What is a Note Payable? Definition, Nature, Example, and Journal Entries

This is a contra-liability account and is offset against the Notes Payable account on the balance sheet. The concepts related to these notes can easily be applied to other forms of notes payable. Notes payable is a liability that results from purchases of goods and services or loans. Usually, any written instrument that includes interest is a form of long-term debt. When a business owner needs to raise money for their business, they can turn to notes payable for funding. Capital raised from selling notes can improve a business’s financial stability.

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On February 1, 2019, the company must charge the remaining balance of discount on notes payable to expense by making the following journal entry. The company obtains a loan of $100,000 against a note with a face value of $102,250. The difference between the face value of the note and the loan obtained against it is debited to discount on notes payable. A zero-interest-bearing note (also known as non-interest bearing note) is a promissory note on which the interest rate is not explicitly stated. When a zero-interest-bearing note is issued, the lender lends to the borrower an amount less than the face value of the note.

The discount simply represents the total potential interest expense to be incurred if the note remains’ unpaid for the full 120 days. If neither of these amounts can be determined, the note should be recorded at its present value, using an appropriate interest rate for that type of note. Notes payable include terms agreed upon by both parties—the note’s payee and the note’s issuer—such as the principal, interest, maturity (payable date), and the signature of the issuer.

Journal entries for interest-bearing notes:

There was an older practice of adding interest expense to the face value of the note—however, the convention of fair disclosure under truth-in-lending law. F. Giant must pay the entire principal and, in the first case, the accrued interest. In both cases, the final month’s interest expense, $50, is recognized. Thus, S. F. Giant receives only $5,000 instead of $5,200, the face value of the note. It would be inappropriate to record this transaction by debiting the Equipment account and crediting Notes Payable for $18,735 (i.e., the total amount of the cash out-flows).

The agreement may also require collateral, such as a company-owned building, or a guarantee by either an individual or another entity. Many notes payable require formal approval by a company’s board of directors before a lender will issue funds. Notes payable is a liability account that’s part of the general ledger. Businesses use this account in their books to record their written promises to repay lenders. Likewise, lenders record the business’s written promise to pay back funds in their notes receivable. Accounts payable typically do not have terms as specific as those for notes payable.

At maturity, the borrower repays to lender the amount equal to face vale of the note. Thus, the difference between the face value of the note and the amount lent to the borrower represents the interest charged by the lender. We can suggest a note payable to be the written promissory note. Many business transactions result in notes payable to the debtor. However, the notes payable are written on the will of both parties.

1. A note payable is a borrowing that is written as a legal contract.
2. The entry is for $150 because the amortization entry is for a 3-month period.
3. This interest expense is allocated over time, which allows for an increased gain from notes that are issued to creditors.
4. Every company or business requires capital to fund the operations, acquire equipment, or launch a new product.
5. Some people argue that notes payable can be adjusted under the head of account payables.

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This interest expense is allocated over time, which allows for an increased gain from notes that are issued to creditors. You can compare the rate you’d earn with notes payable to rates on similar assets such as fixed-rate bonds, Treasuries, or CDs as you decide whether they would be right for your portfolio. Let’s check out a few examples of recording them in your books. The following entry is required at the time of repayment of the face value of note to the lender on the date of maturity which is February 1, 2019. On November 1, 2018, National Company obtains a loan of $100,000 from City Bank by signing a $102,250, 3 month, zero-interest-bearing note. National Company prepares its financial statements on December 31, each year.

In the first case, the firm receives a total face value of $5,000 and ultimately repays principal and interest of $5,200. You’ve already made your original entries and are ready to pay the loan back. For the past 52 years, Harold Averkamp (CPA, MBA) hasworked as an accounting supervisor, manager, consultant, university instructor, and innovator in teaching accounting online.

With accounts payable, you use the account to record liabilities you owe to vendors (e.g., buy supplies from a vendor on credit). At the beginning of each month, Todd makes the $2,000 loan payment and debits the loan account for $1,500, debits interest expense for $500, and credits cash for $2,000. She debits cash for $2,000 and credits notes receivable for $1,500 and interest income for $500. Recording notes payable in their entirety is crucial for the fair and true representation of the financial statements. The notes payable of a company can also be added to project expenses when you’re budgeting for future periods. This establishes the importance xerocon 2017 austin texas wrapup of notes payable recording in financial statements.

The short term notes payable are classified as short-term obligations of a company because their principle amount and any interest thereon is mostly repayable within one year period. They are usually issued for purchasing merchandise inventory, raw materials and/or obtaining short-term loans from banks or other financial institutions. The short-term notes may be negotiable which means that they may be transferred in favor of a third party as a mode of payment or for the settlement of a debt. The short-term notes are reported as current liabilities and their presence in balance sheet impacts the liquidity position of the business. In accounting, Notes Payable is a general ledger liability account in which a company records the face amounts of the promissory notes that it has issued.

For example, if the borrower needs more money than originally intended, they can issue multiple notes payable. A firm may issue a long-term note payable for a variety of reasons. For example, notes may be issued to purchase equipment or other assets or to borrow money from the bank for working capital purposes. If notes payable are due within 12 months, it is considered as current to the balance sheet date and non-current if it is due after 12 months. You create the note payable and agree to make payments each month along with $100 interest.

How are interest rates determined on a note payable?

A borrower with a weak credit history and a relatively less healthy financial profile may be in for a higher interest rate. Each payment of $6,245 is divided between interest and principal. The interest portion is discount rate accounting 12% of the note’s carrying value at the beginning of each year.