98

The adjusting entry on September 30 should be:

Debit Interest Expense $100
Credit Interest Payable $100

The monthly financial statement should reflect the interest expense incurred by the company during the month of September. The interest payable account represents the amount of interest that has been incurred but not yet paid, hence a credit to that account. The interest expense account represents the cost of borrowing, which is recognized in the income statement, hence a debit to that account.

RockNRoll Music Store Borrowed $24000 from the Bank Signing a 5