A corporation borrowed $124,000 cash by signing a 5-year, 10% installment note requiring equal annual payments each December 31 of $32,711. What journal entry would the issuer record for the first payment?
To answer this question, we need to understand the concept of an installment note and how it works.
An installment note is a loan that requires the borrower to make equal periodic payments over a specified period of time. Each payment typically consists of both interest and principal amounts.
In this case, the corporation borrowed $124,000 cash by signing a 5-year, 10% installment note. The annual payments are $32,711, and there will be a total of five payments to be made.
To record the journal entry for the first payment, we need to break it down into its components: interest expense and reduction of the principal balance.
1. Calculate the interest expense for the first payment:
Interest expense = Principal balance at the beginning of the period x Interest rate
= $124,000 x 10%
= $12,400
2. Calculate the reduction of the principal balance for the first payment:
Principal reduction = Total annual payment - Interest expense
= $32,711 - $12,400
= $20,311
Now, let's record the journal entry for the first payment:
Debit: Interest Expense ($12,400)
Debit: Installment Note Payable - Principal Reduction ($20,311)
Credit: Cash ($32,711)
The interest expense is debited because it represents the cost of borrowing. The installment note payable - principal reduction account is debited to reduce the outstanding principal balance. Finally, the cash account is credited because cash is being paid to fulfill the payment obligation.
It's important to note that for subsequent payments, the interest expense and principal reduction amounts will change as the outstanding balance reduces.