A long-term note payable is also a very common way for companies
to finance operations and growth.
A long-term notes payable is a contract between a lender--
a bank, for example--
and a borrower, let's say a company.
The lender lends cash to the company.
We call this the principal amount.
The company agrees to repay the principal plus interest
at some point in the future, as detailed in the loan contract.
There are a lot of different types of loans,
but I want to introduce you to the three most common types
for long-term business loans.
They are an installment note, a balloon payment note,
and a mortgage.
Many of you might be familiar with the concept
of an installment loan.
If you've ever taken out a loan that
requires regular monthly payments,
chances are, it was an installment loan.
A common characteristic is that the monthly payment
amount is fixed.
Additionally, a portion of the payment
goes to pay for the accrued interest and the remainder
to reduce the principal amount.
This continues month after month until the loan
has been paid off.
A balloon loan isn't very common for individuals,
but it is for businesses, especially large businesses
with access to a lot of cash.
A common characteristic is that no monthly payment is required.
Payments for both accrued interest and principal
are due at the end of the loan term.
An example might be a company that is starting a new product
line, and they may want to repay a loan several years
after the product line has been established and quite
profitable.
A mortgage is a type of installment loan
that is secured by real property,
meaning land or building.
I want to mention this one because business loans are
secured differently than loans for individuals.
Large organizations often provide no specific security
for long-term notes.
Small organizations might be required
to list all of the business assets
and possibly the owner's assets too in order to secure a loan.
Let's wrap up this topic with an example.
On July 1, Joy Division signed a 24-month promissory note
to borrow $11,000 plus 6% annual interest.
They will make a monthly loan payment
of $500 beginning August 1st.
So what is the journal entry to record
the long-term notes payable?
As you can see, it is a debit to cash and a credit
to long-term notes payable for $11,000.
In order to easily make the journal entry to record
the monthly loan payment, companies
prepare an amortization schedule.
I've shortened this one to fit onto the screen,
but it would show each month until the loan balance is zero.
You might recall that interest is
calculated by taking principal times the interest rate times
time.
In this example, that's how the interest column
amounts are calculated.
The principal reduction is the difference between the payment
amount and the amount of interest expense.
We can use the amortization table
to find the data needed to record the journal entry
for the monthly loan payment.
We need the payment amount, the amount of interest expense,
and the amount the notes payable is reduced.
Using the information from the table,
we debit interest expense for $55, debit long-term notes
payable for $445.
This is how we reduce the liability,
and we credit cash for $500.
We could just as easily recorded a journal entry on November 1.
You can see the highlighted data on the amortization table.
So now we debit interest expense for $48, debit long-term notes
payable for $452, and credit cash for $500.