Question

Ch.10 Serial Problem Kate's Cards

Recall that Kate previously obtained a $15,000 bank loan, signing a note payable, on November 30. The note required semiannual interest payments at the rate of six percent. The entire principal balance was due two years from the original date of the note. Kate has been accruing interest on a monthly basis in the amount of $75. Kate would like to know how she should record the interest in May, the month she makes the first interest payment. She is unsure how much expense will need to be recorded in May.

The upcoming interest payment is really not Kate's main concern right now. She was just notified by a lawyer that she is being sued for copyright infringement. Mega Card incorporated, one of the largest greeting card companies, believes that one of Kate's designs is too similar to one of Mega's designs for it to be a coincidence, and has, therefore, decided to sue Kate's Cards. Mega has a prior reputation for suing small companies and settling out of court for lesser damages. Kate, however, knows that her designs that her design is original and that she had never previously seen the Mega design that is the subject of the lawsuit. She has determined to fight the lawsuit, regardless of the cost. She doesn't know, however , how this will affect her financial statements.

1. Record the May journal entry for Kate's first interest payment. How much interest expense is reported in May?

2. How should Kate report the copyright infringement lawsuit in her financial statements?

Answer 1

1. Journal entry is shown below:

Interest expense...........................................Dr $75

Interest payable............................................Dr $375 (75*5)

Cash................................................................Cr $450

2. In this case, the contingent liability of the lawsuit is shown. If the liability is probable and the amount of the liability can be estimated reasonably. Then there will be the following journal entry:

Lawsuit expense.................................Dr

Accrued expense...................................Cr

But in the above case, the liability is not probable as well as the amount of the liability is not given. Therefore, it will be reported in the footnotes of the financial statements.