Question

Ginter Co. holds Kolar Inc.'s \(\$ 10,000,120\)-day, \(9 \%\) note. (SO 8 ) The entry made by Ginter Co. when the note is collected, assuming no interest has been previously accrued, is: \begin{tabular}{l|r|r} a. Cash & 10,300 & \\ Notes Receivable & & 10,300 \\ b. Cash & 10,000 & \\ Notes Receivable & & 10,000 \\ c. Accounts Receivable & 10,300 & \\ Notes Receivable & & 10,000 \\ Interest Revenue & & 300 \\ d. Cash & 10,300 & \\ \(\quad\) Notes Receivable & & 10,000 \\ Interest Revenue & & 300 \end{tabular}

Short answer

Option d: Debit Cash $10,300; Credit Notes Receivable $10,000; Credit Interest Revenue $300.

Step-by-step solution

Calculate the interest on the note

To find the interest accrued, use the formula for simple interest: \( \text{Interest} = \text{Principal} \times \text{Rate} \times \text{Time} \). Here, the principal is \( \$10,000 \), the interest rate is \( 9\% \), and the time is \(120\) days (or \( \frac{120}{360} \) years since banks typically use the 360-day year for interest calculations). Thus, \( \text{Interest} = 10,000 \times 0.09 \times \frac{120}{360} = 300 \).

Determine the total amount collected

The total amount collected when the note matures includes both the principal and the interest. The principal amount of the note is \( \\(10,000 \), and the interest is \( \\)300 \). Therefore, the total amount collected is \( \\(10,000 + \\)300 = \$10,300 \).

Record the journal entry for collection

When the note is collected, Ginter Co. will record the following entry to reflect the receipt of cash and the closing of the note and interest revenue:- Debit \( \text{Cash} \) for \( 10,300 \),- Credit \( \text{Notes Receivable} \) for \( 10,000 \),- Credit \( \text{Interest Revenue} \) for \( 300 \).This journal entry shows cash being received, the note being settled, and interest earnings recognized.

Key concepts

Understanding Notes Receivable

In accounting, notes receivable represent a formal written promise by a borrower to pay a certain amount to the lender at a specified future date. They are similar to loans but are documented in the form of notes. The primary features of a note include:

• Principal amount: The amount of money borrowed, which is often stated as the face value of the note.
• Interest rate: The percentage of interest that the borrower agrees to pay in addition to the principal.
• Maturity date: The due date when the principal amount and accrued interest are payable.

Holders of notes receivable, like Ginter Co. in this example, must recognize them on their balance sheet until payment is collected. Understanding how these notes work is crucial, especially concerning interest calculation and revenue recognition.

The Basics of Simple Interest Calculation

Simple interest is a straightforward method to calculate interest on a note. It is calculated using the formula: \[ \text{Interest} = \text{Principal} \times \text{Rate} \times \text{Time} \]Here:

• The principal is the initial amount of the note, which is \(10,000 in this example.
• The rate is the percentage of interest, here is 9% or 0.09 in decimal form.
• Time is typically expressed in years or fractions of a year. For 120 days, time is \( \frac{120}{360} \) when using a 360-day year convention, making time exactly \( \frac{1}{3} \) year.

For Ginter Co., the interest on a \)10,000 note at a 9% rate for 120 days calculates to $300. This calculated interest is then factored into the total repayment by Kolar Inc. upon the note's maturity. Remember, simple interest does not consider compounding, making it an easier and direct method where interest is only calculated on the original principal.

Recognizing Interest Revenue

Interest revenue refers to the earnings a company receives from its investments or notes receivable. In this exercise, Ginter Co. earns interest revenue from the 120-day note by Kolar Inc. As interest accrues, it is recognized in financial records to reflect true earnings.
When the note is collected, Ginter Co. records interest earned as revenue. This is done by the following journal entry:

• Debit Cash for the total collection amount ($10,300, representing both principal and interest).
• Credit Notes Receivable to decrease the asset account (reflecting the principal $10,000).
• Credit Interest Revenue for the earned interest ($300).

Properly recognizing interest revenue is critical in accounting as it affects reported income and provides insights into the financial health relating to receivables. It ensures all earned income from interest is captured during the period when it is earned, providing a clearer picture of profitability.