Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Chapter 16 Notes Receivable and Notes Payable

16-2 $1,000.00July 10, 2011 Ninety days Barton Company, Los Angeles, CA One thousand and no/ Dollars First National Bank of Los Angeles, CA 42 12% Julia Browne after date I promise to pay to the order of Payable at Value received with interest at per annum No. Due Oct. 8, 2011 Term Payee Maker Learning Objective 1 Describe a promissory note. Principal Interest Rate Due Date A promissory note is a written promise to pay a specified amount of money, usually with interest, either on demand or at a definite future date. LO1

16-3 Learning Objective 2 Compute the maturity date and interest due on a promissory note. The note is due and payable on May 30, How much interest will Matrix pay to Office Supplies, Inc. on this note? On March 1, 2010, Matrix, Inc. purchases a copier for $12,000 from Office Supplies, Inc. Matrix gave Office Supplies a 9% note due in 90 days in payment for the copier. What is the maturity date of the note? What is the maturity date of the note? On March 1, 2010, Matrix, Inc. purchases a copier for $12,000 from Office Supplies, Inc. Matrix gave Office Supplies a 9% note due in 90 days in payment for the copier. What is the maturity date of the note? What is the maturity date of the note? In this example, we add 30 days in March, 30 days in April, and 30 days in May to add up to the note term of 90 days. LO2

16-4 Learning Objective 3 Record the receipt of a note receivable. Here are the entry on March 1, 2006, to record the sale and note receivable. On May 30, 2010, Office Supplies, Inc. receives the principal amount of the note plus interest. LO3

16-5 Learning Objective 4 Record the honoring, discounting, and dishonoring of a note and the adjustment for interest. On March 31, 2010, Office Supplies decides that it needs cash and cannot hold the note any longer. The company goes to First National Bank and discounts the note at 12%. The bank pays Office Supplies cash and deposits the amount in its checking account. Step 1: Calculate the maturity value of the note. Maturity value = Principal + Interest due at Maturity Maturity value $12,270 = $12,000 + $270 = $12,270 Step 2: Determine days in discount period. LO4

16-6 Note Discounted before Maturity Step 3: Compute the bank discount charge. Discount Charge = Maturity Value Discount Rate Discount Period × × Discount Charge $ = $12,270 × 12% × 60/360 = $ Step 4: Compute proceeds from the discounting. Proceeds = Maturity Value – Discount Charge $12, = $12, – $ LO4

16-7 Note Discounted before Maturity Let’s look at the journal entry to record the discounting of the note receivable. Now let’s assume that Office Supplies held the note to maturity. At maturity, Matrix informs Office Supplies that it is unable to pay the note or interest. The note has matured and is no longer valid. LO4

16-8 Accrued Interest on Notes Receivable On December 1, 2010, Matrix, Inc. purchases a copier for $12,000 from Office Supplies, Inc. Matrix issues a 9% note due in 90 days in payment for the copier. What adjusting entry is required on December 31, year-end of Office Supplies? On December 1, 2010, Matrix, Inc. purchases a copier for $12,000 from Office Supplies, Inc. Matrix issues a 9% note due in 90 days in payment for the copier. What adjusting entry is required on December 31, year-end of Office Supplies? $12,000 × 9% × 30/360 = $90 Using the same purchase of a copier example between Matrix and Office Supplies, Inc. that we just reviewed, let’s change the date of the note to December 1 st instead of March 1 st. LO4

16-9 Accrued Interest on Notes Receivable Let’s look at the entry Office Supplies, Inc. will make on March 1 st. LO4

16-10 On March 15, 2010, Western, Inc. issues a $10,000, 12%, 90-day note to First Bank for cash. Let’s make the journal entry. Learning Objective 5 Prepare entries to account for notes payable. Let’s calculate interest to maturity. $10,000 × 12% × 90/360 = $300 LO5

16-11 Discounting a Note Payable On March 31, 2010, Webb Co. discounts its $40,000, 6%, 90-day note at First Bank for cash. Let’s make the journal entry. $40,000 × 6% × 90/360 = $600 Interest to Maturity When the note matures on May 30 th, Webb makes the following journal entry. LO5

16-12 Learning Objective 6 Explain the types and payment patterns of notes. An installment note requires a series of payments over the life of the note rather than one payment at maturity. On January 1, 2010, Gear, Inc. signs a $60,000 note to First Bank. The note bears interest at 10% annually and requires payments of $15, at the end of each of the next five years. LO6

16-13 Learning Objective 7 Compute the interest times earned ratio and use it to analyze liabilities. Experience shows that when times interest earned falls below 1.5 to 2.0 and remains at that level or lower for several periods, the default rate on liabilities increases sharply. When a company has long-tem liabilities, lenders want to know if there will be sufficient earnings to pay interest as it comes due. Lenders can use this ratio to help decide if they should accept the risk. LO7

16-14 End of Chapter 16