Slumbers,Inc.borrows $3,000 at 12% from a bank on September 1,2012 and agrees to pay the interest and principal in two years.What is the effect on the accounting equation of the adjusting entry to record interest for the year ended December 31,2012?
A)Assets will increase by $3,000.
B)Liabilities will decrease by $120.
C)Shareholders' equity will decrease by $120.
D)Cash will decrease by $120.

Question

Quizplus · Accepted Answer

The interest for four months (September to December) at 12% annual interest on $3,000 is calculated as $3,000 * 12% * (4/12) = $120. Recording this interest expense will decrease shareholders' equity (through an increase in expenses) without affecting cash yet, as the interest is not paid until the loan matures.