Question

Will Rate Immediately

Loeb Corp. frequently borrows from the bank in order to maintain sufficient operating cash. The following loans were at a 12% interest rate, with interest payable at maturity. Loeb repaid each loan on its scheduled maturity date. Date of Loan Maturity Date Term of Loan Amount 11/1/Year 1 2/1/Year 2 5/1/Year 2 5,000 15,000 8,000 10/31/Year 2 1 Year 7/31/Year 2 6 Months 1/31/Year 3 9 Months Loeb records interest expense when the loans are repaid. As a result, interest expense of $1,500 was recorded in Year 2. If no correction is made, by what amount would Year 2 interest expense be understated? $540

Answer 1

Answer is $540 Interest expense included in the $1,500 = $5,000 x 12% = $600 Interest expense that should have been included in 20x5 interest expense = $5,000.12)(10/12) = 500 Overstatement of 20x5 interest expense = $100 second loan: (no error because the term is completely within 20x5 so the interest recognized equals the interest paid) Third loan: Interest expense included in the $1,500 = $0 (the loan and therefore the interest was not paid in 20x5) = 0 Interest expense that should have been included in 20x5 interest expense = $8,000 x 12% x (8/12) = 640 Understatement of 20x5 interest expense = $640 Net understatement =$ 640-$100 = $540