On the first day of the fiscal year, Hawthorne Company obtained an $88,000, 5%, 7-year installment note from Seaside Bank. The note requires annual payments of $15,208, with the first payment occurring on the last day of the fiscal year. The first payment consists of interest of $4,400 and principal repayment of $10,808. The journal entry Hawthorne would make for the first annual payment due on the note would include a

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BlackTom AI · Accepted Answer

First, restating the scenario helps set the stage: Hawthorne borrows 88,000 with a 5% interest rate and makes annual payments of 15,208, with the first payment due at year-end. The payment splits into interest and principal: interest portion is 4,400 and the principal portion is 10,808. 
Option 1: Debit to Interest Expense for 4,400. This aligns with accrual accounting for interest on a note payable: the company recognizes interest expense as the cost of borrowing for the period, calculated as 5% of the outstanding principal. Since this is the first year, interest expense should be recorded for 4,400, and the corresponding credit would be to Cash for the total payment, 15,208. 
Option 2: Debit to Notes Payable for 15,208. This would be inappropriate because the cash payment reduces the liability and the principal portion, not the entire payment, reduces Notes Payable. In the journal entry, Notes Payable is decreased (debited) only by the principal portion, which is 10,808, not the full 15,208. 
Option 3: Credit to Notes Payable for 10,808. The principal portion is indeed 10,808, but the reduction of Notes Payable is achieved by a Debit to Notes Payable, not a credit. A credit would increase the liability, which is the opposite of what happens when you amortize the loan. The correct action is to Debit Notes Payable for the principal portion. 
Option 4: Debit to Cash for 15,208. Cash is the payment outflow, so the entry should Credit Cash for 15,208, not Debit Cash. Debiting Cash would incorrectly increase an asset that is decreasing with the payment. 
Putting it together, the correct structure of the first year's entry should reflect: Debit Interest Expense 4,400; Debit Notes Payable 10,808; Credit Cash 15,208. The given option that matches the correct portion of the entry is the Debit to Interest Expense for 4,400, since it correctly records the period’s interest expense component. The other options misstate which accounts are debited or credited and by which amounts, conflicting with how installment notes are amortized and how cash payments reduce both interest expense and the principal.

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