On January 1, 2014, Hays Corporation arranged a $3,000 line of credit with the Barnett Bank. It agreed to accept the bank's offer of 1% above the prime rate with interest payments on December 31 of each year. All borrowings and payments on principal are to take place on January 1 of each year.
Hays paid the first year's interest payment on December 31, 2014. Barnett Bank's prime rate was 4 percent for 2014. Which of the following answers shows the effect of this event on the financial statements?
A) Choice A
B) Choice B
C) Choice C
D) Choice D

Question

On January 1, 2014, Hays Corporation arranged a $3,000 line of credit with the Barnett Bank. It agreed to accept the bank's offer of 1% above the prime rate with interest payments on December 31 of each year. All borrowings and payments on principal are to take place on January 1 of each year.
Hays paid the first year's interest payment on December 31, 2014. Barnett Bank's prime rate was 4 percent for 2014. Which of the following answers shows the effect of this event on the financial statements? 
A) Choice A 
B) Choice B 
C) Choice C 
D) Choice D

Quizplus · Accepted Answer

The effect of paying the first year's interest payment on December 31, 2014, will decrease the cash balance by $30 (1% of $3,000). There will be no effect on the balance sheet since it only includes year-end balances, and the payment was made before the year-end. However, the income statement will show interest expense of $120 (4% prime rate + 1% markup * $3,000) for the year. Thus, option B is the correct answer.

On January 1, 2014, Hays Corporation Arranged a $3,000 Line