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
Uncle Joe took a $10,000 note from first country bank on August 1st, 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:
|Notes Payable $10,000|
On December 31st, 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:
|Interest Expense $333.33|
|Interest Payable $333.33|
On July 31st, 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)
|Interest Expense $466.67|
|Interest Payable $466.67|
Lastly Uncle Joe records the payment of the note and interest
|Interest Payable $800
Note Payable $10,000