Question

Trevor Williams Company borrowed $10,000 from Mike Trout National Bank on May 1, 2019. Interest on the note, which accumulates at 6% annually, is paid when the loan principal is repaid. The loan remains outstanding on June 30 when both the Williams Company’s and the Trout National Bank close their books to prepare financial statements. Other than cash, The Williams Company’s balance sheet shows which of these amounts related to the loan?

a. Reduce June's pre-tax income by $50
b. Reduce June's pre-tax income by $100
c. Increase June's pre-tax income by $100
d. Increase June's pre-tax income by $50

Answer 1

Trevor Williams Company

a. Reduce June's pre-tax income by $50

Step-by-step explanation:

a) Data and Calculations:

Bank loan = $10,000

Date of loan = May 1, 2019

Interest rate on loan = 6%

This amounts to an interest expense of $600 ($10,000 * 6%) per annum

Accounting year end = June 30

To account for the two months at year-end, the interest expense will be $100 ($600 * 2/12), but to account for only June, the interest expense is only $50.

b) Interest expense, whether paid for in cash or not, reduces the pre-tax income. It is accounted for in the income statement after the earnings before interests and taxes.