Learning Outcomes
- Record journal entries related to notes payable
Here’s a short video on Notes Payable.
Let’s follow this example: YourCo borrows $100,000 from the bank on December 1 of 20X1 at 12% interest (compounded monthly) with principal and interest due monthly so that the loan is completely amortized by December 1 of 20X9. Monthly payments will be $1,625.28
Notes Payable is a general ledger liability account in which a company records the face amounts of the promissory notes that it has issued. The balance in Notes Payable represents the amounts that remain to be paid. The journal entry to record the receipt of the proceeds of the note is fairly straight-forward–increase the checking account to reflect the deposit, and increase a long-term liability account called Notes Payable:
| Date | Description | Post. Ref. | Debit | Credit |
|---|---|---|---|---|
| 20X1 | ||||
| Dec 1 | Checking Account | 100,000 | ||
| Dec 1 | Notes Payable | 100,000 | ||
| Dec 1 | To record proceeds from bank loan | |||
Since a note payable will require the issuer/borrower to pay interest, the issuing company will have interest expense. Under the accrual method of accounting, the company will also have another liability account entitled Interest Payable. In this account, the company records the interest it has incurred but has not paid as of the end of the accounting period.
| Date | Description | Post. Ref. | Debit | Credit |
|---|---|---|---|---|
| 20X1 | ||||
| Dec 31 | Interest expense | 1,000.00 | ||
| Dec 31 | Interest payable | 1,000.00 | ||
| Dec 31 | To record interest on bank loan | |||
Interest incurred in December on the $100,000 principle for one month at 12% annual interest was $1,000, so that amount is recorded both as an expense and a payable (current liability).
In January, when the payment is made, the entry looks like this:
| Date | Description | Post. Ref. | Debit | Credit |
|---|---|---|---|---|
| 20X2 | ||||
| January 1 | Interest payable | 1,000.00 | ||
| January 1 | Notes Payable | 625.28 | ||
| January 1 | Checking Account | 1,625.28 | ||
| January 1 | To record monthly payment on bank loan | |||
Here are T account representations of the liability accounts (the checking account with the credit of $1,685.28 is not shown):
The general ledger account for Notes Payable has been reduced by the amount of the principal portion of the payment, and should agree with the amortization schedule.
| payment | Beg. Bal. | Payment | New balance | Interest | Ending Bal. | |
|---|---|---|---|---|---|---|
| 1-Dec-X1 | 100,000.00 | 100,000.00 | 1,000.00 | 101,000.00 | ||
| 1 | 1-Jan-X2 | 101,000.00 | ($1,625.28) | 99,374.72 | 993.75 | 100,368.46 |
| 2 | 1-Feb-X2 | 100,368.46 | ($1,625.28) | 98,743.18 | 987.43 | 99,730.61 |
| 3 | 1-Mar-X2 | 99,730.61 | ($1,625.28) | 98,105.33 | 981.05 | 99,086.38 |
| 4 | 1-Apr-X2 | 99,086.38 | ($1,625.28) | 97,461.10 | 974.61 | 98,435.71 |
| 5 | 1-May-X2 | 98,435.71 | ($1,625.28) | 96,810.42 | 968.10 | 97,778.53 |
Notice when you are studying financial statements that interest expense can be
- capitalized as part of inventory (for instance, auto dealers often finance the inventory) or part of the cost of an asset, such as a building where construction is being financed, or
- shown on the income statement AFTER income from operations.
The reason for showing interest expense after income from operations is so if an investor is comparing two companies that are very similar, except one borrowed very little from third parties, instead relying on equity financing, and the other is heavily debt financed, the interest expense does not affect income from operations, so the two companies are easier to compare.
Also, there normally isn’t an account for the current portion of long-term debt. It is simply a reclassification that happens as the financial statements are being prepared (often on the worksheet).
practice question
