On May 1, 2021, Townsley borrowed $250,000 from Prime Bank by signing a three-year, 6% note payable. Interest is due each May 1. What adjusting entry, if any, should Townsley record on December 31, 2021?

Question

BlackTom AI · Accepted Answer

To determine the proper adjusting entry, we first identify the amount of interest that has accrued from the note's issuance date to the balance sheet date.

- The note is for 250,000 at 6% annual interest. The annual interest would be 250,000 × 6% = 15,000 per year.
- The period from May 1 to December 31 is 8 months. Interest accrues for 8/12 of a year, so accrued interest = 15,000 × (8/12) = 15,000 × 2/3 = 10,000.

Now evaluate each answer choice:

Option 1: Debit Interest Expense and credit Interest Payable for $5,000. This amount corresponds to 4 months of interest, not 8, and is therefore too low given the 8-month accrual period.

Option 2: Debit Interest Expense and credit Interest Payable for $10,000. This matches the calculated 8-month accrual: 10,000 should be recognized as an accrued expense and a liability (Interest Payable) until it is paid.

Option 3: Debit Interest Expense and credit Interest Payable for $15,000. This would record a full year’s interest, not just the 8 months elapsed, overestimating the accrual for the period.

Option 4: No adjusting entry is necessary. Since interest has accrued but not yet been paid by December 31, an adjusting entry is required to recognize the expense and the corresponding payable.

In summary, the correct approach is to recognize 10,000 of interest expense and a 10,000 interest payable, reflecting the 8 months of accrued interest on the note as of December 31.

On May 1, 2021, Townsley borrowed $250,000 from Prime Bank by signing a three-year, 6% note payable. Interest is due each May 1. What adjusting entry, if any, should Townsley record on December 31, 2021?Single choice

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