Question

Use the following to answer questions 6 – 10

On November 1^st, FLY Tech, an Airline maintenance company, borrows $1,000,000cash from Bank of America to expand operations. FLY signs a 1year,3%promissory note.  FLY’s year-end is December 31.

6.     How was the loan classified on the company’s December 31, year 1 balance sheet?

         A.  Current liability

         B.  Long term liability

         C.  Note disclosure only

         D.  Stockholders’ Equity

7.     How was the loan classified on the company’s December 31, year 1 statement of cash flow?

         A.  Operating activity

         B.  Investing activity

         C.  Financing activity

         D.  Not shown on the statement of cash flows

8.     $_________ How much interest should be accrued on December 31 of the first year (assume no previous entry was recorded for interest on the loan)?                           

9.     $______________When the note is paid at maturity (October 31, year 2) how much cash is paid to Bank of America?  

10.   $_________ When the note is paid at maturity in the second accounting year, how much does net income decrease?      

Answer 1

Answers

6. CURRENT LIABILITY, since as at 31st December, the said promissory note is payable within 12 months. Therefore classified as current liability.

7. FINANCING ACTIVITY, since proceeds from bank borrowing is a source of financing the operations and hence the said classification has been made.

8. Interest accrual = $1,000,000 * 3% * 2/12 = $5,000 as at December 31, year 1.

9. Total cash outflow to bank of america = Principal + Interest = $1,000,000 + $ 30,000 = $ 1,030,000.

10. Decline in net income of year 2 :

Particulars	Amount
Total interest outflow at the time of maturity in Year 2	$ 30,000
Less : Interest accrued in Year 1	$ 5,000
Reduction in Net income in year 2	$ 25,000