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On January 1, Year 1, the 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

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On January 1, Year 1, the 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)?

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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