Notes Payable Definition, Journal Entries, and Examples

Once you create a note payable and record the details, you must record the loan as a note payable on your balance sheet (which we’ll discuss later). The cash amount in fact represents the present value of the notes payable and the interest included is referred to as the discount on notes payable. An example of a notes payable is a loan issued to a company by a bank. Negative agreements require borrowers to pay interest less than the applicable interest charges, thereby adding the remaining amount to the principal balance. Though choosing this option helps people refrain from paying more as interest when inconvenient, the same adds up to the total amount to be repaid in the long run, increasing the burden.

Time Value of Money

When one takes up the loan and signs the agreement, it becomes the debit entry on the part of the one who borrows the amount. As soon as the loan is repaid, the note payable account of the borrower is still on the debit side and cash on the credit side. This is because the debit side indicates no further liability for the borrower with the cash account being credited. The customers make the final journal entry when they repay in full. Here, notes payable is a debit entry as it leaves no further liability. The cash account, however, has a credit entry, given the cash outflow in making repayments, which records a decreased asset.

What Are Notes Payable?

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1. The company obtains a loan of $100,000 against a note with a face value of $102,250.
2. According to the calculations, the total amount due on May 1st will be the principal amount plus interest payable.
3. The difference between the face value of the note and the loan obtained against it is debited to discount on notes payable.
4. The cash account is a credit entry as the amount will decrease, given the pending interest payment.

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. In your notes payable account, the record typically specifies the principal amount, due date, and interest.

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As the customers receive the cash, there is an increase in their assets, and hence they debit the account. At the same time, notes payment is a credit entry as they promise repayment, which is a liability. Notes Payable are a promise in writing whereby a borrower assures repaying the lenders within a specific period. These promissory notes indicate the loan that one party lends to the other, expecting the timely repayment, which may be the principal alone or the principal along with the interest amount. The debit of $2,500 in the interest payable account here is to eliminate the payable that the company has previously recorded at period-end adjusting entry on adding new users in xero December 31, 2020. If the company does not make this journal entry, both total expenses on the income statement and total liabilities on the balance sheet will be understated by $2,500 as of December 31, 2020.

The company should also disclose pertinent information for the amounts owed on the notes. This will include the interest rates, maturity dates, collateral pledged, limitations imposed by the creditor, etc. In summary, both cases represent different ways in which notes can be written. In the first case, the firm receives a total face value of $5,000 and ultimately repays principal and interest of $5,200. The entry is for $150 because the amortization entry is for a 3-month period.

The note payable is a written promissory note in which the maker of the note makes an unconditional promise to pay a certain amount of money after a certain predetermined period of time or on demand. The purpose of issuing a note payable is to obtain loan form a lender (i.e., banks or other financial institution) or buy something on credit. However, it should be noted that the current portion of a long term note payable is classified as a current liability. In notes payable accounting there are a number of journal entries needed to record the note payable itself, accrued interest, and finally the repayment. There are usually two parties involved in the notes payable –the borrower and the lender. The borrower is the party that has taken inventory, equipment, plant, or machinery on credit or got a loan from a bank.

If the borrower decides to pay the loan before the due date of the note payable, the computation of interest will not be done for the pre-decided period. Instead, the interest expense will be calculated for an exact period until the loan was paid. The company borrowed $20,000 from a bank due in six months with a 12% interest rate. The loan was taken on Nov 1st, 2019, and it would become payable on May 1st, 2020. The $200 difference is debited to the account Discount on Notes Payable.

Sometimes notes payable are issued for a fixed amount with interest already included in the amount. In this case the business will actually receive cash lower than the face value of the note payable. For example, on October 1, 2020, the company ABC Ltd. signs a $100,000, 10%, 6-month note that matures on March 31, 2021, to borrow the $100,000 money from the bank to meet its short-term financing needs. The company ABC receives the money on the signing date and as agreed in the note, it is required to back both principal and interest at the end of the note maturity. It has agreed-upon terms and conditions that must be satisfied to honor the agreement. However, the account payables are informal records, and the terms & conditions are not rigid.

He has worked as an accountant and consultant for more than 25 years and has built financial models for all types of industries. He has been the CFO or controller of both small and medium sized companies and has run small businesses of his own. He has been a manager and an auditor with Deloitte, a big 4 accountancy firm, and holds a degree from Loughborough University. You can verify a promissory note by checking with the Securities and Exchange Commission’s EDGAR database. Structured notes have complex principal protection that offers investors lower risk, but keep in mind that these notes are not risk-free. The risk of a note ultimately depends on the issuer’s creditworthiness.

Notes Payable resembles any loan, which binds borrowers and lenders against payment and repayment liabilities. In this journal entry, both total assets and total liabilities on the balance sheet of the company ABC increase by $100,000 as at October 1, 2020. We’ve comprehended the concept of notes payable, the right accounting treatment, journal entries, and examples to further elaborate the idea. The journal entries for notes payable related to equipment, inventory, or account payable will also be similar to how we have made entries above.

As the loan will mature and be payable on the due date, the following entry will be passed in the books of account for recording it. Let’s look at what entries are passed in the journal for notes payable. Interest is primarily the fee for allowing the debtor to make payment in the future.

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. As these partial balance sheets show, the total liability related to notes and interest is $5,150 in both cases. Interest expense is not debited because interest is a function of time. The discount simply represents the total potential interest expense to be incurred if the note remains’ unpaid for the full 120 days.