On June 30, 2018, the Esquire Company sold some merchandise to a customer for $70,000. In payment, Esquire agreed to accept a 5% note requiring the payment of interest and principal on March 31, 2019. The 5% rate is appropriate in this situation. Required: 1. Prepare journal entries to record the sale of merchandise (omit any entry that might be required for the cost of the goods sold), the December 31, 2018 interest accrual, and the March 31, 2019 collection. 2. If the December 31 adjusting entry for the interest accrual is not prepared, by how much will income before income taxes be over-or understated in 2018 and 2019?

1.

* journal entry to record the sale of merchandise:

Dr Account Receivable               70,000

Cr Sales revenue                        70,000

(to record sales revenue)

* journal entry to record the December 31, 2018 interest accrual:

Dr Interest receivable                  1,750

Cr Interest income                       1,750

(to record accrued interest income)

* journal entry to record the March 31, 2019 collection:

Dr Cash                                 72,625

Cr Interest receivable          1,750

Cr Interest income               875

Cr Account receivable         70,000

(to record collection of receivable in March 31,2019)

2.

Income before taxes will be understated by $1,750 in 2018 and will be overstated by $1,750 in 2019.

Explanation:

1.

* journal entry to record the sale of merchandise: as sales was made on account - account receivable will go up ( Dr) with the same amount of Sales revenue recorded (Cr)

*  journal entry to record the December 31, 2018 interest accrual: there had been 6 months from the time of accepting sales on account to 31 Dec 2018, so the interest income to be recorded ( Cr) is 70,000 * 5% * 6/12 = $1,750; it is not collected so the Interest receivable account will go up to record the amount (Dr).

*   journal entry to record the March 31, 2019 collection: account receivable is cleared (Cr) by $70,000. Interest Receivable recorded in 31 Dec 18 is also cleared (Cr) by $1,750; further interest income for 3 months in 2019 is recorded (Cr): 70,000 x 5% * 3/12 = $875. Total cash receipt = Principal + interest on the principal = 70,000 + 70,000 * 5% *9/12 = $72,625, and is recorded as Dr.

2.

If the December 31 adjusting entry for the interest accrual is not prepared, 6-month interest income earned but not yet received in 2018, amounted to $1,750 which should be recorded in 2018, would not be recorded in the year. Instead, it would be recorded in 2019 at the time of collection.

So, Income before taxes will be understated by $1,750 in 2018 and will be overstated by $1,750 in 2019.

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