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Use the following information to answer questions1 -6: A company borrowed $100,0 on December1 by signing a six-month note that specifies interest at an annual percentage rate (APR) of12%. No interest or principal payment is due until the note matures on May31. The company prepares financial statements at the end of each calendar month. The following questions pertain to the adjusting entry that should be entered in the company's records. What date should be used to record the December adjusting entry? How many accounts are involved in the adjusting entry? What is the name of the account that will be debited? What is the name of the account that will be credited? What is the amount of the debit and the credit? What would be the effect on the financial statements if the company fails to make the adjusting entry on December31?
The original capital amount should be recorded on December 1st. In the original entry to record the $100 , there are two accounts, the bank/cash account and the loan account. The bank/cash account will be debited. The loan account will be credited. The amount is the capital of $100. Profit will be overstated by $1 which is calculated as follows: Capital x annual interest / 12*6 since it is only a six month borrowing. This leaves the total interest at the end of the 6 months at 100*0.12/12*6=6. The interest accrued by the end of December will be 6/6=1. Therefore if no adjusting entry is made for the interest accrued, profit will be understated by $1. If no entry is made for the capital as well, both assets and liabilities will be understated by $100.
