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On January 1, Year 1, Platte Corporation issues a 5-year note payable for $5,000. The interest rate is 5% and the annual payment of $1,156, due each December 31, includes both interest and principal.
-Which of the following correctly shows the effects of the December 31,Year 2 payment (rounded to the nearest whole dollar)?

Question

Quizplus · Accepted Answer

Carrying value of the note at the beginning of Year 2: $5,000 ? $906 (the amount of principal repayment in Year 1)
Interest expense for Year 2 = ($5,000 ? $906) × 5% = $205
The second annual payment of $1,156 will decrease assets (cash) by $1,156, decrease liabilities (installment notes payable) by $951, which is the difference between the cash payment of $1,156 and the interest expense of $205, and decrease stockholders' equity (retained earnings) by $205. It will increase expenses (interest expense) by $205, which will decrease net income. The principal portion of $951 of the payment is reported as a cash outflow for financing activities, while the interest portion of $205 will be reported as a cash outflow for operating activities.

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