13–1 McQuaig Bille 1 College Accounting 10 th Edition McQuaig Bille Nobles © 2011 Cengage Learning PowerPoint presented by Douglas Cloud Professor Emeritus

13–1McQuaig Bille

11College Accounting10th Edition

McQuaig Bille Nobles

© 2011 Cengage Learning

PowerPoint presented by Douglas Cloud Professor Emeritus of Accounting, Pepperdine University

Chapter 13

Notes Payable

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Promissory NotesPromissory Notes

A promissory note (usually referred to simply as a note) is a written promise to pay a certain sum at a fixed or determinable future time.

Like a check, it must be payable to the order of a particular person or firm, known as the payee.

It must be signed by the person or firm making the promise, known as the maker.

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Interest is a charge made for the use of money.

The following formula is used to calculate interest:

Calculating InterestCalculating Interest

Interest = Principal of Note x Rate of Interest x Time of Note(in dollars) (in dollars) (as a percentage (expressed as of the principal) a year or

fraction of a year)

The principal is the face amount of the note.

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Calculating InterestCalculating Interest The rate of interest is a percentage of the

principal.

Time, or the length of time, is the period between the note’s date of issue and the maturity date (the due date or interest payment date).

Example 1 $8,000, 6 percent, 1 yearInterest = $8,000 x 0.06 x 1 = $480

Example 2 $40,000, 5.5 percent, 4 months

Interest = $40,000 x 0.055 x 4/12 = $733.33

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The period of time between a promissory note’s issue date and its maturity date is called the duration of the note.

The duration of a note may be expressed in either days or months.

EXAMPLE: The due date of a promissory note is specified as 60 days after April 8. What is the due date?

Determining Due DatesDetermining Due Dates

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STEP 1. Determine the number of days remaining in the month of issue by subtracting the date of the note from the number of days in the month in which it is dated.

April (30 – 8) = 22 days left in April

STEP 2. Add as many full months as possible without exceeding the number of days in the note, counting the full number of days in these months.April (30 – 8) = 22 days left in AprilMay = 31 daysTotal days so far = 53 days


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STEP 3. Determine the number of days remaining in the month in which the note matures by subtracting the total days counted so far from the number of days in the note.


April (30 – 8) = 22 days left in AprilMay = 31 days

Total days so far = 53 daysJune (60 – 53) = 7th day of June

Therefore, June 7th is the due date.

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Transactions Involving Notes Payable

Transactions Involving Notes Payable

1. Note given to a supplier in return for an extension of time for payment of an open account (charge account)

2. Note given in exchange for merchandise or other property purchased

3. Note given as evidence of a loan

4. Note renewed at maturity

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Note Given to Secure an Extension of an Open Account


On April 12, Whitewater Raft Supply bought merchandise from Dana Manufacturing Company for $900. That entry appears below:

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On May 12, Dana Manufacturing Company agrees to accept a 60-day, 6 percent, $900 note from Whitewater Raft Supply in settlement of the account.



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By T accounts, the transactions look like this:



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Payment of an Interest-Bearing Note at MaturityPayment of an Interest-Bearing Note at Maturity

Payment for a matured note may be made directly to the holder, or it may be made to a bank with which the note was left for collection.

When a note is left with a bank for collection, the bank usually mails the maker a notice of maturity specifying the terms, the due date of the note, and the maturity value (principal plus interest).

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Payment of an Interest-Bearing Note at MaturityPayment of an Interest-Bearing Note at Maturity

Whitewater Raft Supply pays the note on July 11. In general journal form, the entry is as follows:

Note Given in Exchange for Assets Purchased


Occasionally, when the price of an item is high or the credit period is long, a buyer gives a note instead of buying the item on account.

Whitewater Supply issues a 90-day, 5 percent, interest-bearing note for $7,000 to Wilder Equipment Company in exchange for equipment purchased June 5 and records the transaction in general journal form.

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When Whitewater Raft Supply pays the note at maturity, the follow entry (in general journal form) is made:

$7,000 x .05 x 90/360

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The due date of September 3 was determined as follows:

June (30 – 5) = 25 days lefts in JuneJuly = 31 daysAugust = 31 days

Total days so far = 87 daysSeptember (90 – 87) = 3rd day of September (due date)



Interest = $7,000 x 0.05 x 90/360 = $87.50

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Borrowing from a Bank When Borrower Receives Full Face Value of Note

Borrowing from a Bank When Borrower Receives Full Face Value of Note

On June 7, Whitewater Raft Supply borrows $8,500 from Foster National Bank for 120 days with interest at 5.5 percent payable at maturity.

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Note Paid to the Bank at MaturityNote Paid to the Bank at Maturity

After Whitewater Raft Supply has paid the note and interest on October 5, its account makes the following entry (in general journal form):

$8,500 x 0.055 x 120/360

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Borrowing from a Bank When Bank Discounts Note


The bank may deduct the interest in advance, which is called discounting a note payable.

On June 22, Whitewater Raft Supply borrows $12,000 for 60 days from Westmore National Bank, and the bank requires Whitewater Raft Supply to sign a note. The bank deducts $100, which is 5 percent interest for 60 days ($12,000 x 0.05 x 60/360 = $100).

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This interest deducted in advance by a bank is called the discount.

The principal of the loan left after the discount has been subtracted is called the proceeds.

The bank deducts the discount from the face amount of the note before making the money available to the borrower.

Principal ($12,000) – Discount ($100) = Proceeds ($11,900)

Entry When Note Discounted at Bank Matures Before End of Fiscal Period

Entry When Note Discounted at Bank Matures Before End of Fiscal Period

On June 7, Whitewater Raft Supply issues a discounted note payable to Westmore National Bank. The $10,000, 120-day, 6 percent note matures October 5.

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Note Paid to the Bank at MaturityNote Paid to the Bank at Maturity

Whitewater Raft Supply pays the bank only the face value of the note and records the transaction as follows (in general journal form):

If the duration of the discounted note extends into the next fiscal period, the journal entry must include a debit to Discount on Notes Payable instead of a debit to Interest Expense.

Discount on Notes Payable is a contra-liability account; it is a deduction from Notes Payable.

Entry When Note Discounted at Bank Matures After End of the Fiscal PeriodEntry When Note Discounted at Bank Matures After End of the Fiscal Period

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Entry When Note Discounted at Bank Matures After End of the Fiscal PeriodEntry When Note Discounted at Bank Matures After End of the Fiscal Period

On December 1, Whitewater Raft Supply borrows $8,000 from Midland Bank for 120 days. The bank deducts 6 percent interest (in advance).

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Renewal of Note at MaturityRenewal of Note at Maturity

On June 25, Whitewater Raft Supply issues a 45-day note to Batisto, Inc. for $9,500, with interest at 5.5 percent. The original entry is as follows:

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Renewal of Note with Payment of Interest


The note to Batisto, Inc., matured on August 9 and has interest accrued of $65.31 ($9,500 x 0.055 x 45/360). The note is renewed and the accrued interest is paid.

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A separate entry is made for the issuance of the new note, to run for 30 days at 6 percent.

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Renewal of Note with Payment of Interest and Part Payment of Principal

Renewal of Note with Payment of Interest and Part Payment of PrincipalWhitewater Raft Supply pays $1,500 of the principal of the note that is due and also pays the entire interest on it. A new note for $8,000 is issued.

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A notes payable register is an auxiliary record used for listing the details of notes issued.

Notes Payable RegisterNotes Payable Register

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On all interest-bearing notes, interest expense accrues, or accumulates, daily.

A firm has two notes payable outstanding as of December 31, the end of the current fiscal period.

Accrued Interest on Notes Payable


Note 1: $12,000, 60 days, 5%, dated December 10Note 2: $7,200, 90 days, 6%, dated December 2

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Interest = $12,000 x 0.05 x 21/360 = $35.00

Note 1:

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Note 2:

Interest = $7,200 x 0.06 x 29/360 = $34.80

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In T account format:

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Discount on Notes PayableDiscount on Notes Payable

When a note payable is discounted at the bank, the bank deducts the interest in advance.

If the note begins and ends during one fiscal period, the interest is recorded as Interest Expense, and no adjustment is needed.

If the note extends into the next fiscal period, the interest is recorded as Discount on Notes Payable.


Interest = $8,000 x 0.06 x 30/360 = $40.00

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In T account format:


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Two journal entries can be used to record the final payment of the discounted note. The first is like the payment of any discounted note.


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In addition to recording Interest Expense, the second entry reduces the balance of Discount on Notes Payable to its correct amount.


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In T accounts, the entries look like this:

Documents

13–1 McQuaig Bille 1 College Accounting 10 th Edition McQuaig Bille Nobles © 2011 Cengage Learning PowerPoint presented by Douglas Cloud Professor Emeritus