Question

On August 1, 2016, ACE Corp. purchased parts from SUPPLY Corp. In payment for the $54,000 purchase, ACE issued a 1-year installment note to be paid in equal monthly payments at the end of each month. The payments include interest at the rate of 12%.

1. What entry will ACE make to record the August 1, 2016 purchase of the parts?
2. What entry will ACE make to record the 1st installment payment on August 31, 2016? 3. How much interest expense will ACE report in its income statement for the year ended 12/31/2016?

Answer 1

a- Parts - (asset) Dr $54000

Note payable Cr $54000

b- Note payable Dr $4500

Cash/Bank Cr 4500

c- Interest expense for the year end= $2700

Step-by-step explanation:

The entry to record the purchase of parts from SUPPLY Corp will result in, an increase in asset and liability because ACE Corp isn't settling the purchase via a cash/bank payment rather it's issuing a 1-year installment note. Therefore the entry is as follows:

Parts - (asset) Dr $54000

Note payable Cr $54000

Now the payments on the 1-year note are installment based which means the $54000 note payments would have to be split between twelve months (i.e one year). The monthly payment would be $4500 against note payable.

The entry to record first installment payment on august is as follows:

Note payable Dr $4500

Cash/Bank Cr 4500

Moreover, along with payment of $4500 ACE Corp is also liable to pay interest on the payments made. Therefore, interest shall be calculated on monthly payment of $4500 at the rate of 12% as follows:

Interest on payment = $4500×12%

Interest on monthly payment = $540

The interest expense to be reported by ACE in its income statement for the year ended 12/31/2016 is of Five months (i.e from Aug till Dec), see as follows:

Interest expense for the year end= $540×5

Interest expense for the year end= $2700