Question

AP10-1A (Journal entries for a loan) A company takes out a five-year, $1-million mortgage on October 1. The interest rate on the loan is 6% per year, and blended payments of $19,333 (including both interest and principal) are to be made at the end of each month. The following is an extract from the loan amortization table the bank provided the company: Beginning Loan Balance Ending Loan Balance Payment Interest Principal Payment 1 $19,333 $5,000 $1,000,000 985,667 $14,333 14,405 $985,667 971,262 Payment 2 19,333 4,928 Payment 3 971,262 19,333 4,856 14,477 956,785 Payment 4 956,785 19,333 4,784 14,549 942,236 Required a. The monthly payments will be the same amount each month, throughout the entire term of the loan. From the loan amortization table, we can see that the portion of the payment related to interest is decreasing each payment. Prepare a brief explanation for why this is happening. b. Prepare the journal entries to record the inception of the loan and the first two monthly payments.

Answer 1

a. Of the monthly payment of $19,333 made each month, a portion goes towards the interest amount on the loan while the remaining amount is towards the principal amount of the loan. Thus, the principal amount of the loan outstanding goes on reducing after every payment. Since the principal amount reduces, the amount of interest computed on the principal amount also decreases with each payment.

For example, for the first payment, the interest of $5,000 is computed on the outstanding loan amount of $1,000,000. However, for the second payment, the principal outstanding is $985,667 on which the interest amount is lower at $4,928, for the third payment, the principal outstanding is $971,262 on which interest is $4,856 and so on.

b.

Date	General Journal	Debit	Credit
October 1	Cash	1000000
	Mortgage loan payable		1000000
	(To record the inception of the loan)
October 31	Interest expense	5000
	Mortgage loan payable	14333
	Cash		19333
	(To record the first monthly payment)
November 30	Interest expense	4928
	Mortgage loan payable	14405
	Cash		19333
	(To record the second monthly payment)