What adjusting entry should be made by Sheridan Company before preparing the financial statements on April 30, after lending $10800 to Pharoah Company at a 5% interest rate for four months?
The adjusting entry that Sheridan Company should make is to debit the Interest Receivable account and credit the Interest Revenue account by $45, which is the interest earned on the loan.
Calculating Interest Revenue
Explanation: The question involves calculating the interest on the loan provided by Sheridan Company to Pharoah Company for a four-month period and creating an adjusting journal entry for it.
The loan amount is $10800, the interest rate is 5% per annum, and the period is only for a month because the company prepares its financial statements on a monthly basis. To calculate the interest, we need to use the formula: (Principal * Rate of Interest * Time) / 100.
Here, we consider time as 1/12 (for one month), the rate of interest as 5%, and the principal as $10800. Hence, the interest will be ($10800 * 5 * 1/12) / 100 = $45.
Now, to prepare the adjusting journal entry, we need to debit Interest Receivable (an asset account) and credit Interest Revenue (an income account) by $45. Therefore, the adjusting entry would be:
Interest Receivable Dr. $45
To
Interest Revenue Cr. $45
The entry reflects the fact that Sheridan Company has earned $45 in interest on the loan it has given to Pharoah Company which needs to be recognized in the current accounting period. Furthermore, by recording this entry, Sheridan Company has conformed to the revenue recognition principle that states that revenue must be recognized when it is earned.