FAR · Select balance sheet accounts · 4 practice questions
Interest payable at year end: accrual and balance sheet
Accrue interest expense and interest payable for the time elapsed by the reporting date. Below: one quick calc example and four free practice questions.
Try one first
Hint
Focus on when interest is incurred, not when it is paid. Then count how many months have passed by year-end.
Answer B. Raven should accrue interest incurred through December 31 even though payment is at maturity. Annual interest = $600,000 × 10% = $60,000. Seven months have elapsed from June 1 through December 31, so interest payable = $60,000 × 7/12 = $35,000.
Why not A: Tempting because no cash payment is due until May 31, Year 2, but under accrual accounting the liability is recognized as interest is incurred, not when paid.
Why not C: Reflects the full year's interest; incorrect because only 7 months of interest have accrued by December 31, not the full 12 months.
Why not D: Results from miscounting the elapsed period as 6 months instead of 7 months (June-December = 7 months).
Worked example
On September 1, Year 1, Lake Co. signed a $240,000, 8% note payable due March 1, Year 2. Principal and interest are payable at maturity. Record the year-end accrual at December 31, Year 1, and state the balance sheet amounts.
| 1 | Annual interest$240,000 × 8% | $19,200 |
| 2 | Fraction of year elapsedSeptember through December = 4 months; 4/12 | 4/12 |
| 3 | Accrued interest expense and interest payable$19,200 × 4/12 | $6,400 |
| 4 | Balance sheet amounts at December 31Note payable $240,000; Interest payable $6,400 | $246,400 total current liability related to the note |
At December 31, record interest expense and interest payable of $6,400; present Note payable $240,000 and Interest payable $6,400 as current liabilities.
Check: Shortcut: monthly interest = $240,000 × 8% ÷ 12 = $1,600; for 4 months, $1,600 × 4 = $6,400.
Key points
- Accrue interest even if cash interest is due only at maturity.
- Count the exact months from the issue date through December 31; do not round to a full year.
- Show note payable and interest payable on separate balance sheet lines.
- If the note matures within one year of the balance sheet date, both principal and accrued interest are current liabilities.
- Missing the accrual understates current liabilities and interest expense and overstates income and the current ratio.
- Mixed drill: Payables and accrued liabilities.
How the exam traps you
- Waiting to record interest until the payment date. Record an adjusting entry at year end for interest incurred to date as interest expense and interest payable.
- Accruing a full year of interest when only part of the year has passed. Prorate using months outstanding through December 31: Principal × Rate × Months/12.
- Combining accrued interest with the note’s principal on the balance sheet. Keep principal as note payable and the accrual as interest payable on separate lines.
- Miscounting months between the issue date and year end. Count calendar months inclusive of the start month to December 31, consistent with the note’s terms.
Question 2
Hint
Focus on the accrual basis, not the payment date. Ask how much interest has been incurred by December 31 based on the time the note has been outstanding.
Answer C. Under accrual accounting, interest expense is recognized as it is incurred, not when cash is paid. From October 1 through December 31, three months of interest have accrued: $500,000 × 12% × 3/12 = $15,000. Harlan should record interest expense and a corresponding interest payable at year-end.
Why not A: This applies a cash-basis perspective. Under accrual accounting, interest is incurred over time and must be recorded as an expense and payable when earned, even if payment is due later.
Why not B: This reflects the full annual interest ($500,000 × 12% = $60,000) but ignores that only three months have passed by December 31; only one-quarter of the annual amount ($15,000) should be accrued in Year 1.
Why not D: Accrued interest does not reduce the principal of the note; unpaid interest is recorded separately as interest payable, while the note payable remains at the principal amount.
Question 3
Hint
Keep the principal and the interest separate, and accrue interest only for the time that has passed by the balance sheet date.
Answer C. The note principal remains $200,000 until it is paid or otherwise settled. Interest accrues from October 1 through December 31 (3 months): $200,000 × 9% × 3/12 = $4,500, which is reported as accrued interest payable separate from the note principal.
Why not A: This attracts a candidate who incorrectly thinks only part of the principal should be shown at an interim date. The full unpaid principal remains outstanding on the balance sheet, so the note payable is $200,000, not $100,000.
Why not B: This option combines accrued interest with the face amount of the note and shows no accrued liability. That is incorrect: the principal stays at $200,000 and accrued but unpaid interest is reported separately as an accrued liability.
Why not D: This reflects calculating interest for the full six-month term instead of only the three months that have passed by December 31. Only $4,500 (3 months) has accrued by year-end.
Question 4
Hint
Separate what is owed on the note itself from what has accrued in interest by year-end, then decide whether both are current.
Answer C. Because the note matures within one year of the balance sheet date, the $300,000 principal is a current liability. Interest has accrued for 3 months from October 1 through December 31: $300,000 × 12% × 3/12 = $9,000. Therefore, the total current liability related to the note at December 31 is $309,000.
Why not A: This includes the principal but ignores accrued interest. At year-end Rudd must recognize the interest earned through December 31 ($9,000), so total current liability is higher than $300,000.
Why not B: This assumes interest for the full six-month term (300,000 × 12% × 6/12 = $18,000). Only three months of interest have accrued by December 31, so include $9,000, not $18,000.
Why not D: This represents only the accrued interest through December 31. The question asks for the total current liability related to the note, which includes both the principal ($300,000) and accrued interest ($9,000).
Common questions
Do I accrue interest at year end if interest is paid at maturity?
Yes. Under accrual accounting, recognize interest expense and interest payable for the portion of the term elapsed by year end, even if cash is due later.
How do I present notes and interest on the balance sheet?
Report the unpaid principal as note payable and the accrued but unpaid interest as interest payable. Present both as current if the note matures within one year of the balance sheet date.
How do I prorate interest when a note spans two reporting periods?
Use Principal × Stated rate × Months outstanding/12 for the months from the issue date through the reporting date. Accrue only the portion incurred by year end.
Watch it solved
A full CPA FAR task-based simulation on Payables and accrued liabilities, worked step by step.
FAR Simulation: Accounts Payable Cutoff and Accruals on YouTube
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