Financial Accounting Fundamentals | Online Course Support

On July 1, 2020, company takes out a $100,000 5-year loan with annual interest rate of 3%. Principal is scheduled to all be paid at the end of the loan term of 5 years, and interest payable annually on June 30. The company is getting ready to prepare financial statement for the year ending Dec 31, 2020. Which of the following entries correctly reflects what the company records, related to interest, for 2020 (assuming no other transactions affecting the relevant accounts)?


On Dec 31, 2020: Retained Earnings (OE) (interest expense) (dec) 1,500

…Cash (A) (dec) 1,500


On Dec 31, 2020: Retained Earnings (OE) (interest expense) (dec) 1,500

…Interest Payable (L) (inc) 1,500


On July 1, 2020: Retained Earnings (OE) (interest expense) (dec) 15,000

…Interest Payable (L) (inc) 15,000


Correct answer. According to the matching principle, expenses are recognized in the period in which related revenue is recognized. The interest for July to December makes the company’s operation and sales in July through December possible, and therefore should be recognized as an expense in the same period, with a corresponding increase in Interest Payable. The interest expense = 100,000*3%*6/12=1,500.

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