Question

Part 4: Interest Calculations Healthy Farms borrowed $83,500 on March 31, 2020. The loan had a 7% interest rate and is due on March 31, 2021. (round to the nearest dollar) 1. Calculate the interest incurred by Healthy Farms during 2020. Where will this appear in the financial statements for the year ended December 31, 2020? 2. How much interest will Healthy Farms incur in 2021? 3. How much will Healthy Farms pay the bank on March 31, 2021? How will the repayment impact the balance sheet?

Answer 1

Solution

Part 4

Healthy Farm

1. Calculation of the interest incurred by Healthy Farm during 2020:

Interest incurred during 2020, is for 9 months (March 31 to Dec 31)

Interest incurred = $83,500 x 7% x 9/12 = $4,383.75

For the year ended December 31, 2020, the interest incurred would appear as ‘Interest Payable’ under the Current Liabilities section of the Balance Sheet.

2. Calculation of interest that Healthy Farm would incur in 2021:

Healthy Farm would incur interest for the three months, (Jan 1 – March 31) in 2021.

Interest incurred in 2021 = 83,500 x 7% x 3/12 = $1,461.25

3. Healthy Farm would pay $89,345 to the bank on March 31, 2021.

The payment of $89,345 comprises,

Short-term Loan Payable $83,500

Add: interest Payable $4,383.75

Add: interest Expense $1,461.25

Total amount paid = $89,345

The payment of $89,345 to the bank would, reduce Cash (Assets) by $89,345.

The Liabilities also would show a reduction of $83,500 (Short-Term Loan Payable) and $4,383.75 (Interest Payable).

The current year interest expense of $1,461.25 is reported in the Income Statement, but reduces the Stockholders’ Equity in the Balance Sheet.

Part 5

1. According to the GAAP, the company should recognize expense,

a. When resources are utilized.

Explanation – the GAAP advocates the accrual basis of accounting, which requires recording revenues when earned and expenses as incurred. So, when resources are utilized the same is reported as expense.

2. DeShawn’s Data Recovery

The impact on the June Income Statement of Deshawn’s Data Recovery for the amount of $4290 earned by employees in June, but paid in July is as follows,

The amount earned by employees in June but to be paid in first week of July would be reported as Salary Expense in the June Income Statement.

Explanation – The accrual method of accounting advocates reporting expenses are incurred and not when paid. Hence, since the salaries expense is incurred in June, the same is reported in the June’s Income Statement but not in July’s.

3. Collection of $2,000 from customer in October for a sale made in June –

b. The October income statement is not affected by this transaction.

Explanation – Though the cash related to sale made in June is collected in October, the sale would have been reported in the June Income Statement as Sales Revenue $2,000. Hence, the collection of cash does not affect the October income statement.

This is in accordance to the accrual method of accounting, which requires revenues to be reported when earned but not when received. Since, the sale revenue is earned in June, the same is reported in June Income Statement.

4. Collection of $2,000 from customer in October for a sale made in June –

The October statement of cash flows would report this transaction as

a. Cash inflow from operating activities

Explanation – statement of cash flows, reports the inflow and outflow of cash during an accounting period. The cash flows are reported under the three categories, operating activities, investing activities and financing activities.

The operating activities report cash inflows and outflows resulting from the regular conduct of business, such as sales revenue, expenses, gain and loss. Hence, the collection of $2,000 is reported as collections from customers in the operating activities section of the cash flow statement.

5. Misty’s Catering would recognize revenue when,

Option c. Misty’s Catering catered a dinner meeting for Arts and such billed the customer $850.

Explanation: the above transaction indicates revenue earned by Misty Catering by providing catering service. Hence, the company would recognize $850 as Catering Revenue.

Other options are incorrect for the following reasons,

a. An agreement to cater an office lunch is just an agreement and not a business transaction. Hence, no revenue is recognized.

b. A deposit $500 received to cater a wedding reception next summer is an advance and reported as Deferred Revenue. The revenue is recognized next summer when the service is performed.

Hence, $500 is not current period revenue.

Option d. collection of $900 for services performed during last month, is recognized as revenue in last month. This does not pertain to current month’s revenue, hence not recognized in current month.

6. Bella’s Bakery

Interest expense to be reported in the income statement for the year ended December 31, 2020 is as follows,

Since loan is taken on June 30, 2020 the company incurs 6 months interest in current year, June 30 to December 31.

Hence, interest expense to be reported in the income statement for the year ended December 31, 2020 = 70,000 x 5% x 6/12 = $1,750

Option d. $1,750

7. Payment of $590 to employees, impact on the balance sheet –

Option c. stockholders’ equity will decrease.

Explanation – payment of $590 to employees is a salary expense. Expenses reduce income, which in turn reduce the retained earnings and consequently the stockholders’ equity is reduced.