On January 1, Gemstone Company obtained a $165,000, 7%, 10-year installment note from Guarantee Bank. The note requires annual payments of $23,492, with the first payment occurring on December 31. The first payment consists of interest of $11,550 and principal repayment of $11,942. The journal entry for the payment would include a

Question

On January 1, Gemstone Company obtained a $165,000, 7%, 10-year installment note from Guarantee Bank. The note requires annual payments of $23,492, with the first payment occurring on December 31. The first payment consists of interest of $11,550 and principal repayment of $11,942. The journal entry for the payment would include a

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Question restatement: On January 1, Gemstone Company obtained a $165,000, 7%, 10-year installment note from Guarantee Bank. The note requires annual payments of $23,492, with the first payment on December 31. The first payment consists of interest of $11,550 and principal repayment of $11,942. The journal entry for the payment would include a

Option 1: credit to Interest Payable for $11,550
- Why this is unlikely: When a payment is made, you typically reduce the liability and record the expense related to interest. Interest Payable is a liability account that would be credited when interest accrues but not yet paid. Since the payment includes current interest, we would not credit Interest Payable; we would recognize interest expense and reduce the notes payable for the principal. This option misstates the nature of the account and the direction of the entry for the portion of the payment related to interest.

Option 2: debit to Interest Expense for $23,492
- Why this is unlikely: The amount 23,492 is the total cash outlay for the year (interest plus principal). Interest Expense should only reflect the interest portion of the payment, which is 11,550. Debiting Interest Expense for the full payment ignores the principal reduction and would overstate interest expense and understate the reduction in the notes payable.

Option 3: debit to Cash for $11,942
- Why this is unlikely: Cash is decreased by the total payment amount, which is 23,492, not just the principal portion. Debiting Cash for 11,942 would understate the cash outflow and misstate the total payment, leaving an incorrect cash balance and an incorrect overall journal entry.

Option 4: debit to Notes Payable for $11,942
- Why this is correct: The principal portion of the payment reduces the outstanding balance of the installment note, so Notes Payable should be debited for the principal reduction amount of 11,942. The interest portion (11,550) would be recorded as Interest Expense (debited) and Cash would be credited for the total payment of 23,492. This option correctly reflects the reduction of the notes payable due to the principal payment.

Additional notes: In the typical installment-note journal entry for the first payment, you would record: Debit Interest Expense 11,550; Debit Notes Payable 11,942; Credit Cash 23,492. None of the other options correctly depict the appropriate accounts and amounts for the components of the payment, given that interest is expensed and principal reduces the liability, while cash decreases by the total payment amount.

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