Troop Co. frequently borrows from the bank to maintain sufficient operating cash. The following loans were at a 12% interest rate, with interest payable at maturity. Troop repaid each loan on its scheduled maturity date.

Date of Maturity Term of

Loan Amount Date Loan

11/1/95 $10,000 10/31/96 1 year

2/1/96 30,000 7/31/96 6 months

5/1/96 16,000 1/31/97 9 months

Troop records interest expense when the loans are repaid. Accordingly, interest expense of $3,000 was recorded in 1996. If no correction is made, by what amount would 1996 interest expense be understated?

Solution

Actual interest expense:

Date Amount Rate Time

11/1/95 Loan $10,000