Question

current attempt in progress
on october 1, 2020, sunland company borrows $29000 from first street bank on a 12%, 6 - month loan. sunland fails to prepare the adjusting entry on december 31, 2020. state the effects of this error on the 2020 financial statements.

• interest receivable is overstated $870 and interest payable is overstated $870.
• net income is understated $870 and interest payable is overstated $870.
• net income is understated $3480 and interest payable is overstated $3480.
• net income is overstated $870 and interest payable is understated $870.

Explanation:

Step1: Calculate Accrued Interest

The formula for simple interest is $I = P \times r \times t$. Here, $P = \$29000$, $r = 12\% = 0.12$, and $t$ is the time from October 1 to December 31, which is 3 months or $\frac{3}{12}$ years.
So, $I = 29000 \times 0.12 \times \frac{3}{12} = 29000 \times 0.12 \times 0.25 = 870$.

Step2: Analyze the Effect of Missing Adjusting Entry

The adjusting entry for accrued interest would be to debit Interest Expense and credit Interest Payable for $\$870$. If this entry is not made:

• Interest Expense is understated (since we didn't record the expense).
• Net Income is overstated (because expenses reduce net income; if an expense is understated, net income is overstated by the amount of the unrecorded expense, which is $\$870$ here).
• Interest Payable is understated (because we didn't record the liability for the accrued interest, so the liability is understated by $\$870$).

Answer:

Net income is overstated $870 and Interest Payable is understated $870.