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The lender earns interest revenue each period. It gets paid off at note's maturity.
Accrual-basis accounting means we must record interest revenue at the end of each period it is truly earned (before it's all paid at maturity).
Scenario: On May 1st, 2022, a customer makes a mass order for lemonade. To pay off the order, you both agree upon a $1,000, 12% annual interest note due in 9 months. Write the journal entry for December 31st, 2022.
The blue underlined text signals...
- We're writing the journal entry for December 31st, 2022, and we issued the note to the borrower on May 1st, 2022 ➡️ We're recording Interest Revenue over the course of 2022 (before we move into 2023).
- We will be actually receiving this interest revenue at maturity... ➡️ We will represent this through Interest Receivable.
Note Amount = $1,000
Annual Interest = 12%
Annual Interest = $1,000 x 12%
Annual Interest = $120
Monthly Interest = $120 / 12 months
Monthly Interest = $10
Between May 1st, 2022 and December 31st, 2022, there's 8 months.
2022 Interest = $10 x 8 months
2022 Interest = $80
The reason is...
- We have earned revenue (+) through interest on the note we lent.
- This is represented through Interest Revenue.
- Which is a revenue account, and therefore has a normal credit balance.
- So, to increase it by $80, we'll credit it.
The reason is...
- We will be receiving (+) money from the borrower for this interest once the note matures.
- This is represented through Interest Receivable.
- Which is an asset account, and therefore has a normal debit balance.
- So, to increase it by $80, we'll debit it.
