We are moving to the next accounting period (20X8). Recall that in 20X7 we only recorded interest expense for 8 months and the maturity term of the note is 1 year. Thus, in period 20X8 we need to recognize 4 more months of interest expense. The adjusting entry acts to increase liabilities (reduce the discount account to zero) and decrease equity (by increasing the Interest Expense account):
Illustration 30: Effect of discount amortization in the horizontal model
| Event No. |
Assets |
= |
Liabilities |
+ |
Equity |
Rev. |
- |
Exp. |
= |
Net Inc. |
Cash Flow |
|
| 3 |
n/a |
= |
116.7 |
+ |
(116.7) |
n/a |
- |
(116.7) |
= |
(116.7) |
n/a |
|
Note that the total liabilities are $5,000 now:
| Notes Payable |
$5,000 |
| Less: Discount on Notes Payable |
(0) |
| Carrying Value of Liability |
$5,000 |
Finally, at the note maturity date (April 31, 20X8), settlement for the face value of the note is made. The face value includes both the principal ($4,650) and interest ($350):
Illustration 31: Effect of discount note maturity in the horizontal model
| Event No. |
Assets |
= |
Liabilities |
+ |
Equity |
Rev. |
- |
Exp. |
= |
Net Inc. |
Cash Flow |
|
| 4 |
(5,000) |
= |
(5,000) |
+ |
n/a |
n/a |
- |
n/a |
= |
n/a |
(4,650) |
FA |
|
|
|
|
|
|
|
|
|
|
|
|
(350) |
OA |
Payment of the principal represents financing activity, and payment of the interest represents operating activity in the statement of cash flows.
