Companies may issue a notes payable when borrowing cash,
purchasing assets, or in settlement of a past due accounts payable.
Notes Payable is just the opposite side of the same transaction as Notes Receivable.
The source document of a Notes Payable is a promissory note.
A promissory note is a legal document that binds parties in a contact.
A student loan is a type of promissory note.
Here are some terms related to Notes Payable that you will want to be familiar with.
You might want to pause the video and write those definitions down.
Computing interest is an important part of property accounting for notes payable.
You’ve probably learned how to do this calculation before
in some business or financial math class, but we will revisit here anyway.
Interest is calculated by taking the principal of the note,
times the annual interest rate of the note, times the term of the note.
I remember this with the acronym PRT: Principle times Rate times Time.
Make sure to remember that interest is always stated in terms of an annual rate,
so time must also be in terms of one year.
Here are some examples to reinforce the point.
We have three notes here, let's calculate interest for each of them.
For Note One, interest is $10,000, times 6% interest, times 120/365, which is equal to $197.
You can see that the term 120 days is converted into years by dividing 120 by 365.
For Note Two, the interest is $50,000, times 4% interest, times 6/12, which equals $1,000.
You can see the term six months is converted into years by dividing six by 12.
Finally note 3 is for 1 year so it is just the principal, times the rate, times 1.
Let’s look at a typical example.
The Motley Crue Company issues a $5,000, three-month, 6% promissory note dated May 1,
to settle a past due accounts payable.
The journal entry to record the note is a debit to accounts payable for $5,000,
and credit to Notes Payable, since the note was issued to settle the past due account.
And it's also for the $5,000.
Assume on August 1, Motley Crue pays off the note and accrued interest.
The journal entry to record the settlement of the note is a debit to Notes Payable for $5,000.
A debit to Interest Expense for $75, and that's for three months of interest,
and a credit to cash for $5,075.
this amount equals the principle plus the interest.
You can see the interest calculation on the slide.
These are the basic journal entries for issuing and then settling (or paying off) a notes payable.
But before we wrap up this video, let's complicate this example just a bit.
In this case, assume the transaction is dated December 1st rather than May 1st.
How does this change any of the journal entries? Well, let's take a look at that.
The issuance of the note is exactly the same.
but now we have to make an adjusting entry on December 31st,
to accrue the amount of interest expense incurred for the month of December.
So the adjusting entry would be $25.00, because that's one month's interest.
Finally, paying off the note on March 1st is a lengthy journal entry, but we can work through it.
Notes Payable is still debited for $5,000, because that's the amount of the note,
and that balance needs to be zero after Motley Crue pays it off.
Interest Payable, which has a credit balance of $25.00 from the December 31 adjusting entry,
also needs to be debited for $25.00
because that account balance needs to be zero, after the note is paid off.
Interest Expense is debited for $50
because that is the amount of interest incurred in the new year.
Finally, Cash is still credited for $5,075, which is the principal and interest paid.