Question

On October 1, Sam's Painting Service borrows $150,000 from National Bank on a 6-month, $150,000, 4% note. What entry must Sam's Painting Service make on December 31 before financial statements are prepared?

A) Interest Payable- Dr 1,500, Interest Expense- Cr 1,500
B) Interest Expense- Dr 6,000, Interest Payable- Cr 6,000
C) Interest Expense- Dr 1,500, Interest Payable- Cr 1,500
D) Interest Expense- Dr 1,500, Notes Payable- Cr 1,500

Answer 1

The correct journal entry for the interest on Sam's Painting Service's borrowed funds from National Bank as of December 31 is a debit to Interest Expense for $1,500 and a credit to Interest Payable for $1,500, which corresponds to option C.

Step-by-step explanation:

On October 1, Sam's Painting Service borrows $150,000 from National Bank on a 6-month, $150,000, 4% note. The entry that Sam's Painting Service must make on December 31 before financial statements are prepared to account for the interest on this note would be:

Interest Expense - Dr $1,500
Interest Payable - Cr $1,500

This is calculated based on the formula for simple interest: Interest = Principal × Rate × Time. Here, the principal is $150,000, the annual rate is 4%, and the time is 3/12 of a year (since October 1 to December 31 is a three-month period). Therefore, the interest for three months is $150,000 × 0.04 × 0.25 = $1,500. This amount represents the cost of borrowing for the period and it needs to be recorded as an expense. The correct journal entry is option C.