2.18 Accrued Revenue - Interest Revenue Example

Accrued Revenue Example: Interest Revenue

Problem Setup

  • Desert Incorporated accepted a 6-month, 10,00010,000, 12%12\% APR note receivable from a customer on November 1 in exchange for services.

  • Desert's year-end is December 31.

  • The customer will pay principal and interest at maturity.

Key Concepts

  • Note Receivable: Desert is owed money; they're giving a loan to their customer.

  • Terms: 6 months, starting November 1, ending April 30 of the next year. Amount: 10,00010,000, APR: 12%12\% .

  • APR (Annual Percentage Rate): The total interest rate for one year.

  • Year-End: December 31, important for adjusting journal entries.

  • Maturity: April 30, when the customer pays back the 10,00010,000 loan plus interest.

  • Interest Payment: The customer pays the total interest for the six-month life of the loan at maturity (April 30), not in monthly installments.

November 1: Original Journal Entry

  • Recognize the note receivable on the company's books.

  • Note Receivable: An asset account; assets have a normal debit balance.

    • Debit note receivable for 10,00010,000.

  • Sales Revenue: Desert provided services in exchange for the note.

    • Under the revenue recognition principle, recognize the revenue when the performance obligation is satisfied.

    • Credit sales revenue for 10,00010,000.

  • Accruals Before Cash (ABCD): Even though the customer isn't paying cash upfront, revenue is recorded.

    Date

    Account

    Debit

    Credit

    November 1

    Note Receivable

    10,000</p></td><tdcolspan="1"rowspan="1"><p></p></td></tr><tr><tdcolspan="1"rowspan="1"><p></p></td><tdcolspan="1"rowspan="1"><p>SalesRevenue</p></td><tdcolspan="1"rowspan="1"><p></p></td><tdcolspan="1"rowspan="1"><p>10,000</p></td><td colspan="1" rowspan="1"><p></p></td></tr><tr><td colspan="1" rowspan="1"><p></p></td><td colspan="1" rowspan="1"><p>Sales Revenue</p></td><td colspan="1" rowspan="1"><p></p></td><td colspan="1" rowspan="1"><p>10,000

    Explanation

    To record services provided in exchange for note receivable

December 31: Adjusting Journal Entry at Year-End

  • Desert already provided the services and recorded the revenue.

  • Adjusting journal entries settle accounts with balances that change due to the passage of time.

  • Desert is earning interest as time goes by (due to the 12%12\% APR).

  • Between November 1 and December 31, two months have passed.

  • Calculation: $10,000×12%×(2/12)=$200\$10,000 \times 12\% \times (2/12) = \$200

  • Desert has earned $200 of interest, but the customer will not pay until maturity.

  • Interest Receivable: We are owed for interest we have earned; it's an asset account with a normal debit balance.

  • Interest Revenue: Recognize the revenue earned due to the passage of time.

  • If the adjustment isn't made, assets and revenues would be understated.

    Date

    Account

    Debit

    Credit

    December 31

    Interest Receivable

    200</p></td><tdcolspan="1"rowspan="1"><p></p></td></tr><tr><tdcolspan="1"rowspan="1"><p></p></td><tdcolspan="1"rowspan="1"><p>InterestRevenue</p></td><tdcolspan="1"rowspan="1"><p></p></td><tdcolspan="1"rowspan="1"><p>200</p></td><td colspan="1" rowspan="1"><p></p></td></tr><tr><td colspan="1" rowspan="1"><p></p></td><td colspan="1" rowspan="1"><p>Interest Revenue</p></td><td colspan="1" rowspan="1"><p></p></td><td colspan="1" rowspan="1"><p>200

    Explanation

    To accrue interest revenue for two months

April 30: Entry at Maturity

  • The customer pays principal and interest.

  • Desert receives cash.

  • Cash Amount: Principal + Total Interest over six months.

  • Calculation:

    • 6 months interest: $10,000×12%×(6/12)=$600\$10,000 \times 12\% \times (6/12) = \$600

    • Total payment: $10,000+$600=$10,600\$10,000 + \$600 = \$10,600

  • Close out the note receivable (it's no longer a receivable because we've been paid).

  • Adjust the interest receivable account.

  • Between December 31 and April 30, four months have passed.

  • Calculate interest earned over those four months:

    • $10,000×12%×(4/12)=$400\$10,000 \times 12\% \times (4/12) = \$400

  • The cash received represents the principal, interest earned from November 1 to December 31, and interest earned in the four months of the current year.

    Date

    Account

    Debit

    Credit

    April 30

    Cash

    10,600</p></td><tdcolspan="1"rowspan="1"><p></p></td></tr><tr><tdcolspan="1"rowspan="1"colwidth="101"><p></p></td><tdcolspan="1"rowspan="1"><p>NoteReceivable</p></td><tdcolspan="1"rowspan="1"><p></p></td><tdcolspan="1"rowspan="1"><p>10,600</p></td><td colspan="1" rowspan="1"><p></p></td></tr><tr><td colspan="1" rowspan="1" colwidth="101"><p></p></td><td colspan="1" rowspan="1"><p>Note Receivable</p></td><td colspan="1" rowspan="1"><p></p></td><td colspan="1" rowspan="1"><p>10,000

    Interest Receivable

    200</p></td></tr><tr><tdcolspan="1"rowspan="1"colwidth="101"><p></p></td><tdcolspan="1"rowspan="1"><p>InterestRevenue</p></td><tdcolspan="1"rowspan="1"><p></p></td><tdcolspan="1"rowspan="1"><p>200</p></td></tr><tr><td colspan="1" rowspan="1" colwidth="101"><p></p></td><td colspan="1" rowspan="1"><p>Interest Revenue</p></td><td colspan="1" rowspan="1"><p></p></td><td colspan="1" rowspan="1"><p>400

    Explanation

    To record collection of note receivable and interest

Accrued Revenue

  • Accruals are recorded before cash changes hands.

  • In this case, we are accruing revenue, but the customer hasn't paid us yet.