Notes Receivable and Notes Payable Chapter 15 2

Determining interest calculations and maturity dates on notes. Learning Objective 1 Determining interest calculations and maturity dates on notes. 5

Learning Unit 15-1 What are promissory notes? They are a written promise to pay a certain sum of money to a lender at a fixed future date. The payee is the lender. The maker is the borrower.

Learning Unit 15-1 Date of issue Principal Payee Maker $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. __________ Date of issue Principal Payee Maker

Learning Unit 15-1 Principal is the amount borrowed. Maturity date is the date the money is to be repaid. The interest rate is the yearly interest rate. The interest is adjusted to the length of time for short term notes. The obligation is called a note payable. 5

Learning Unit 15-1 Interest = Principal × Rate × Time What is the interest on the note due to National Bank? Principal: $20,000 Interest: 12% Time: October 2, 200x to December 1, 200x $20,000 × 12% × 60 ÷ 360 = $400

Learning Unit 15-1 Determining maturity date: The exact number of days in each month must be used. The date the note was issued is omitted. Add the days remaining until the total time on the note is reached. 7

Journalizing entries to record renewal of a note, dishonoring 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. 5

Learning Unit 15-2 What is the entry to record a note receivable? Notes Receivable xxx Sales xxx Notes Receivable xxx Accounts Receivable xxx 8

Learning Unit 15-2 What is the entry to record payments? Cash xxx Notes Receivable xxx Interest Income xxx Notes Payable xxx Interest Expense xxx Cash xxx 8

Learning Unit 15-2 What is the entry to record a dishonored note? Accounts Receivable xxx Interest Income xxx Notes Receivable xxx Notes Payable xxx Interest Expense xxx Accounts Payable xxx 8

Discounting an interest-bearing note receivable and recording Learning Objective 3 Discounting an interest-bearing note receivable and recording a discounted note that has been dishonored. 5

Learning Unit 15-3 Sometimes notes are exchanged for cash at the bank (discounting). The number of days (up to maturity) that the bank will hold the note is called the discount period. Maturity value becomes the new principal (of the note) used to compute bank interest to be charged on the note. 11

Learning Unit 15-3 Bank discount is the amount of interest the bank will charge on the note. Cash proceeds is the amount of cash that will be received. Interest is deducted on the day the note is discounted and the money borrowed. That means the business uses less cash. 12

Learning Unit 15-3 The bank will receive the exact maturity value at due date. No interest is computed at that time. What are the steps? Compute maturity value: Interest = Principal × Rate × Time Principal + Interest = Maturity Value

Learning Unit 15-3 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.

Maturity Value – Bank Discount Learning Unit 15-3 Cash Proceeds = Maturity Value – Bank Discount

Learning Unit 15-3 Cash xxx Notes Receivable xxx Interest Income xxx Interest Expense xxx Notes Receivable xxx 8

Learning Unit 15-3 The bank usually requires that a note be discounted with recourse. This means that if a note maker does not pay the maturity value to the bank, the company will have to pay the bank. This is called a contingent liability.

Learning Unit 15-3 If a note is dishonored, it is charged back to the customer using maturity value plus penalties as the new principal amount.

Handling adjustments for interest expense and interest income. Learning Objective 4 Handling adjustments for interest expense and interest income. 5

Learning Unit 15-4 What does it mean to discount one’s own note payable? This means the interest is deducted from the amount borrowed. The cash proceeds to be used will be less than the principal amount.

Learning Unit 15-4 At maturity, the amount that has to be repaid is the exact face value of the note. The discount is a contra-account that is written off to interest expense over the life of the note.

Learning Unit 15-4 Interest expense and interest income will be computed up to the last day of the accounting period. An adjusting entry will be made to recognize interest expense as a debit and accounts payable as a credit. An adjusting entry will be made to recognize interest earned as a credit and interest receivable as a debit.

End of Chapter 15