Question

Great Adventures obtains a $42,000 low-interest loan for the company from the city council, which has recently passed an initiative encouraging business development related to outdoor activities. The loan is due in three years, and 6% annual interest is due each year on July 31. Record adjusting entries as of December 31, 2018.

Assume the following ending balances for the month of July.

Cash $ 27,250 Prepaid insurance 5,640 Supplies (Office) 1,800 Equipment (Bikes) 15,700 Accounts payable 1,800 Deferred revenue 6,500 Common stock 39,000 Service revenue (Clinic) 5,350 Advertising expense 1,060 Legal fees expense 1,200

Answer 1

The balance sheet for the last July is as below.

Assets	$	Liabilities & Capital	$
Current assets:		Current liabilities:
Cash	27,250	Accounts payable	1,800
Prepaid insurance	5,640	Deferred revenue	6,500
Supplies	1,800	Total current liabilities	8,300
Total current assets	34,690	Capital:
Fixed assets:		Common stock	39,000
Equipment	15,700	Retained earnings (Note 1)	3,090
Total assets	50,390	Total liabilities & capital	50,390

Note 1: Retained earnings = Net income = Service revenue – Advertising expense – Legal fees

                                                                        = 5,350 – 1,060 – 1,200

                                                                        = 3,090

There is no loan amount in the above balance sheet, since it is taken on 31^st July.

Therefore, the adjustment entry for interest amount should be made for 31^st July to 31^st December (the gap of 5 months).

Interest amount = Loan amount × Annual interest rate × (Number of months / Months is a year)

                        = $42,000 × 6% × (5 / 12)

                        = $42,000 × 0.06 × 0.416666

                        = $1,050

Interest expense is debited, since it is chargeable during the year; interest payable is credited, since it becomes due to be paid.

Adjusting entry

Date	Accounts titles & explanations	P.ref	Debit	Credit
31/12/18	Interest expense		$1,050
	Interest payable			$1,050
	To record adjusting entry at the year end