Midtown Distribution sells a variety of merchandise to retail stores on account, but it insists that any customer who fails to pay an invoice when due must replace their account receivable with an interest-bearing note. The company adjusts and closes its accounts at December 31. Among the transactions relating to notes receivable were the following:
Nov. 1 Received from a customer (Sampson Co.) a nine-month, 12 percent note for $30,000 in settlement of an account receivable due today.
Aug. 1 Collected in full the nine-month, 12 percent note receivable from Sampson Co., including interest.
Instructions
a. Prepare journal entries (in general journal form) to record: (1) the receipt of the note on November 1; (2) the adjustment for interest on December 31; and (3) the collection of principal and interest on August 1. (To better illustrate the allocation of interest revenue between accounting periods, we will assume Midtown makes adjusting entries only at year-end.)
b. Assume that instead of paying the note on August 1, the customer (Sampson Co.) had defaulted. Give the journal entry by Midtown to record the default. Assume that Sampson Co. has sufficient resources that the note eventually will be collected.
c. Explain why the company insists that any customer who fails to pay an invoice when due must replace it with an interest-bearing note.