On March 1, LGE asks to extend its past-due $3,200 account payable to Tyson. Tyson agrees to accept $700 cash and a 180-day, $2,500 note payable to replace the account payable.
Note: Use 360 days a year.
1. Prepare the March 1 entry for LGE.
2. Prepare the August 28 entry for LGE when it pays the note and interest to Tyson.
Answer (1)
On March 1, LGE reduces accounts payable by $3 , 200 by debiting Accounts Payable, credits Cash for $700 , and credits Notes Payable for $2 , 500 .
Calculate the interest expense on August 28: Interest = Principal × Rate × Time = 2500 × 0.08 × 0.5 = $100 .
On August 28, LGE debits Notes Payable for $2 , 500 , debits Interest Expense for $100 , and credits Cash for $2 , 600 .
The final payment on August 28 is $2 , 600 .
Explanation
Understanding the Problem Let's break down this problem step by step. LGE initially owes Tyson $3 , 200 . To settle this debt, LGE makes a cash payment of $700 and issues a note payable for $2 , 500 . We need to record these transactions as journal entries for LGE on March 1 and August 28.
March 1 Entry On March 1, LGE reduces its accounts payable by $3 , 200 . This is done by debiting the Accounts Payable account. LGE then makes a cash payment of $700 , which is recorded by crediting the Cash account. Finally, LGE issues a note payable of $2 , 500 , which is recorded by crediting the Notes Payable account.
Recording March 1 Entry The journal entry on March 1 will look like this:
Debit Accounts Payable: $3 , 200
Credit Cash: $700
Credit Notes Payable: $2 , 500
Calculating Interest On August 28, LGE pays the note payable along with interest. First, we need to calculate the interest. The note is for 180 days with an annual interest rate of 8%. The formula for calculating simple interest is:
Interest = Principal × Rate × Time
Interest Calculation In this case:
Principal = $2 , 500
Rate = 8% or 0.08
Time = 180/360 = 0.5 years
So, the interest is: Interest = 2500 × 0.08 × 0.5 = $100
August 28 Entry On August 28, LGE pays the note payable of $2 , 500 and the interest of $100 . This is recorded by debiting Notes Payable for $2 , 500 , debiting Interest Expense for $100 , and crediting Cash for the total amount paid, which is $2 , 600 .
Recording August 28 Entry The journal entry on August 28 will look like this:
Debit Notes Payable: $2 , 500
Debit Interest Expense: $100
Credit Cash: $2 , 600
Examples
Imagine you borrow money from a friend to buy a new bicycle. Initially, you owe your friend $300 (like the accounts payable). You then pay your friend $100 in cash and promise to pay the remaining $200 later with a written agreement (like the note payable). When you finally pay back the $200 along with an extra $10 as a thank you (interest), you record all these transactions to keep track of your debt and payments. This is similar to how companies manage their debts and payments using journal entries.
