>> A long term notes 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, 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 of long term business loans.
They are an installment note,
a balloon payment note and a mortgage.
The focus of this video will be on an installment note with a variable payment.
Many of you might be familiar with the concept of an installment note.
If you've ever taken out a loan that requires a regular monthly payment,
chances are it was an installment loan.
You are likely most familiar with an installment note that
has a fixed amount for the monthly payment.
For fixed payments, a portion of the payment goes to pay
for accrued interest and the remainder to reduce the principal amount.
This continues month after month until the loan has been paid off.
However, some notes have variable payments.
When this occurs, the monthly payment amount contains a fixed portion
for the reduction of the principal balance and
a variable amount for the monthly interest portion.
I think the easiest way to understand this is with an example.
On July 1, Joy Division signed a 24 month promissory note
to borrow $24,000 plus six percent annual interest.
They will make monthly loan payment of
$1,000 plus accrued interest beginning on August 1st.
So what is the journal entry to record the long term note payable?
You can see it's a debit to cash and a credit to long term note payable for $24,000.
In order to easily make the journal entry to record the monthly loan payment,
companies prepare an amortization schedule.
I've shorten this one to fit on the screen,
but it would show each month until the loan balance is zero.
Notice that the payment amount is different each month.
This is a variable payment note.
You might recall that interests is calculated by taking
principal times the interest rate times time.
In this example, that is how the interests column amounts are calculated.
The principal reduction is the fixed amount to pay off the $24,000 note in 24 months.
The payment is the principal amount and the interest added together.
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 a $120,
debit long term notes payable for $1000,
and this is how we reduce the liability,
and we credit cash for $1,120.
We could have just as easily recorded the journal entry for November 1.
You see the data highlighted on the amortization table.
So we debit interest expense for a $105,
debit long term notes payable for $1,000,
and credit cash for $1,105.