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Chapter 8: Problem 8

Calculating Interest on Promissory Notes Receivable Houston Company receives a six-month note from a customer. The note has a face amount of \(\$ 8,000\) and an interest rate of nine percent. What is the total amount of interest income to be received? a. \(\$ 720\) b. \(\$ 540\) c. \(\$ 360\) d. \(\$ 180\)

Short Answer

Expert verified
The total interest income to be received is \( \$360 \), which is option (c).

Step by step solution

01

Understand the Formula for Interest

The formula to calculate interest on a note is given by \( \ ext{Interest} = P \times R \times T \), where \( P \) is the principal amount, \( R \) is the interest rate, and \( T \) is the time period in years.
02

Identify the Values from the Problem

From the problem, the principal amount \( P \) is \( \$8,000 \), the annual interest rate \( R \) is 9% or 0.09, and the time period \( T \) is 6 months. Since the time needs to be in years, we convert 6 months to years: \( T = \frac{6}{12} = 0.5 \).
03

Plug the Values into the Interest Formula

Substitute the values into the formula: \( \ ext{Interest} = 8,000 \times 0.09 \times 0.5 \).
04

Calculate the Interest

Perform the calculation: \( 8,000 \times 0.09 = 720 \). Then multiply \( 720 \times 0.5 = 360 \). So, the total interest income is \( \$360 \).
05

Compare with Given Options

The calculated interest, \( \\(360 \), matches the option (c). Therefore, the correct answer is (c) \( \\)360 \).

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Key Concepts

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

Interest Calculation
Interest calculation helps us determine how much extra money will be gained from a loan or note over time. For promissory notes, we use a specific formula: interest = principal amount \( P \) * interest rate \( R \) * time period \( T \). The key components are:
  • Principal (\(P)\): the initial amount of money, in this case, \( \\(8,000 \).
  • Rate (\)R)\(: the annual interest rate, converted to a decimal, here 9% becomes 0.09.
  • Time (\)T)$: expressed in years, given that we have 6 months, this converts to 0.5 years. Thus, doing the calculation: \( 8,000 \times 0.09 \times 0.5 = 360 \).
Understanding this formula is key to effectively calculating the interest on any promissory note receivable.
Financial Accounting
Financial accounting involves recording, summarizing, and reporting financial transactions. In the context of promissory notes, this means accounting for notes receivable and recognizing corresponding interest income at the correct periods. Let's see how it integrates:
  • Recording: the principal amount of \( \$8,000 \) from the note is initially recorded as an asset (Notes Receivable) on the balance sheet.
  • Recognizing income: as the note earns interest over time, this interest is recorded as income, impacting financial documents like income statements.
  • Time matching: the interest accrued over six months should be appropriately reflected in the financial statements to match the timing of the transaction.
Thus, financial accounting ensures that the interest is correctly accounted for, providing a true financial position.
Principal Amount
The principal amount refers to the original sum of money borrowed or invested, which, in this exercise, is \( \$8,000 \). It's the base amount on which the interest is calculated. Understanding the principal is essential because:
  • It represents the amount to which interest rates apply.
  • When repaid, the total includes both principal and any accumulated interest.
  • It determines the proportion of periodic interest payments when dealing with loans or notes.
Thus, correctly identifying and applying the principal ensures accurate interest calculation.
Interest Income
Interest income is the reward received from lending money, expressed as a percentage of the principal. For Houston Company, the total interest earned from the note is \( \$360 \) for six months. Here's how it adds value:
  • Increases revenue: It counts as financial gain, boosting overall income.
  • Cash flow enhancement: Provides extra cash that can be used for reinvestment or expenditures.
  • Reflects investment quality: Higher interest income indicates a potentially lucrative investment.
Interest income is recorded in financial statements, contributing to the company's financial health and offering insights into profitable transactions.

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Most popular questions from this chapter

Credit Losses Based on Accounts Receivable Miller, Inc., analyzed its accounts receivable balances at December 31 and arrived at the aged balances listed below, along with the percentage that is estimated to be uncollectible: The company handles credit losses using the allowance method. The credit balance of the Allowance for Doubtful Accounts is \(\$ 1,150\) on December 31 , before any adjustments. a. Prepare the adjusting entry for estimated credit losses on December 31 . b. Prepare the journal entry to write off the Lyons Company's account on April 10 of the following year in the amount of \(\$ 575\).

Haley Company estimates its bad debts expense by aging its accounts receivable and applying percentages to various age groups of the accounts. Haley calculated a total of \(\$ 2,100\) in possible credit losses as of December 31 . Accounts Receivable has a balance of \(\$ 98,000\), and the Allowance for Doubtful Accounts has a credit balance of \(\$ 500\) before adjustment at December 31 . What is the December 31 adjusting entry to provide for credit losses? What is the net amount of accounts receivable that should be included in current assets?

Journal Entries for Credit Losses At January 1, the Sherry Company had the following accounts on its books: During the year, credit sales were \(\$ 1,750,000\) and collections on account were \(\$ 1,588,000\). The following transactions, among others, occurred during the year: Jan. 11 Wrote off J. Smith's account, \(\$ 5,800\). Apr. 29 Wrote off B. Bird's account, \(\$ 2,500\). Nov. 15 Received \(\$ 1,500\) from B. Bird to pay a debt that had been written off April 29 . This amount is not included in the \(\$ 1,588,000\) collections. Dec. 5 Wrote off D. Finger's account, \(\$ 4,300\). 31 In an adjusting entry, recorded the allowance for doubtful accounts at three 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.

Allowance Method versus Direct Write-Off Method On March 10, Barnes, Inc., declared a \$3,700 account receivable from Lamas Company as uncollectible and wrote off the account. On November 18. Barnes received a \(\$ 1,600\) payment on the account from Lamas. a. Assume that Barnes uses the allowance method of handling credit losses. Prepare the journal entries to record the write-off and the subsequent recovery of Lamas's account. b. Assume that Barnes uses the direct write-off method of handling credit losses. Prepare the journal entries to record the write-off and the subsequent recovery of Lamas's account. c. Assume that the payment from Lamas arrives on the following February 5 , rather than on November 18 of the current year. (1) Prepare the journal entries to record the write-off and subsequent recovery of Lamas's account under the allowance method. (2) Prepare the joumal entries to record the write-off and subsequent recovery of Lamas's account under the direct write- off method.

Define accounts receivable turnover and explain its use. How is the average collection period determined?
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