Final answer:
Uncle Tupelo's Gifts would need to make an adjusting entry on December 31 for the interest accrued on a three-month note payable by debiting Interest Expense for $3,000 and crediting Interest Payable for $3,000. This recognizes the 2 months' worth of interest that has accrued but has not been paid.
Step-by-step explanation:
When Uncle Tupelo's Gifts signs a three-month note payable on November 1 for the amount of $150,000 with an annual interest rate of 12%, they must recognize interest expense incurred by December 31. To calculate the interest expense accrued, use the formula: Interest = Principal x Rate x Time. As no entries have been made previously for the interest, we take the principal amount of $150,000, the annual interest rate of 0.12 (12%), and the time which is 2 months out of 12, or 2/12 of a year.
The calculation is as follows: Interest = $150,000 x 0.12 x (2/12) = $150,000 x 0.12 x 0.16667 = $3,000.
The adjusting entry on December 31 would be:
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- Debit Interest Expense $3,000
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- Credit Interest Payable $3,000
This entry increases the Interest Expense account on the income statement and also creates a liability on the balance sheet under Interest Payable for the interest that is owed but not yet paid.