ABC, Inc. discounts a 5%, 9-month, $1,000 note with a financial institution after holding the note for 3 months. The note was received on the sale of an asset to another party. The discount percentage is 7%. The proceeds to ABC, Inc. equal $1,001.19.

interest receivable 12.50 debit

interest revenue 12.50 credit

--adjusting entry for the interest accrued--

interest expense 11.31 debit

cash 1,001.19 debit

note receivable 1,000.00 credit

interest receivable 12.50 credit

--to record early discount of the note--

Explanation:

We are going to write-off the note and check for the interest expense:

book value of the note:

principal + interest accrued

principal x rate x time = interest

1,000 x 0.05 x 3 months/12 month a year = 12.50

we had interest receivable for 12.50

1,000 + 12.5 = 1,012.5 we receive 1,001.19

interest expense: 11.31

We are following this process to avoid compensate balance as is the company earned interest during those three months and then it pay interest to get cash earlier.