Question

On April 1 20X0, your company finances partial payment of the sale of machinery to a customer for a $20,000, 3 year, 8% note receivable. Interest is payable annually on April 1.On December 31, 20X0, an adjusting entry debits Interest Receivable and credits Interest Revenue for $1,600. The entry necessary to correct the error before the books are closed would include...

a. a $400 debit to Interest Revenue
b. a $400 credit to Interest Expense
c. a $400 credit to Unearned Interest Receivable
d. a $400 credit to Sales

Answer 1

An error was made in recording interest revenue for a nine-month period as if it were twelve months, overstating it by $400. To correct the error, a $400 debit to Interest Revenue is necessary.

Step-by-step explanation:

The student's question relates to an adjusting entry error made on December 31 for interest accrual on a note receivable. The note was issued on April 1, so interest for nine months should be recorded, not for the full year.

To calculate the correct interest for nine months at 8% annual interest on a $20,000 note, we use: Interest = Principal × Interest Rate × Time. This equates to $20,000 × 0.08 × (9/12), which gives us $1,200. The entry that was made recorded $1,600, which is excessive by $400. Therefore, to correct this error, we need to reverse the excess interest that was recognized.

The correct entry to rectify this mistake is: a $400 debit to Interest Revenue. This action will decrease the interest revenue that was overstated and thus correct the books.