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Notes Payable quiz #1

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  • What is the primary difference between notes payable and accounts payable, and how does this difference affect the accounting treatment of each?
    Notes payable are formal written contracts that specify a maturity date and accrue interest, while accounts payable typically do not involve interest and are less formal. This means notes payable require accounting for both principal and interest, including periodic accruals and payments, whereas accounts payable are usually settled without interest and do not require such accruals.
  • How is interest expense calculated and recorded for a short-term note payable, and what journal entries are made at the end of an accounting period before the note matures?
    Interest expense on a short-term note payable is calculated as: Principal × Annual Interest Rate × (Months Outstanding ÷ 12). At the end of an accounting period, an adjusting entry is made by debiting Interest Expense and crediting Interest Payable for the amount of interest accrued to date, even though no cash is paid until the note matures.
  • Describe the journal entries required to repay a long-term note payable and all accrued interest at maturity, including how interest is handled if it is paid annually.
    At maturity, the company debits Note Payable for the principal, debits Interest Payable for any previously accrued interest, debits Interest Expense for interest incurred since the last payment, and credits Cash for the total amount paid (principal plus all accrued interest). If interest is paid annually, adjusting entries accrue interest between payment dates, and the final payment clears both the principal and any remaining interest liabilities.
  • What is the main distinction between notes payable and accounts payable in terms of formality and interest?
    Notes payable are formal written contracts that specify a maturity date and accrue interest, while accounts payable are less formal and typically do not involve interest.
  • When a company acquires a note payable, what are the basic journal entries made?
    The company debits cash for the principal amount received and credits notes payable for the same amount, recording the liability.
  • How do you calculate the interest expense to accrue on a note payable at the end of an accounting period?
    Interest expense is calculated as Principal × Annual Interest Rate × (Months Outstanding ÷ 12).
  • What adjusting entry is made at year-end for a short-term note payable before any cash interest is paid?
    The company debits Interest Expense and credits Interest Payable for the amount of interest accrued to date.
  • How are interest payments typically handled for long-term notes payable?
    Interest on long-term notes is usually paid periodically (e.g., annually or semi-annually), with adjusting entries made to accrue interest between payment dates.
  • What journal entries are required when repaying a short-term note payable and all accrued interest at maturity?
    The company debits Notes Payable for the principal, debits Interest Payable for previously accrued interest, debits Interest Expense for current period interest, and credits Cash for the total amount paid.
  • At the maturity of a long-term note payable, how are the principal and any remaining interest liabilities cleared from the books?
    The company debits Note Payable for the principal, debits Interest Payable for any accrued interest, debits Interest Expense for interest since the last payment, and credits Cash for the total payment.
  • Why do some lenders require borrowers to secure credit when issuing notes payable?
    Some lenders require borrowers to secure credit to reduce the risk of loss in case the borrower defaults. By securing credit with collateral, the lender has a claim on specific assets, which can be used to recover the loan amount if the borrower fails to repay.
  • What does negative amortization mean in the context of a loan balance?
    Negative amortization describes a situation where the loan balance increases over time because the payments made are not sufficient to cover the accrued interest, causing unpaid interest to be added to the principal.
  • Which type of credit is most likely to be unsecured: notes payable or accounts payable?
    Accounts payable is most likely to be unsecured, as it typically involves short-term credit extended by suppliers without collateral or a formal contract, whereas notes payable often involve formal contracts and may be secured by collateral.