On Dec 31, 2024, Chairs Inc. signed a contract and delivered office furniture with a fair value of $100,000 to a local insurance company. This furniture cost Chairs Inc $60,000 to produce. The terms of this deal require the insurance company to pay for the furniture on Dec 31, 2027. The interest rate implied by this contract is 7% compounding annually. Which of the following would be included in the adjusting journal entry made by Chairs Inc. on Dec 31, 2026? Single choice
A
$7,000 Credit to Interest Revenue
B
$7,000 Debit to Interest Expense
C
$7,490 Credit to Interest Revenue
D
$7,490 Debit to Interest Expense

Question

On Dec 31, 2024, Chairs Inc. signed a contract and delivered office furniture with a fair value of $100,000 to a local insurance company. This furniture cost Chairs Inc $60,000 to produce. The terms of this deal require the insurance company to pay for the furniture on Dec 31, 2027. The interest rate implied by this contract is 7% compounding annually. Which of the following would be included in the adjusting journal entry made by Chairs Inc. on Dec 31, 2026? Single choice

A

$7,000 Credit to Interest Revenue

B

$7,000 Debit to Interest Expense

C

$7,490 Credit to Interest Revenue

D

$7,490 Debit to Interest Expense

BlackTom AI · Accepted Answer

When a sale is made with payment deferred and an explicit interest rate, the seller recognizes interest income each period on the unpaid balance. Here the furniture’s cash price (fair value) is $100,000, payment is due Dec 31, 2027, and the contract specifies 7% annual interest.

1) Relevant concepts
- Deferred payment sales: seller recognizes revenue for the fair value of goods and recognizes interest on the financing element separately.
- Interest accrues each year on the outstanding principal at the stated annual rate.
- For the seller, interest is recorded as Interest Revenue (credit); the corresponding accrued amount is Interest Receivable (debit) until cash is received.

2) Step-by-step reasoning
- The unpaid principal throughout the deferral period is $100,000 (no principal payments are made until maturity).
- Annual interest for each year = principal × annual interest rate.

3) Calculations (intermediate steps)
- Principal = $100,000
- Annual interest = 100,000 × 0.07 = 7,000

So on each Dec 31 (including Dec 31, 2026) the seller should record $7,000 of interest earned during that year.

4) Why the correct answer is correct
- The adjusting entry on Dec 31, 2026 must include recognition of one year’s accrued interest: Credit Interest Revenue $7,000 (and Debit Interest Receivable $7,000). That credit of $7,000 matches the correct choice.

5) Why the other options are incorrect
- “$7,000 Debit to Interest Expense”: interest expense is recorded by the borrower, not the seller; and the seller records interest revenue, not expense.
- “$7,490 Credit to Interest Revenue”: $7,490 is not the annual interest on the $100,000 principal at 7% (it would correspond to an amount that arises from compounding interest on previously accrued interest), so it’s the wrong dollar amount for the one-year accrual.
- “$7,490 Debit to Interest Expense”: wrong amount and wrong account (expense vs. revenue).