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Chapter 11: Problem 2

Home Center Warehouse issues a 90 -day note for \(\$ 250,000\) to Gem Lighting Co. for merchandise inventory. Gem Lighting Co. discounts the note at \(5 \%\). a. Journalize Home Center Warehouse's entries to record: 1\. the issuance of the note. 2\. the payment of the note at maturity. b. Journalize Gem Lighting Co.'s entries to record: 1\. the receipt of the note. 2\. the receipt of the payment of the note at maturity.

Short Answer

Expert verified
Home Center issues and pays a $250,000 note; Gem Lighting receives note & interest totaling $253,125.

Step by step solution

01

Record the Issuance of the Note for Home Center Warehouse

When Home Center Warehouse issues a note for merchandise inventory, they create a liability on their books. **Journal Entry:** - Debit Merchandise Inventory for $250,000 - Credit Notes Payable for $250,000 This records the inventory received and the liability for the note issued.
02

Record the Payment of the Note by Home Center Warehouse at Maturity

When Home Center Warehouse pays the note at maturity after 90 days, they must pay the principal amount. **Journal Entry:** - Debit Notes Payable for $250,000 - Credit Cash for $250,000 This settles the liability by paying off the note.
03

Record Receipt of Note by Gem Lighting Co.

Gem Lighting Co. receives the note from Home Center Warehouse. This creates a receivable for them. **Journal Entry:** - Debit Notes Receivable for $250,000 - Credit Sales for $250,000 This recognizes the receivable and records the sale of inventory.
04

Record Receipt of Payment by Gem Lighting Co. at Maturity

Gem Lighting Co. receives the maturity payment which includes both principal and interest. The interest is calculated and recognized.First, calculate Interest:\[\text{Interest} = \text{Principal} \times \text{Rate} \times \text{Time} = 250,000 \times 0.05 \times \frac{90}{360} = 3,125 \]**Journal Entry:**- Debit Cash for \(253,125 (Principal + Interest)- Credit Notes Receivable for \)250,000 (to remove the note from books)- Credit Interest Revenue for $3,125This records the receipt of the payment including interest.

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Key Concepts

These are the key concepts you need to understand to accurately answer the question.

Understanding Notes Payable
Notes payable are formal written agreements in which a party (the borrower) promises to pay a specific amount of money at a future date to another party (the lender). These notes often come with interest, which acts as a fee for borrowing the money. In accounting, when a company issues a note, it becomes a liability for the borrower as it represents an obligation to pay. For example, Home Center Warehouse's issuance of the note for merchandise inventory resulted in creating a liability on their books. They debited Merchandise Inventory and credited Notes Payable for $250,000 to account for this transaction.
  • Liability Creation: The issuance of a note increases the borrower's liabilities.
  • Merchandise Inventory: When the note is issued for inventory, it allows the company to acquire goods immediately while deferring the payment.
  • Obligation to Pay: The borrower has a legal obligation to pay back the principal amount, and usually with interest, at maturity.
Merchandise Inventory and Its Role
Merchandise inventory represents the goods a company holds for the purpose of resale. It is a current asset listed on the company's balance sheet and is crucial for businesses dealing in retail or wholesale. In our case, Home Center Warehouse issued a note payable to acquire merchandise inventory from Gem Lighting Co., making use of their inventory in daily operations. This transaction showcases how companies acquire additional inventory without immediate cash outlay by using notes payable.
  • Asset Management: Inventory is a key asset and needs to be efficiently managed to ensure profitability.
  • Operational Efficiency: By acquiring inventory on credit, businesses can maintain liquidity while meeting customer demands.
  • Inventory Valuation: The cost of procured inventory must be accurately capitalized and recorded.
Calculating Interest for Notes
Interest calculation is a critical aspect when dealing with notes payable or receivable. It refers to the cost imposed for borrowing funds, and it is usually expressed as a percentage of the principal loan amount. In our exercise, Gem Lighting Co. calculates interest on the note from Home Center Warehouse for 90 days. The formula used for calculating interest is: \[\text{Interest} = \text{Principal} \times \text{Interest Rate} \times \frac{\text{Time}}{360}\] In our example, the calculated interest on the \(250,000 note would be \)3,125, based on a 5% annual interest rate. This interest amount is added to the principal when the payment is received at maturity by the lender.
  • Interest Application: Understand that interest affects the total payable or receivable amount.
  • Time Consideration: Interest is typically prorated based on the note's term using a 360-day year convention.
  • Revenue Recognition: Interest earned is recognized in the lender's accounts as revenue.

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Most popular questions from this chapter

An employee earns \(\$ 22\) per hour and \(11 / 2\) times that rate for all hours in excess of 40 hours per week. Assume that the employee worked 50 hours during the week, and that the gross pay prior to the current week totaled \(\$ 42,710\). Assume further that the social security tax rate was \(6.0 \%\) (on earnings up to \(\$ 100,000\) ), the Medicare tax rate was \(1.5 \%\), and federal income tax to be withheld was \(\$ 236\). a. Determine the gross pay for the week. b. Determine the net pay for the week.

A borrower has two alternatives for a loan: (1) issue a \(\$ 120,000,90\)-day, \(6 \%\) note or (2) issue a \(\$ 120,000,90\)-day note that the creditor discounts at \(6 \%\). a. Calculate the amount of the interest expense for each option. b. Determine the proceeds received by the borrower in each situation. c. Which alternative is more favorable to the borrower? Explain.

Urban-Wear Clothes Co. had the following current assets and liabilities for two comparative years: \begin{tabular}{lrr} & Dec. 31, 2008 & Dec. 31, 2007 \\ \hline Current assets: & & \\ Cash & \(\$ 140,000\) & \(\$ 205,000\) \\ Accounts receivable & 250,000 & 245,000 \\ Inventory & 300,000 & 180,000 \\ \(\quad\) Total current assets & \(\$ 690,000\) & \(\$ 630,000\) \\ Current liabilities: & & \\ Current portion of long-term debt & \(\$ 50,000\) & \(\$ 50,000\) \\ Accounts payable & 200,000 & 190,000 \\ Accrued expenses payable & 140,000 & 135,000 \\ \(\quad\) Total current liabilities & \(\$ 390,000\) & \(\$ 375,000\) \\ \hline \end{tabular} a. Determine the quick ratio for December 31, 2008 and \(2007 .\) b. Interpret the change in the quick ratio between the two balance sheet dates.

Dowling Company had gross wages of \(\$ 356,000\) during the week ended December 6 . The amount of wages subject to social security tax was \(\$ 285,000\), while the amount of wages subject to federal and state unemployment taxes was \(\$ 18,000\). Tax rates are as follows: \(\begin{array}{ll}\text { Social security } & 6.0 \% \\ \text { Medicare } & 1.5 \% \\ \text { State unemployment } & 5.4 \% \\ \text { Federal unemployment } & 0.8 \%\end{array}\) The total amount withheld from employee wages for federal taxes was \(\$ 66,900\). a. Journalize the entry to record the payroll for the week of December 6 . b. Journalize the entry to record the payroll tax expense incurred for the week of December 6 .

Rock On Magazine Co. sold 11,400 annual subscriptions of Rock On for \(\$ 35\) during December 2008. These new subscribers will receive monthly issues, beginning in January 2009. In addition, the business had taxable income of \(\$ 140,000\) during the first calendar quarter of 2009 . The federal tax rate is \(35 \%\). A quarterly tax payment will be made on April 7,2009 . Prepare the Current Liabilities section of the balance sheet for Rock On Magazine Co. on March 31,2009 .
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