A book resale business converts a past-due accounts receivable of $100,000 into a notes receivable with a 5% penalty, a maturity of 6 months, and a 12% annual interest rate. How would you record this transaction?

A book resale business converts a past-due accounts receivable of $100,000 into a notes receivable with a 5% penalty, a maturity of 6 months, and a 12% annual interest rate. How would you record this transaction?

• A. Debit Notes Receivable for $105,000, credit Accounts Receivable for $100,000, and Penalty Revenue for $5,000
• B. Debit Notes Receivable for $105,000, credit Accounts Receivable for $100,000, and Interest Revenue for $5,000
• C. Debit Notes Receivable for $105,000 and credit Accounts Receivable for $98,000, Sales Discounts for $2,000, and Interest Revenue for $5,000
• D. Debit Notes Receivable for $105,000; credit Accounts Receivable for $100,000; and Penalty Revenue for $5,000

Answer: (A)

When a past-due accounts receivable is converted into a note receivable, you replace the old receivable with a note for the amount expected to be paid, including any penalties charged for converting to a note. Here, the note should reflect the original amount plus the penalty: 100,000 + 5,000 = 105,000. Record the note by debiting Notes Receivable for 105,000 to reflect the new asset, credit Accounts Receivable for 100,000 to remove the old balance, and credit Penalty Revenue for 5,000 to recognize the penalty as revenue. The interest rate and the 6-month term don’t affect this initial entry; they pertain to interest earned over the life of the note and would be addressed as interest accrues (for example, 105,000 × 6% = 6,300 over six months).

When a past-due accounts receivable is converted into a note receivable, you replace the old receivable with a note for the amount expected to be paid, including any penalties charged for converting to a note. Here, the note should reflect the original amount plus the penalty: 100,000 + 5,000 = 105,000.

Record the note by debiting Notes Receivable for 105,000 to reflect the new asset, credit Accounts Receivable for 100,000 to remove the old balance, and credit Penalty Revenue for 5,000 to recognize the penalty as revenue. The interest rate and the 6-month term don’t affect this initial entry; they pertain to interest earned over the life of the note and would be addressed as interest accrues (for example, 105,000 × 6% = 6,300 over six months).