Question

On June 30, 2018, the Esquire Company sold some merchandise to a customer for $56,000. In payment, Esquire agreed to accept a 8% note requiring the payment of interest and principal on March 31, 2019. The 8% rate is appropriate in this situation.
  
Required:
1. Prepare journal entries to record the sale of merchandise (omit any entry that might be required for the cost of the goods sold), the December 31, 2018 interest accrual, and the March 31, 2019 collection.

Prepare journal entries to record the sale of merchandise (omit any entry that might be required for the cost of the goods sold), the December 31, 2018 interest accrual, and the March 31, 2019 collection. (If no entry is required for a transaction/event, select "No journal entry required" in the first account field.)

Record the sale of merchandise.

Record the interest accrual.

Record the cash collection.
2. If the December 31 adjusting entry for the interest accrual is not prepared, by how much will income before income taxes be over-or understated in 2018 and 2019?

If the December 31 adjusting entry for the interest accrual is not prepared, by how much will income before income taxes be over-or understated in 2018 and 2019?

	2018 income before income taxes would be by 2019 income before income taxes would be by

Answer 1

Notes receivable is a promissory note made by the maker of the note to the payee of the note. The payee of the note will book as notes receivable on their accounts books. The note mentions a time period and interest rate to be paid and will pay on demand the principle and interest amount on maturity.

Answer with explanation:

1. It is given that, the merchandise is sold on June 30, 2018 for $56,000.
Interest rate of notes receivable is 8%.
The payment of principal and interest will be made only om March 31, 2019.

Hence, when the books are closed on December 31, 2018, interest to be received till that date (6 months) should be recorded by passing an adjusting entry. The interest accrued receivable will be 56,000 × 8% × 6/12 = $2,240
On March 31, 2019, Esquire Company will collect the principal amount along with the receivable interest as well as interest revenue for the current year till March 31, 2019 (3 months).
Interest revenue for the current year is 56,000 × 8% × 3/12 = $1,120

Total cash received on March 31, 2019 is Principal + Interest receivable + Interest revenue = $56,000 + $2,240 + $1,120 = $59,360

The journal entries are given below.

2. Interest receivable ($2,240) is usually recorded as a revenue in the income statement.
If the December 31 adjusting entry for the interest accrual is not prepared, that interest receivable amount ($2,240) will not be recorded in the income statement.
Hence, 2018 income before income taxes would be understated by $2,240.

If the December 31 adjusting entry for the interest accrual is not prepared, that interest receivable amount ($2,240) also will be recorded as interest revenue on March 31, 2019.
Hence, 2019 income before income taxes would be overstated by $2,240.