Hi All,
I hate asking this, because it's from basic accounting but I noticed a discrepancy in my understanding of the direct method for interest expense for the cash flow statement, and need someone to help clear it up.
Ninja MCQ had the following question and answer:
In its cash flow statement for the current year, Ness Co. reported cash paid for interest of $70,000. Ness did not capitalize any interest during the current year. Changes occurred in several balance sheet accounts as follows:
Accrued interest payable $17,000 decrease
Prepaid interest 23,000 decrease
In its income statement for the current year, what amount should Ness report as interest expense?
NINJA ANSWER:
Interest expense = Cash interest + Decrease in prepaid interest – Decrease in interest payable
• Interest expense = $70,000 + 23,000 – $17,000 = $76,000
Another simple way to analyze a question like this is to prepare a journal entry reflecting the appropriate account changes. In this case:
DR Interest Expense Unknown
DR Interest Payable (decrease) 17,000
CR Prepaid Interest (decrease) 23,000
CR Cash (interest paid) 70,000
Interest expense must be debited for $76,000 to balance the entry.
MY ANSWER:
From my understanding, the answer should be 64000 instead of 76000, because a decrease in interest payable of 17000 means additional cash was paid out (so add it to interest expense), while a decrease in prepaid interest of 23000 means additional cash was not paid out (so subtract it from interest expense) as follows:
70000 + 17000 -23000 = 64000
Also, on a separate note, bond premium amortization is added to interest expense while bond discount amortization is subtracted from interest expense in the direct cash flow method, right?
Thank you for your replies!
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