[Hussainsajwani]

Thank you for taking time to read and answer my question

On August 15, 2005, Benet Co. sold goods for which it received a note bearing the market rate of

interest on that date. The four-month note was dated July 15, 2005.

Note that the principal, together with all interest, is due November 15, 2005.

When the note was recorded on August 15, which of the following accounts increased?

A. Unearned discount.

B. Interest receivable.

C. Prepaid interest.

D. Interest revenue.

B. (Correct!) The note was received one month into its term. Like a bond issued between interest dates

and which collects accrued interest from the bondholder since the most recent interest payment date, this

note is recorded with interest receivable for one month. Benet earns only three months of interest revenue

because that is the length of time it will hold the note.

D. Benet has no revenue yet. Interest revenue accrues over time. The “loan” to the customer has just

begun.

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My question is that if interest receivable has increased (DR) what account would be (CR) since it can’t be interest revenue

[Freyer002]

I could be wrong, but maybe Unearned Interest Revenue…

FAR 66 (07/01/13), 75! (10/01/13)
AUD 64 (08/12/13), 80! (11/23/13)
BEC 84! (05/22/14)
REG 77! (08/28/14)
DONE!!!!!!!!!!!!!!
"Failure is only the opportunity to more intelligently begin again"

[Hussainsajwani]

Hmm if we were to credit unearned interest revenue … then eventually we would debit cash and credit accounts receivable right … so how would be then get rid of the unearned interest revenue account?

[mla1169]

I think you missed a significant point of the problem (see below for the problem in its entirety) which is that the company chose not to record the note at fair value. So when it was recorded a month later, I'm pretty sure that you're crediting a discount account.

Very important on exam day not to miss those subtleties, ignoring the part of the question that indicates the method being used is one of the “tricks” to thwart you.

https://books.google.com/books?id=gBCm9EFNgjkC&pg=PA314&lpg=PA314&dq=%22interest+receivable%22+%2B+%22unearned+discount%22&source=bl&ots=Aee4EBIOix&sig=PAwYuV1WTEXBlchkxRlZC3bhW54&hl=en&sa=X&ei=e7WbUcTMI6XA4AP-w4HgCg&ved=0CFIQ6AEwBg#v=onepage&q=%22interest%20receivable%22%20%2B%20%22unearned%20discount%22&f=false

FAR- 77
AUD -49, 71, 84
REG -56,75!
BEC -75

Massachusetts CPA (non reporting) since 3/12.

[J]

I think you all are approaching this on the wrong track…

Generally questions like these deal with bonds that are issued between interest dates, but the concept can be applied to a note as well. In the case of a bond issued between interest dates, the buyer of the bond essentially pays more to then get the accrued interest on the next actual interest payout… .

For example, say a bond is dated January 1, Year 1 and pays interest semiannually on June 30 and Dec 31. If the bond isn't purchased until March 1, there is really accrued interest on the bond for the months of January and February. If the bond is issued at face value, the buyer of the bond will pay cash for the face value of the bond PLUS the accrued interest. Then on June 30, the holder of the bond would receive a cash interest payment as if he held the bond for the entire six months, but would only recognize four months of interest revenue.

In the case of the above problem, this is exactly what is occurring. Let's say that Benet Co. sold goods with a price of $600. The goods cost Benet Co. $400. The buyer of the goods has a note with a face value of $500 but with $100 of accrued interest (from July 15 to Aug 15), so it is really worth $600. In this case, here's your journal entry on Aug 15:

Db. Notes Receivable 500

Db. Interest Receivable 100

Cr. Sales 600

AND

Db. COGS 400

Cr. Merchandise Inventory 400

When the note comes due on November 15th, Benet Company would receive the cash plus accrued interest (using my above example, let's say accrued interest is $100/month, so $300 of interest revenue PLUS the $100 previously indicated as interest receivable):

Db. Cash 900

Cr. Notes Receivable 500

Cr. Interest Receivable 100

Cr. Interest Revenue 300

Hope that helps a little bit…

[Hussainsajwani]

Thank you InterFC1. See what you did there. Genius.

[Author]

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