Ask Me Help Desk - Notes payable adjusting entries

Quote:

Loan #1: 250,000 which was obtained February 1, 2009. The company pays interest on this loan at February 1 each years. The interest rate on this loan is 6%. The company has to repay $25,000 principal each February.

MY POSSIBLE ANSWER:

I put DR Interest expense $6,250 and CR Interest payable $6,250.
[$250,000 x 6% x(5 months/12)]

Take note of the dates. You are doing June of 2010. The loan was in February of 2009. At June of 2010 a payment of 25,000 would already have been made, reducing the principal.

Quote:

I also put DR Notes payable $10,417 and CR Cash $10,417
[$25,000x(5months/12)]

Two things wrong here. One, the payment due is the payment due. A payment of principal has nothing to do with the time. $25,000 is due, period. Second, it's asking for adjusting entries. This isn't an adjusting entry. It's just a plain old daily transaction and they are not even asking for it.

Quote:

Loan #2: this loan for $70,000 was obtained during the year to help with the purchase of new equipment. The interest rate on the loan is 7% and is automatically taken out by the bank on the last day of each month. Principal payments are $14,000 per year paid on August 1. You review the books and note the interest expensive for June, 2010 has been recorded.

MY POSSIBLE ANSWER:

I don't need to adjust interest expense since it's already recorded, right? So i DR Notes payable $12,833 and CR Cash $12,833.
($14,000 x (11months/12)

You're correct that you don't need to adjust interest since it's already been recorded. But again, you're trying to turn an everyday transaction into an adjusting entry. And again, you're trying to turn the principal into a "time" issue.

Let's see if we can clear this up. Interest rates are quoted annually, unless otherwise stated. The reason we have to do the "time" part of PXRXT is because if you have to accrue/pay interest at anything but annually, you've got to get it to match the time. If you pay 6% for a year, you're only going to pay 3% for half the year, etc.

But this does not have anything to do with whatever principal amount is due on the loan. If $100 is due, then $100 is due. They don't mean you have $100 of annual "loan" that has to be divided down to some time. They just mean $100 is due. If your credit card says you have a minimum balance of $20, you don't try to figure out what that would be per day and then pay less. You pay $20. You're trying to create something there that just doesn't exist, out of what I suspect is habit of stuffing things into an equation. (Learn what the equations mean, not just how to plug n chug them. Plug n chug leads to using them at the wrong time.)