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Notes Receivableand Notes PayableChapter

15

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Learning Objective 1

Determining interest calculations

and maturity dates on notes.

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Learning Unit 15-1

What are promissory notes? They are a written promise to pay a certain

sum of money to a lender at a fixed future date.

The payee is the lender. The maker is the borrower.

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$20,000.00 Oct. 2, 20xx

We, Green Company, promise to pay

NATIONAL BANK

TWENTY-THOUSAND AND 00/100…DOLLARS

ON DECEMBER 1, 200x

Plus interest at the annual rate of 12 percent.

__________

MakerPayee

Learning Unit 15-1

Date of issue

Principal

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Learning Unit 15-1

Principal is the amount borrowed. Maturity date is the date the money is to be

repaid. The interest rate is the yearly interest rate. The interest is adjusted to the length of time

for short term notes. The obligation is called a note payable.

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Learning Unit 15-1

Interest = Principal × Rate × Time What is the interest on the note due to

National Bank? Principal: $20,000

Interest: 12% Time: October 2, 200x to December 1, 200x

$20,000 × 12% × 60 ÷ 360 = $400

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Learning Unit 15-1

Determining maturity date: The exact number of days in each month

must be used. The date the note was issued is omitted. Add the days remaining until the total time

on the note is reached.

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Learning Objective 2

Journalizing entries to recordrenewal of a note, dishonoringof a note, eventual receipt ofpayment, and note given in

exchange for equipment purchased.

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Notes Receivable xxxSales xxx

Notes Receivable xxxSales xxx

Notes Receivable xxxAccounts Receivable xxx

Notes Receivable xxxAccounts Receivable xxx

Learning Unit 15-2

What is the entry to record a note receivable?

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Cash xxxNotes Receivable xxxInterest Income xxx

Cash xxxNotes Receivable xxxInterest Income xxx

Learning Unit 15-2

What is the entry to record payments?

Notes Payable xxxInterest Expense xxx

Cash xxx

Notes Payable xxxInterest Expense xxx

Cash xxx

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Accounts Receivable xxxInterest Income xxxNotes Receivable xxx

Accounts Receivable xxxInterest Income xxxNotes Receivable xxx

Learning Unit 15-2

What is the entry to record a dishonored note?

Notes Payable xxxInterest Expense xxx

Accounts Payable xxx

Notes Payable xxxInterest Expense xxx

Accounts Payable xxx

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Learning Objective 3

Discounting an interest-bearing

note receivable and recordinga discounted note that has

been dishonored.

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Learning Unit 15-3

Sometimes notes are exchanged for cash at the bank (discounting).

The number of days (up to maturity) that the bank will hold the note is called the discount period.

Maturity value becomes the new principal (of the note) used to compute bank interest to be charged on the note.

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Learning Unit 15-3

Bank discount is the amount of interest the bank will charge on the note.

Cash proceeds is the amount of cash that will be received.

Interest is deducted on the day the note is discounted and the money borrowed.

That means the business uses less cash.

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Compute maturity value:Interest = Principal × Rate × Time

Principal + Interest = Maturity Value

Compute maturity value:Interest = Principal × Rate × Time

Principal + Interest = Maturity Value

Learning Unit 15-3

The bank will receive the exact maturity value at due date.

No interest is computed at that time. What are the steps?

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Calculate discount period:Number of days bank holds the note

Calculate discount period:Number of days bank holds the note

Bank discount = Maturity value× Bank discount rate (interest rate)

× No. days bank holds note÷ by 360.

Bank discount = Maturity value× Bank discount rate (interest rate)

× No. days bank holds note÷ by 360.

Learning Unit 15-3

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Cash Proceeds =Maturity Value – Bank Discount

Learning Unit 15-3

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Cash xxxNotes Receivable xxxInterest Income xxx

Cash xxxNotes Receivable xxxInterest Income xxx

Learning Unit 15-3

Cash xxxInterest Expense xxx

Notes Receivable xxx

Cash xxxInterest Expense xxx

Notes Receivable xxx

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Learning Unit 15-3

The bank usually requires that a note be discounted with recourse.

This means that if a note maker does not pay the maturity value to the bank, the company will have to pay the bank.

This is called a contingent liability.

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Learning Unit 15-3

If a note is dishonored, it is charged back to the customer using maturity value plus penalties as the new principal amount.

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Learning Objective 4

Handling adjustments for interest

expense and interest income.

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Learning Unit 15-4

What does it mean to discount one’s own note payable?

This means the interest is deducted from the amount borrowed.

The cash proceeds to be used will be less than the principal amount.

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Learning Unit 15-4

At maturity, the amount that has to be repaid is the exact face value of the note.

The discount is a contra-account that is written off to interest expense over the life of the note.

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Learning Unit 15-4

Interest expense and interest income will be computed up to the last day of the accounting period.

An adjusting entry will be made to recognize interest expense as a debit and accounts payable as a credit.

An adjusting entry will be made to recognize interest earned as a credit and interest receivable as a debit.

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End of Chapter 15