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Chapter 8: Problem 10

On September 1, the Pavey Company accepted a \(\$ 24,000,60\) day, nine percent, promissory note in exchange for overdue accounts receivable balance for the same amount from the Wagner Company. On November 30, the Wagner Company dishonored the note. What journal entry should be recorded on November 30 ? a. Debit Dishonored Note Receivable Expense; credit Notes Receivable. b. Debit Allowance for Doubtful Accounts; credit Notes Receivable. c. Debit Accounts Receivable; credit Interest Income; credit Notes Receivable. d. None of the above entries is correct.

Short Answer

Expert verified
(c) Debit Accounts Receivable; credit Interest Income; credit Notes Receivable.

Step by step solution

01

Calculate Interest on the Note

The promissory note is for \(24,000 at an interest rate of 9% over a period of 60 days. First, we calculate the interest:\[\text{Interest} = \frac{\text{Principal} \times \text{Rate} \times \text{Time}}{360} = \frac{24000 \times 0.09 \times 60}{360} = 360\]The interest on the note is \)360.
02

Understand the Dishonor of the Note

When Wagner Company fails to honor the note, the note becomes dishonored. The principal amount along with the accrued interest needs to be reverted back to accounts receivable.
03

Record the Dishonored Note

To record the dishonored note, the principal amount of $24,000 and the interest accrued, $360, need to be transferred to accounts receivable. Thus, the journal entry would be: - Debit Accounts Receivable: $24,360 - Credit Notes Receivable: $24,000 - Credit Interest Income: $360
04

Choose the Correct Journal Entry

Given the possible choices: - Option (c) is correct: Debit Accounts Receivable $24,360; credit Interest Income $360; credit Notes Receivable $24,000. This entry properly reflects the transfer of the note back to accounts receivable and recognizes the interest income.

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Key Concepts

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

Promissory Note
A promissory note is a written promise to pay a specified amount of money at a future date or on demand. It's a valuable financial instrument used in business transactions to formalize the credit agreement between a lender and a borrower. In the context of our exercise:
  • The Pavey Company accepted a promissory note from the Wagner Company for $24,000.
  • This note was intended to settle an overdue accounts receivable balance.
  • The note had a term of 60 days, with a nine percent interest rate.
Understanding the terms of a promissory note is crucial as it specifies the principal amount, interest rate, and the maturity date. These details influence the financial recording and reporting in the company's books.
Interest Calculation
Interest calculation is an essential part of understanding the financial implications of promissory notes. The interest is the cost of borrowing money and it must be calculated precisely:
  • To find the interest amount, use the formula: \[ \text{Interest} = \frac{\text{Principal} \times \text{Rate} \times \text{Time}}{360} \]
  • For the given note, the principal is \(24,000, the rate is 9%, and the time is 60 days.
  • Plugging in these values, we calculate the interest: \[ \text{Interest} = \frac{24000 \times 0.09 \times 60}{360} = 360 \]
This calculation indicates that the interest for 60 days amounts to \)360. Properly calculating interest ensures accurate financial reporting and helps in forming reliable financial expectations for both parties involved.
Accounts Receivable
Accounts Receivable is an account that represents money owed to a company by its clients or customers for goods or services delivered but not yet paid for. It reflects the credit sales not yet collected by a business:
  • In our scenario, initially, the Pavey Company had an accounts receivable balance from Wagner Company.
  • When Wagner Company provided a promissory note, the receivable was settled through it.
  • However, if the promissory note is dishonored, the original accounts receivable balance must be reinstated.
Maintaining an accurate accounts receivable account is vital for liquidity analysis and financial management. It allows businesses to monitor the effectiveness of their credit policy and ensure they are recovering outstanding amounts efficiently.
Dishonored Note
A dishonored note occurs when the borrower fails to fulfill the payment terms outlined in a promissory note. This situation requires careful accounting adjustments:
  • When Wagner Company dishonored the note, Pavey Company had to reclassify the amount plus accrued interest back to accounts receivable.
  • The journal entry involves debiting Accounts Receivable for the total of the principal and interest ($24,360 in this case).
  • Concurrent credits are made to Notes Receivable ($24,000) and Interest Income ($360).
Recording a dishonored note ensures that the lender recognizes any potential risk or concern of uncollected dues. It also allows them to take additional actions such as attempting to collect the debt through legal means or adjusting their allowance for doubtful accounts accordingly.

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Most popular questions from this chapter

A firm receives a six-month note from a customer. The note has a face amount of \(\$ 4,000\) and an interest rate of nine percent. What is the total amount of interest to be received? a. \(\$ 1,080\) b. \(\$ 30\) c. \(\$ 360\) d. \(\$ 180\)

Credit Losses Based on Credit Sales Ranch Company uses the allowance method of handling its credit losses. It estimates credit losses at \(2.5\) percent of credit sales, which were \(\$ 2,700,000\) during the year. On December 31 , the Accounts Receivable balance was \(\$ 475,000\), and the Allowance for Doubtful Accounts had a credit balance of \(\$ 30,600\) before adjustment. a. Prepare the adjusting entry to record the credit losses for the year. b. Show how Accounts Receivable and the Allowance for Doubtful Accounts would appear in the December 31 balance sheet.

A business has an accounts receivable turnover of ten. What is the company's average collection period? a. \(36.0\) b. \(30.8\) c. \(34.6\) d. \(36.5\)

Allowance Method versus Direct Write-Off Method On April 12, Mitch Company declared a \(\$ 2,000\) account receivable from the Ward Company as uncollectible and wrote off the account. On December 5 , Mitch received a \(\$ 600\) payment on the account from Ward. a. Assume that Mitch uses the allowance method of handling credit losses. Prepare the journal entries to record the write-off and the subsequent recovery of Ward's account. c. Assume that the payment from Ward arrives on the following January 18 , rather than on December 5 of the current year. (1) Prepare the journal entries to record the write-off and subsequent recovery of Ward's account under the allowance method. (2) Prepare the journal entries to record the write-off and subsequent recovery of Ward's account under the direct write-off method. b. Assume that Mitch uses the direct write-off method of handling credit losses. Prepare the journal entries to record the write-off and the subsequent recovery of Ward's account.

During the year, credit sales were \(\$ 850,000\) and collections on account were \(\$ 794,000\). The following transactions, among others, occurred during the year: Jan. 11 Wrote off J. Wolf's account, \(\$ 3,000\). Apr. 29 Wrote off B. Avery's account, \(\$ 2,000\). Nov. 15 Received \(\$ 1,000\) from B. Avery to pay a debt that had been written off April 29 . This amount is not included in the \(\$ 794,000\) collections. Dec. 5 Wrote off D. Wright's account, \(\$ 2,250\). 31 In an adjusting entry, recorded the allowance for doubtful accounts at one percent of credit sales for the year. Required a. Prepare journal entries to record the credit sales, the collections on account, the transactions, and the adjustment. b. Show how Accounts Receivable and the Allowance for Doubtful Accounts appear on the December 31 balance sheet.
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