Notes Payable Definition, Journal Entries, and Examples

Thus, S. F. Giant receives only $5,000 instead of $5,200, the face value of the note. Notes payable is a liability that results from purchases of goods and services or loans. Usually, any written instrument that includes interest is a form of long-term debt. The example entries show the credit being made directly to the notes receivable account, just as if the note had been collected.

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Another problem with issuing a note payable is it increases the organization’s fixed expenses, and this leads to increased difficulty of planning for future expenditures. Discounted on Note Receivable happens when the holder (lender) needs cash before the maturity date and decides to sell them to other financial institutes (bank) at a lower price. The bank will charge a discount as they have to pay immediately while waiting to receive a whole amount at the maturity date. In addition to discounted, the note also requires guarantee from the lender. It means that if the borrower fails to make full payment on the maturity date, the company (lender) will take full responsibility and pay back to the bank.

Interest expense is not debited because interest is a function of time. The discount simply represents the total potential interest expense to be incurred if the note remains’ unpaid for the full 120 days. A problem does arise, however, when an obligation has no stated interest or the interest rate is substantially below the current rate for similar notes. Someone on our team will connect you with a financial professional in our network holding the correct designation and expertise.

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The concepts related to these notes can easily be applied to other forms of notes payable. Generally, there are no special problems to solve when accounting for these notes. As interest accrues, it is periodically recorded and eventually paid. Our writing and editorial staff are a team of experts holding advanced financial designations and have written for most major financial media publications. Our work has been directly cited by organizations including Entrepreneur, Business Insider, Investopedia, Forbes, CNBC, and many others. 11 Financial is a registered investment adviser located in Lufkin, Texas.

The note, amounting to $64,349.44, bears interest at 18% and is due on 31 December 2019. Disclosure of receivables, including footnote details (related-party receivables), are shown for Scott’s Liquid Gold Inc. below. If the maker fails to make the required payments, the bank will present the note to the endorser and demand full payment. The term “discount” is used because the bank deducts the interest it charges from the note’s maturity value and thus discounts the note. If there is a net interest expense, the journal entry will be as church accounting follows.

Usually, notes receivable balances are common for financial institutions, such as banks. These institutions provide loans to customers along with a note stating they will pay the institution within a specific amount of time. Some notes may also come with interest payments that the lender will receive based on a predetermined rate. While accounts receivable balances represent any amount owed to the company by its customers, notes receivable represent loans to third parties. Usually, notes receivable balances are current assets, which companies expect to receive within 12 months.

Accounting for Discount on Notes Receivable

Instead, investors purchase discount notes at a discounted price and receive the note’s face value (also called “par value”) at maturity. BC Co. has a note receivable with a face value of $25,000 on Jan 1st, 20×1. The borrower has promised to repay the company in the next three months. The note receivable comes with a predetermined interest rate of 10%.

This type of liability is not disclosed in the balance sheet but should be described in a footnote if it is material. The proceed will be equal to the maturity value minus the discount. Shaun Conrad is a Certified Public Accountant and CPA exam expert with a passion for teaching. After almost a decade of experience in public accounting, he created MyAccountingCourse.com to help people learn accounting & finance, pass the CPA exam, and start their career. This is because such an entry would overstate the acquisition cost of the equipment and subsequent depreciation charges and understate subsequent interest expense.

1. Thus, the company will have contingent liabilities that may arise due to the default of the note receivable.
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4. That is to say, if the original holder is without further liability, then the asset is effectively transferred and its amount should be removed from the books.

There are many examples of discounted note, but zero interest notes are most common. These notes are called zero interest, but they do carry an implicit interest rate figured into the face value of the note. Discount notes issued by Freddie Mac, for example, have maturities that range from overnight to one year. The notes are issued and maintained in book-entry form through the Federal Reserve Bank of New York, and investors may acquire the notes how to change your tax filing status in denominations as small as $1,000.

A promissory note is a financial instrument that consists of a written promise from its issuer to pay the company. Usually, it also includes the terms and conditions related to the arrangement as well. For example, a bank might loan a business $9,000 with a 10-year, $10,000 zero interest note. This means the company borrows $9,000 from the bank and must pay back $10,000 over the course of 10 years.

What is the Discount on Note Receivable? (Journal Entry, Example, And Calculation)

The difference between the face value of a note and the amount paid for it is recorded in a Discount on Notes Payable account. This is classified as a contra liability account; as such, it is paired with and offsets the Notes Payable account. The amount in the Discount on Notes Payable account is gradually amortized over the remaining life of the note, so that the difference is eliminated as of the maturity date. A financial professional will offer guidance based on the information provided and offer a no-obligation call to better understand your situation.