What is a Note Payable? Definition, Nature, Example, and Journal Entries

On February 1, 2019, the company must charge the remaining balance of discount on notes payable to expense by making the following journal entry. A zero-interest-bearing note (also known as non-interest bearing note) is a promissory note on which the interest rate is not explicitly stated. When a zero-interest-bearing note is issued, the lender lends to the borrower an amount less than the face value of the note.

General ledgers in accounting track all of the major accounts and are used to provide the information used in financial reporting. 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. There are other instances when notes payable or a promissory note can be issued, depending on the type of business you have. You create the note payable and agree to make payments each month along with $100 interest. Notes payable and accounts payable are both liability accounts that deal with borrowed funds.

Journal Entries

When payments are made on the bank note principal (original amount not including interest), the Notes Payable account will be debited (decreased) to reflect the amount remaining to pay off the loan. When you go back to your company and speak to your accountant, he/she will perform the appropriate transactions in the general ledger to record the day’s events. The accountant will debit the Cash account by $75,000 to show the deposit from the bank and credit the Notes Payable account and include the details of the loan for future reference.

From the perspective of the company, the interest expense due on the notes payable is debited while the interest payable account is credited. On the other hand, the notes payable account is credited to account for the liability. One thing to be noted for the notes payable is that the interest payable or interest liability has not been recorded in the first entry. It’s because the interest amount was not due on the date of loan issuance. The due date and allowed period are also mentioned on the note payable. The time allowed for payment is an agreed-upon timeline at the will of both parties to contracts.

Journal entries for interest-bearing notes:

John signs the note and agrees to pay Michelle $100,000 six months later (January 1 through June 30). Additionally, John also agrees to pay Michelle a 15% interest rate every 2 months. In conclusion, all three of the short-term liabilities mentioned represent cash outflows once the financial obligations to the lender are fulfilled. But the latter two come with more stringent lending terms and represent more formal sources of financing.

• National Company prepares its financial statements on December 31, each year.
• For most companies, if the note will be due within one year, the borrower will classify the note payable as a current liability.
• It is a formal and written agreement, typically bears interest, and can be a short-term or long-term liability, depending on the note’s maturity time frame.
• It must charge the discount of two months to expense by making the following adjusting entry on December 31, 2018.
• The adjusting journal entry in Case 1 is similar to the entries to accrue interest.

National Company must record the following journal entry at the time of obtaining loan and issuing note on November 1, 2018. An example of a notes payable is a loan issued to a company by a bank. The $200 difference is debited to the account Discount on Notes Payable. This is a contra-liability account and is offset against the Notes Payable account on the balance sheet.

Everything You Need To Master Financial Modeling

Examples of unearned revenues are deposits, subscriptions for magazines or newspapers paid in advance, airline tickets paid in advance of flying, and season tickets to sporting and entertainment events. As the cash is received, the cash account is increased (debited) and unearned revenue, a liability account, is increased (credited). As the seller of the product or service earns the revenue by providing the goods or services, the unearned revenues account is decreased (debited) and revenues are increased (credited). Unearned revenues are classified as current or long‐term liabilities based on when the product or service is expected to be delivered to the customer.

On this date, National Company must record the following journal entry for the payment of principal amount (i.e., $100,000) plus interest thereon (i.e., $1,000 + $500). The adjusting journal entry in Case 1 is similar hr transformation to the entries to accrue interest. Interest Expense is debited and Interest Payable is credited for three months of accrued interest. There is always interest on notes payable, which needs to be recorded separately.

• However, the nature of liability depends on the amount, terms of payments, etc.
• Notes payable are classified as current liabilities when the amounts are due within one year of the balance sheet date.
• Notes payable have an interest payment coming from promissory notes or promises to pay back a bank or individual and often carry balances over from one month to the next.
• An automated financial management system, such as NetSuite Cloud Accounting Software, simplifies the journal entry process and integrates with cash management to more easily manage notes receivable.
• John signs the note and agrees to pay Michelle $100,000 six months later (January 1 through June 30).

At Finance Strategists, we partner with financial experts to ensure the accuracy of our financial content. The note in Case 2 is drawn for $5,200, but the interest element is not stated separately. The principal is just the total payment less the amount allocated to interest. This is because such an entry would overstate the acquisition cost of the equipment and subsequent depreciation charges and understate subsequent interest expense. The present value technique can be used to determine that this implied interest rate is 12%.

Note Payable

In this example, there is a 6% interest rate, which is paid quarterly to the bank. In your notes payable account, the record typically specifies the principal amount, due date, and interest. By contrast, accounts payable is a company’s accumulated owed payments to suppliers/vendors for products or services already received (i.e. an invoice was processed).

The agreement calls for Ng to make 3 equal annual payments of $6,245 at the end of the next 3 years, for a total payment of $18,935. Harold Averkamp (CPA, MBA) has worked as a university accounting instructor, accountant, and consultant for more than 25 years. Debit your Notes Payable account and debit your Cash account to show a decrease for paying back the loan. Get instant access to video lessons taught by experienced investment bankers.

If a company borrows capital under a note payable, the cash account is debited for the amount received on the ledger. Notes payable are most generally issued by the borrower or the lender when a bank loan is taken. When a company purchases bulk inventory from suppliers, acquire machinery, plant & equipment, or take a loan from a financial institution.

Your day-to-day business expenses such as office supplies, utilities, goods to be used as inventory, and professional services such as legal and other consulting services are all considered accounts payable. If your company borrows money under a note payable, debit your Cash account for the amount of cash received and credit your Notes Payable account for the liability. Additionally, they are classified as current liabilities when the amounts are due within a year. When a note’s maturity is more than one year in the future, it is classified with long-term liabilities. Business owners record notes payable as “bank debt” or “long-term notes payable” on the current balance sheet.

Many notes payable require formal approval by a company’s board of directors before a lender will issue funds. Accounts payable is an account that includes items that are to be paid immediately, without a loan. Notes payable are loans that charge interest as they are payments for items over a longer period of time. Businesses use money to purchase inventory, equipment, land, buildings, or many other things to help them to expand or become more profitable.

An interest-bearing note is a promissory note with a stated interest rate on its face. This note represents the principal amount of money that a lender lends to the borrower and on which the interest is to be accrued using the stated rate of interest. A discount on a note payable is the difference between the face value and the discounted value at issuance. This interest expense is allocated over time, which allows for an increased gain from notes that are issued to creditors. For most companies, if the note will be due within one year, the borrower will classify the note payable as a current liability. If the note is due after one year, the note payable will be reported as a long-term or noncurrent liability.

Notes Payable and Accounts Payable are different because Notes Payable are based on written promissory notes, while Accounts Payable are not. Accounts Payable involve regular debts made from such things as purchasing supplies or materials on credit. These accounts are typically settled (paid off) within 30 days and usually do not involve interest payments. The “Notes Payable” line item is recorded on the balance sheet as a current liability – and represents a written agreement between a borrower and lender specifying the obligation of repayment at a later date. These agreements often come with varying timeframes, such as less than 12 months or five years.