Financial Accounting Quiz: Notes Payable And Interest
20 questions · exam conditions
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Notes Payable And InterestQuestion 1 of 20

On January 1, Year 1, Frontier Corp. acquired equipment by issuing a two-year, non-interest-bearing note with a face value of $100,000. The prevailing market rate of interest for similar notes is 10%. What is the initial journal entry to record the transaction? (Round to the nearest dollar).

Debit Equipment $100,000; Credit Notes Payable $100,000
Debit Equipment $82,645; Debit Discount on Notes Payable $17,355; Credit Notes Payable $100,000
Debit Equipment $82,645; Credit Notes Payable $82,645
Debit Equipment $100,000; Credit Discount on Notes Payable $17,355; Credit Notes Payable $82,645
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Financial Accounting Quiz

Financial Accounting Quiz: Notes Payable And Interest

Practice Notes Payable And Interest in Financial Accounting with focused quiz questions that help you check what you know, review explanations, and build confidence with test-style prompts.

What this quiz covers

This quiz focuses on Notes Payable And Interest, giving you a quick way to practice the rules, question types, and explanations that matter most for Financial Accounting.

How to use this quiz

Try each quiz question before looking at the correct answer. Use the explanations to review missed ideas, then come back to similar questions until the pattern feels familiar.

All questions

Question 1

On January 1, Year 1, Frontier Corp. acquired equipment by issuing a two-year, non-interest-bearing note with a face value of $100,000. The prevailing market rate of interest for similar notes is 10%. What is the initial journal entry to record the transaction? (Round to the nearest dollar).

  1. Debit Equipment $100,000; Credit Notes Payable $100,000
  2. Debit Equipment $82,645; Debit Discount on Notes Payable $17,355; Credit Notes Payable $100,000 (correct answer)
  3. Debit Equipment $82,645; Credit Notes Payable $82,645
  4. Debit Equipment $100,000; Credit Discount on Notes Payable $17,355; Credit Notes Payable $82,645
Explanation: A non-interest-bearing note should be recorded at its present value. The equipment's cost is the present value of the note, calculated by discounting the face value at the market interest rate. PV = $100,000 / (1 + 0.10)^2 = 82,645.Thedifferencebetweenthefacevalue(82,645. The difference between the face value (100,000) and the present value (82,645)isrecordedasaDiscountonNotesPayable(82,645) is recorded as a Discount on Notes Payable (17,355). The entry debits Equipment for the present value, debits the Discount account, and credits Notes Payable for its face value.

Question 2

Phoenix Industries issued a $180,000, 6%, 4-month note payable on October 1, 2024. The company prepares quarterly financial statements and has a December 31 year-end. What adjusting entry should be recorded on December 31, 2024?

  1. Debit Interest Expense $3,600; Credit Interest Payable $3,600
  2. Debit Interest Expense $2,700; Credit Interest Payable $2,700 (correct answer)
  3. Debit Interest Payable $2,700; Credit Interest Expense $2,700
  4. Debit Notes Payable $2,700; Credit Interest Expense $2,700
Explanation: From October 1 to December 31 is 3 months. Interest expense for 3 months = $180,000 × 6% × (3/12) = $2,700. The adjusting entry debits Interest Expense and credits Interest Payable. Choice A incorrectly uses 4 months instead of 3. Choice C reverses the debit and credit. Choice D incorrectly debits Notes Payable instead of Interest Expense.

Question 3

On January 1, a company issued a $200,000, 5-year installment note. The note requires annual payments of $52,759, which includes principal and interest at a rate of 10%. What is the carrying value of the note payable immediately after the first payment is made?

  1. $200,000
  2. $167,241 (correct answer)
  3. $147,241
  4. $172,517
Explanation: The first step is to break down the first payment into interest and principal components. Interest for the first year = Carrying Value × Rate = $200,000 × 10% = $20,000. The remainder of the payment is principal reduction: Principal Payment = Total Payment - Interest Portion = $52,759 - $20,000 = $32,759. The new carrying value is the original carrying value minus the principal reduction: $200,000 - $32,759 = $167,241.

Question 4

A company issued a note payable with a face value of $200,000 and a stated interest rate of 10%. The market interest rate was 8%, resulting in the company receiving $207,987 in proceeds. The company uses the effective interest method. The journal entry to record the first annual interest payment would include:

  1. A debit to Interest Expense for $20,000.
  2. A credit to Cash for $16,641.
  3. A credit to Interest Payable for $16,641.
  4. A debit to Premium on Notes Payable for $3,359. (correct answer)
Explanation: The cash interest payment is based on the stated rate: $200,000 × 10% = $20,000 (Credit Cash). Interest expense is based on the market rate and the carrying value: $207,987 × 8% = $16,639 (Debit Interest Expense). The difference between the cash paid and the interest expense is the amortization of the premium: $20,000 - $16,639 = 3,361.Thisamortizationreducesthepremium,soPremiumonNotesPayableisdebited.OptionBistheclosestvalue,accountingforminorroundingdifferencesintheprompt(3,361. This amortization reduces the premium, so Premium on Notes Payable is debited. Option B is the closest value, accounting for minor rounding differences in the prompt (20,000 - $16,641 = $3,359).

Question 5

At its December 31 year-end, a company has a long-term note payable that becomes callable by the creditor on demand due to a violation of a debt covenant. The creditor has verbally indicated they will not call the loan, but no written waiver has been obtained before the financial statements are issued. How should this note be classified on the December 31 balance sheet?

  1. As a long-term liability, since the creditor is not expected to call the loan.
  2. As a long-term liability, but with required disclosure of the covenant violation.
  3. Partly as current and partly as long-term based on the payment schedule.
  4. As a current liability, because the violation makes it callable on demand. (correct answer)
Explanation: If a debt covenant is violated, the debt becomes callable by the creditor and must be reclassified as a current liability. This is the case even if it is unlikely that the creditor will exercise the right to call the loan. The only exception is if the creditor provides a waiver for a period longer than one year before the balance sheet is issued.

Question 6

On July 1, Year 1, a company issued a one-year, 6% note for $40,000. Interest is payable at maturity. The company's fiscal year ends December 31. At maturity on June 30, Year 2, what is the journal entry to record the payment of the note and interest?

  1. Debit Notes Payable $40,000; Debit Interest Expense $2,400; Credit Cash $42,400
  2. Debit Notes Payable $40,000; Debit Interest Payable $1,200; Debit Interest Expense $1,200; Credit Cash $42,400 (correct answer)
  3. Debit Notes Payable $40,000; Debit Interest Payable $2,400; Credit Cash $42,400
  4. Debit Notes Payable $41,200; Debit Interest Expense $1,200; Credit Cash $42,400
Explanation: At maturity, the company must pay the principal and total interest. Total interest is $40,000 × 6% × 1 year = 2,400.However,halfofthisinterest(2,400. However, half of this interest (1,200 for July 1 - Dec 31, Year 1) was accrued at the end of Year 1 and is in the Interest Payable account. The other half (1,200forJan1−June30,Year2)istheinterestexpenseforYear2.TheentrymustcleartheNotePayable(1,200 for Jan 1 - June 30, Year 2) is the interest expense for Year 2. The entry must clear the Note Payable (40,000) and the Interest Payable (1,200),recordthecurrentperiod′sInterestExpense(1,200), record the current period's Interest Expense (1,200), and credit Cash for the total amount ($42,400).

Question 7

On November 1, Year 1, a company discounted its own $120,000, 120-day, non-interest-bearing note at a bank with a 9% discount rate. The company's fiscal year ends December 31, Year 1. What amount of interest expense should be recognized in Year 1?

  1. $900
  2. $1,800 (correct answer)
  3. $3,600
  4. $1,770
Explanation: First, calculate the total discount (total interest expense). Discount = Face Value × Rate × Time = $120,000 × 9% × (120/360) = $3,600. This is the total interest for the 120-day period. The note is outstanding in Year 1 for 60 days (November and December). The interest expense recognized in Year 1 is a portion of the total discount: $3,600 × (60 days / 120 days) = $1,800.

Question 8

During Year 1, a company issued a note payable for cash, made a scheduled principal repayment on the note, and made an interest payment on the note. How should these three events be classified on the Statement of Cash Flows under U.S. GAAP?

  1. All three are financing activities.
  2. Issuance is an investing inflow; repayments of principal and interest are financing outflows.
  3. Issuance and principal repayment are financing activities; interest payment is an operating activity. (correct answer)
  4. Issuance is a financing inflow; principal repayment is a financing outflow; interest payment is an investing outflow.
Explanation: Under U.S. GAAP, cash flows from borrowing and repaying principal are classified as financing activities. The issuance of the note is a cash inflow from financing, and the principal repayment is a cash outflow from financing. However, interest payments are generally classified as cash outflows from operating activities.

Question 9

A company has a $500,000 note payable due on March 1, Year 2. On January 15, Year 2, before the Year 1 financial statements are issued, the company enters into a binding agreement with a bank to refinance the note on a long-term basis. On its December 31, Year 1 balance sheet, how should the company classify the note?

  1. As a current liability because it is due within one year of the balance sheet date.
  2. As a contingent liability disclosed only in the footnotes to the financial statements.
  3. As a non-current asset under the heading 'Assets Held for Refinancing'.
  4. As a long-term liability because the intent and ability to refinance have been demonstrated. (correct answer)
Explanation: A short-term obligation can be reclassified as long-term if the company has both the intent and the ability to refinance it on a long-term basis. The ability to refinance is demonstrated by entering into a financing agreement before the balance sheet is issued. Since the company entered into such an agreement, the note should be classified as a long-term liability.

Question 10

On May 1, Year 1, a company borrows $150,000 on a 6%, 3-year note. Interest is payable annually on April 30. The company's fiscal year ends on December 31. What is the total amount of liabilities related to this note that should be reported on the December 31, Year 1 balance sheet?

  1. $150,000
  2. $6,000
  3. $159,000
  4. $156,000 (correct answer)
Explanation: Two liabilities related to this note exist at year-end. First, the principal of the note, $150,000, is a long-term liability. Second, interest has accrued for 8 months (May 1 to Dec 31). Accrued Interest = $150,000 × 6% × (8/12) = $6,000. This is a current liability (Interest Payable). The total liabilities reported are the sum of the note payable and the interest payable: $150,000 + $6,000 = $156,000.

Question 11

On January 1, Year 1, a company issued a $300,000, 3-year note payable with a stated rate of 5%. The market rate of interest was 7%. The company received proceeds of $292,118. Using the effective interest method, what is the carrying value of the note on December 31, Year 1?

  1. $297,566 (correct answer)
  2. $300,000
  3. $292,118
  4. $296,013
Explanation: The carrying value at year-end is the beginning carrying value plus the amortization of the discount. Interest Expense = Beginning Carrying Value × Market Rate = $292,118 × 7% = $20,448. Cash Interest Paid = Face Value × Stated Rate = $300,000 × 5% = $15,000. The discount amortization is the difference: $20,448 - $15,000 = $5,448. The ending carrying value is: $292,118 + $5,448 = $297,566.

Question 12

On October 1, Year 1, Apex Corporation signed a $60,000, 8%, nine-month note payable. The company's fiscal year ends on December 31. What is the adjusting entry Apex should record on December 31, Year 1?

  1. Debit Interest Expense $1,200; Credit Interest Payable $1,200 (correct answer)
  2. Debit Interest Expense $3,600; Credit Interest Payable $3,600
  3. Debit Interest Expense $1,200; Credit Notes Payable $1,200
  4. Debit Interest Expense $4,800; Credit Cash $4,800
Explanation: The adjusting entry at year-end must recognize the interest expense incurred but not yet paid. The note was outstanding for three months in Year 1 (October, November, December). The accrued interest is calculated as: Principal × Rate × Time = $60,000 × 8% × (3/12) = $1,200. The journal entry is a debit to Interest Expense and a credit to Interest Payable.

Question 13

A company issues a 3-year, $500,000 note payable with a stated interest rate of 7%, equal to the market rate. Interest is paid annually. Which of the following correctly describes the total interest expense recognized over the life of the note?

  1. The present value of the future interest payments at the market rate.
  2. Zero, because the stated rate equals the market rate.
  3. The total cash interest paid over the three-year term. (correct answer)
  4. The difference between the face value and the total cash payments.
Explanation: When a note is issued at par (stated rate equals market rate), there is no discount or premium. The interest expense recognized each period is equal to the cash interest paid. Therefore, the total interest expense over the life of the note is the sum of all cash interest payments. Total interest = $500,000 × 7% × 3 years = $105,000.

Question 14

A company issues a zero-coupon note at a discount. If the company uses the effective interest method for amortizing the discount, which of the following statements is correct?

  1. The amount of interest expense recognized is constant each year.
  2. The carrying value of the note decreases each year.
  3. The amount of interest expense recognized increases each year. (correct answer)
  4. No interest expense is recognized until the note matures.
Explanation: Under the effective interest method, interest expense equals the carrying value of the note at the beginning of the period multiplied by the market interest rate. As the discount is amortized, it is added to the carrying value, causing the carrying value to increase each period. A constant market rate applied to an increasing carrying value results in an increasing amount of interest expense each year.

Question 15

On April 1, Year 1, a company issued a 2-year, $100,000 non-interest-bearing note in exchange for cash. The market rate of interest for this type of note was 10%. The company's fiscal year ends on December 31.

Using the information provided, what is the carrying amount of the note payable on the December 31, Year 1 balance sheet? (Round to the nearest dollar).

  1. $82,645
  2. $90,909
  3. $88,844 (correct answer)
  4. $100,000
Explanation: The initial carrying amount is the present value: PV = $100,000 / (1.10)^2 = 82,645.InterestexpenseforYear1istheinitialcarryingamounttimesthemarketrate,proratedfor9months:(82,645. Interest expense for Year 1 is the initial carrying amount times the market rate, prorated for 9 months: (82,645 × 10%) × (9/12) = $6,199. This interest expense represents the amortization of the discount for the period. The ending carrying amount is the beginning carrying amount plus the amortized discount: $82,645 + $6,199 = $88,844.

Question 16

On January 1, Year 1, Frontier Corp. acquired equipment by issuing a two-year, non-interest-bearing note with a face value of $100,000. The prevailing market rate of interest for similar notes is 10%. Frontier uses the effective interest method.

Using the information provided, what is the amount of interest expense Frontier should recognize for the year ended December 31, Year 1? (Round to the nearest dollar).

  1. $10,000
  2. $8,678
  3. $8,265 (correct answer)
  4. $9,091
Explanation: Interest expense is calculated by applying the market interest rate to the carrying value of the note at the beginning of the period. The initial carrying value is the present value of the note: PV = $100,000 / (1.10)^2 = $82,645. Interest expense for Year 1 = Carrying Value × Market Rate = $82,645 × 10% = $8,265.

Question 17

On March 1, Year 1, a company borrows $80,000 by signing a 7%, one-year note. Interest is payable at maturity. The company's fiscal year ends on September 30. What is the amount of interest payable that should be reported on the September 30, Year 1 balance sheet?

  1. $3,267 (correct answer)
  2. $2,333
  3. $5,600
  4. $2,800
Explanation: Interest must be accrued for the period the note has been outstanding during the fiscal year. The note was outstanding for 7 months (March through September) before the fiscal year-end. Accrued Interest = Principal × Rate × Time = $80,000 × 7% × (7/12) = $3,266.67, which rounds to $3,267. This amount is reported as a current liability, Interest Payable.

Question 18

On December 1, Year 1, a company borrowed $25,000 on a 90-day, 8% note. The company's fiscal year ends December 31 and it uses a 360-day year for interest calculations. What is the total interest expense to be recognized over the life of this note?

  1. $166.67
  2. $500.00 (correct answer)
  3. $1,500.00
  4. $2,000.00
Explanation: The question asks for the total interest expense over the entire life of the note, not just the portion accrued in Year 1. The total interest is calculated for the full 90-day term. Interest = Principal × Rate × Time = $25,000 × 8% × (90/360) = $500.00. This tests whether the student carefully reads the question and avoids the common trap of only calculating the year-end accrual.

Question 19

A company signs a $40,000, 6-month, 9% note on a date other than the first of the month. When calculating the interest expense for a partial month, what is the most precise method according to accounting convention?

  1. Calculate interest based on the exact number of days the note is outstanding and a 365-day year. (correct answer)
  2. Divide the annual interest by 12 and prorate based on the fraction of the month.
  3. Assume each month has 30 days and use a 360-day year.
  4. Ignore partial months and only calculate interest for full months outstanding.
Explanation: While different conventions exist (e.g., 360-day year), the most precise method is to calculate interest based on the exact number of days the loan is outstanding during the period, typically using a 365-day year unless another convention is specified. This method accurately reflects the interest cost for the specific period. The other methods are simplifying assumptions that are less precise.

Question 20

On December 31, Year 1, a company issued a $1,000,000, 8% note payable at face value. The company paid $40,000 in debt issuance costs to its underwriters. What is the initial carrying amount of the note payable to be reported on the December 31, Year 1 balance sheet?

  1. $1,040,000
  2. $1,000,000
  3. $960,000 (correct answer)
  4. $40,000, classified as a deferred charge asset.
Explanation: Under U.S. GAAP, debt issuance costs are not recorded as a separate asset. Instead, they are presented on the balance sheet as a direct deduction from the face amount of the related debt liability. Therefore, the initial carrying amount of the note is its face value minus the debt issuance costs: $1,000,000 - $40,000 = $960,000.