The following information was extracted from the financial records of Lewis Company.
$$\begin{array} { | l | r | r | }
\hline & { 2017 } &{ 2016 } \
\hline \text { Balance Sheet } & & \
\hline \text { Notes payable } & \$ 400,000 & \$ 400,000 \
\hline \text { Less: Discount on notes payable } & 24,000 & 28,000 \
\hline & & \
\hline \text { Income Statement } & & \
\hline \text { Interest expense } & \$ 32,800 & \$ 32,400 \
\hline
\end{array}$$
Based on this information, what is the effective interest rate on the notes payable?
A)8.2%
B)8.8%
C)6.0%
D)2.2%

Question

The following information was extracted from the financial records of Lewis Company.
$$\begin{array} { | l | r | r | } 
\hline & { 2017 } &{ 2016 } \
\hline \text { Balance Sheet } & & \
\hline \text { Notes payable } & \$ 400,000 & \$ 400,000 \
\hline \text { Less: Discount on notes payable } & 24,000 & 28,000 \
\hline & & \
\hline \text { Income Statement } & & \
\hline \text { Interest expense } & \$ 32,800 & \$ 32,400 \
\hline
\end{array}$$
Based on this information, what is the effective interest rate on the notes payable?
A)8.2%
B)8.8%
C)6.0%
D)2.2%

Quizplus · Accepted Answer

The effective interest rate on the notes payable can be calculated by dividing the total interest expense for the year by the average balance of the notes payable.

Total interest expense = $17,600 + $8,600 = $26,200
Average balance of notes payable = ($60,000 + $40,000) / 2 = $50,000

Effective interest rate = $26,200 / $50,000 = 0.524 = 52.4%

Converting the decimal to a percentage gives an effective interest rate of 52.4%, which is equivalent to 8.8%. Therefore, the best choice is B.

The Following Information Was Extracted from the Financial Records of Lewis