Question

Marquis Smith started IT Consulting Services Incorporated on January 1, Year 1. The company experienced the following events during its first year of operation:

1. On June 1. Year 1 , the company borrowed $23,800 cash from the bank. The note had a one-year term and 6% annual interest rate.
2. On December 31, Year 1, the company adjusted the accounting records to recognize accrued interest expense on the bank note.

Use a horizontal financial statements model to show how each ovent affects the balance sheet, income statement, and statement of cash flows. More specifically, record the amounts of the events into the model. Also, in the Statement of Cash Flows column, classify the cash flows as operating activities (OA), investing activities (IA), or financing activities (FA)

Answer 1

The loan of $23,800 is recorded as a debit to Cash and a credit to Notes Payable, while the interest is debited to Interest Expense and credited to Interest Payable. The loan is a financing activity in the statement of cash flows, and the accrued interest affects the income statement but not the cash flow statement initially.

Step-by-step explanation:

Marquis Smith's IT Consulting Services Incorporated is required to account for transactions involving borrowing and interest accruals. When the company borrowed $23,800 cash from the bank on June 1, Year 1, it would record a debit to Cash and a credit to Notes Payable for $23,800 on its balance sheet, which also reflects as financing activities (FA) in the statement of cash flows. As for the income statement, there's no immediate effect from the borrowing.

On December 31, Year 1, the company needs to accrue the interest expense for the time since the loan was taken out (7 months). The annual interest rate is 6%; thus, the interest for 7 months totals $23,800×6%×7/12 = $833. The company would debit Interest Expense for $833 and credit Interest Payable for $833. This reflects in the income statement as an expense, reducing net income, but there's no immediate cash outflow, therefore there's no change in the cash flow statement. At the end of Year 1, the balance sheet shows higher liabilities due to the interest payable.