Question

Specialty Inc. converts an existing account receivable to a note receivable to allow an extended payment period. Specialty receives a $2,000, 3-month, 12% promissory note from its customer. What entry will Specialty make upon receipt of the note?

A. Debit Notes Receivable and credit Accounts Receivable for $2,060.

B. Debit Accounts Receivable and credit Notes Receivable for $2,000.

C. Debit Notes Receivable for $2,000, debit Interest Receivable for $60, credit Accounts Receivable for $2,000, and credit Interest Revenue for $60.

D. Debit Notes Receivable and credit Accounts Receivable for $2,000.

Answer 1

Upon receiving a $2,000 note in exchange for an account receivable, Specialty Inc. will make an entry debiting Notes Receivable and crediting Accounts Receivable for the $2,000 face value of the note, with no immediate recognition of interest.

Step-by-step explanation:

When Specialty Inc. converts an existing account receivable to a note receivable, the entry made upon receipt of the note is quite straightforward. Since the note is for a $2,000 amount with a 3-month term at a 12% annual interest rate, no interest is earned at the time of the conversion (the interest will be recognized over the life of the note). Therefore, the correct journal entry would be:

• Debit Notes Receivable $2,000
• Credit Accounts Receivable $2,000

This entry reflects the transfer of the customer's obligation from an account receivable to a note receivable, without recognizing any interest revenue at the moment of conversion. The interest will be recognized periodically or at the end of the note's term, depending on the company's accounting policy.