On January 1, Year 1, Carlyle Corporation issued a five-year term note. The note requires an annual cash payment on December 31 of each year. The payment includes a principal reduction and interest. Indicate whether each of the following statements is true or false._____ a) The issuance of the note will increase assets and liabilities._____ b) The first payment on the note will reduce liabilities and assets, but will not affect equity._____ c) The second payment on the note will include higher interest expense than did the first payment._____ d) Each payment on the note includes a cash flow from operating activities and a cash flow from financing activities._____ e) The amount of reduction in liabilities will increase with each succeeding payment.

Question

What will be an ideal response?

Answer 1

a) This is true. Issuing an installment note increases assets (cash) and liabilities (installment notes payable).
b) This is false. Each payment made decreases assets (cash), liabilities (installment notes payable), and equity (interest expense).
c) This is false. The second payment on the note will include less interest expense than did the first payment.
d) This is true. The portion of a payment that reduces principal is a cash flow for financing activities, and the portion that is interest is a cash flow for operating activities.
e) This is true. As interest expense goes down with each payment, the portion that reduces principal on the liability goes up.