15 - 2 Learning Objective 1 Determining interest calculations and maturity dates on notes.
15 - 3 Learning Unit 15-1 What are promissory notes? n They are a written promise to pay a certain sum of money to a lender at a fixed future date. n The payee is the lender. n The maker is the borrower.
15 - 4 $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. __________ Maker Payee Learning Unit 15-1 Date of issue Principal
15 - 5 Learning Unit 15-1 n Principal is the amount borrowed. n Maturity date is the date the money is to be repaid. n The interest rate is the yearly interest rate. n The interest is adjusted to the length of time for short term notes. n The obligation is called a note payable.
15 - 6 Learning Unit 15-1 n Interest = Principal × Rate × Time n What is the interest on the note due to National Bank? n Principal:$20,000 Interest:12% Time:October 2, 200x to December 1, 200x n $20,000 × 12% × 60 ÷ 360 = $400
15 - 7 Learning Unit 15-1 Determining maturity date: n The exact number of days in each month must be used. n The date the note was issued is omitted. n Add the days remaining until the total time on the note is reached.
15 - 8 Learning Objective 2 Journalizing entries to record renewal of a note, dishonoring of a note, eventual receipt of payment, and note given in exchange for equipment purchased.
15 - 9 Notes Receivablexxx Salesxxx Notes Receivablexxx Salesxxx Notes Receivablexxx Accounts Receivablexxx Notes Receivablexxx Accounts Receivablexxx Learning Unit 15-2 What is the entry to record a note receivable?
15 - 10 Cashxxx Notes Receivablexxx Interest Incomexxx Cashxxx Notes Receivablexxx Interest Incomexxx Learning Unit 15-2 What is the entry to record payments? Notes Payablexxx Interest Expensexxx Cashxxx Notes Payablexxx Interest Expensexxx Cashxxx
15 - 11 Accounts Receivablexxx Interest Incomexxx Notes Receivablexxx Accounts Receivablexxx Interest Incomexxx Notes Receivablexxx Learning Unit 15-2 What is the entry to record a dishonored note? Notes Payablexxx Interest Expensexxx Accounts Payablexxx Notes Payablexxx Interest Expensexxx Accounts Payablexxx
15 - 12 Learning Objective 3 Discounting an interest-bearing note receivable and recording a discounted note that has been dishonored.
15 - 13 Learning Unit 15-3 n Sometimes notes are exchanged for cash at the bank (discounting). n The number of days (up to maturity) that the bank will hold the note is called the discount period. n Maturity value becomes the new principal (of the note) used to compute bank interest to be charged on the note.
15 - 14 Learning Unit 15-3 n Bank discount is the amount of interest the bank will charge on the note. n Cash proceeds is the amount of cash that will be received. n Interest is deducted on the day the note is discounted and the money borrowed. n That means the business uses less cash.
15 - 15 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 n The bank will receive the exact maturity value at due date. n No interest is computed at that time. n What are the steps?
15 - 16 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
15 - 17 Cash Proceeds = Maturity Value – Bank Discount Learning Unit 15-3
15 - 19 Learning Unit 15-3 n The bank usually requires that a note be discounted with recourse. n This means that if a note maker does not pay the maturity value to the bank, the company will have to pay the bank. n This is called a contingent liability.
15 - 20 Learning Unit 15-3 n If a note is dishonored, it is charged back to the customer using maturity value plus penalties as the new principal amount.
15 - 21 Learning Objective 4 Handling adjustments for interest expense and interest income.
15 - 22 Learning Unit 15-4 n What does it mean to discount one’s own note payable? n This means the interest is deducted from the amount borrowed. n The cash proceeds to be used will be less than the principal amount.
15 - 23 Learning Unit 15-4 n At maturity, the amount that has to be repaid is the exact face value of the note. n The discount is a contra-account that is written off to interest expense over the life of the note.
15 - 24 Learning Unit 15-4 n Interest expense and interest income will be computed up to the last day of the accounting period. n An adjusting entry will be made to recognize interest expense as a debit and accounts payable as a credit. n An adjusting entry will be made to recognize interest earned as a credit and interest receivable as a debit.