What are notes?

A note payable is also known as a promissory note. It is a very simple document created by the lender that lists the interest rate and repayment terms. On the balance sheet, the notes payable is a liability with a natural credit balance. If a note is due within one year it is a current liability. If due one year or later it is a long term liability.

Notes with less than 12 months term are usually paid in full at the end of the term. For instance, if a business owner takes a 12 month note in August, no payment will be due till July of the next year.

There are 4 main events to account for when a note is taken

• The receipt of the cash from the note
• The adjusting entry at the end of the year (before the payment is due)
• The interest expense due at the end of the term of the note
• The note and interest payment

Example

Uncle Joe took a $10,000 note from first country bank on August 1^st, 2014. The interest rate of the note was 8% and the note was due one year later.

At the time of the note, Uncle Joe will make the entry below:

On December 31^st, Uncle Joe will need to make an adjusting entry to record the accrued interest. In this case 5 months have passed since the inception of the note, so interest has to be computed on 5 months. The interest after 5 months is $333.33 ($10,000 * 8% * 5/12). Uncle Joe makes the entry below:

On July 31^st, 2015, when the loan is due, Uncle Joe will have to recognize the interest for the remaining 7 months as follows (10,0000 * 8% *7/12 = $466.67)

Lastly Uncle Joe records the payment of the note and interest