Accounting for Notes Issued: Cash, Rights, Property, Goods & Services

Instructor: Mark Koscinski

Mark has a doctorate from Drew University and teaches accounting classes. He is a writer, editor and has experience in public and private accounting.

In this lesson, you will learn how to account for notes payable issued for cash, property and services. Additionally, you will learn how to classify notes payable on the balance sheet.

Like all new companies, yours is struggling with cash flow. You are looking for ways to finance your company's growth without putting any more of your personal money into the company. It seems the only remaining option is to secure financing.

Notes Issued for Cash

The most common type of financing is obtaining a loan from your bank in the form of a note payable. The bank will examine your company's creditworthiness, collateral, ability to make loan payments, and other factors before agreeing to lend it money. Suppose the bank agrees to lend you $1 million for a five-year period, with interest of 5% payable only during the term of the loan. The journal entry (followed by the explanation recorded in the general journal) for such a transaction is:

Dr. Cash 1,000,000
Cr. Notes payable 1,000,000

To record cash received for a five-year loan from the bank.

The note will be classified as a long-term liability on your company's balance sheet until one year before its maturity date. It will then become a short-term liability. At the end of the five-year period, the entry to record the payment of the note is:

Dr. Note payable 1,000,000
Cr. Cash 1,000,000

To record the payment of the five-year loan from the bank.

Note Issued for Property

Notes payable can be issued to acquire property. For example, some car dealers are willing to sell automobiles with no down payment if they are carrying too much inventory. Equipment manufacturers will also do the same thing to promote sales of their product. Another similar scenario is the assumption of a loan payment to take possession of property. Suppose you arrange to purchase a new piece of equipment with no down payment. The asset has a value of $60,000 and you agree to pay $1,000 principal and 10% annual interest monthly. The entry at the acquisition date is:

Dr. Equipment 60,000
Cr. Short-term portion of notes payable 12,000
Cr. Long-term portion of notes payable 48,000

To record issuing a $60,000 note for equipment.

Notice the note is now split into a short-term and long-term portion on the classified balance sheet. When the first payment is made one month later, the following entry is recorded:

Dr. Interest Expense 500
Dr. Long-term portion of notes payable 1,000
Cr. Cash 1,500

To record interest and principal payment on the equipment note payable.

The principal payment for the first month is the original loan balance divided by the number of months in the term (5 years or 60 months). The interest expense for the first month is calculated as 1/10th of the outstanding principal of $60,000 divided by twelve (6,000 divided by 12 = 500: number of months in the year). In the following month, the same calculation will be made but the principal balance outstanding will be reduced by one thousand dollars to reflect the principal payment. The debit to the notes payable is to the long-term portion because at the end of the first month there is still $12,000 due within the next twelve months.

Notes Issued for Goods

Sometimes a vendor will ask a customer to execute a note payable if the customer is not current in paying their invoices for goods sold. The vendor believes the note will put it in a better legal position or will spur the customer to pay through moral suasion (psychological pressure). The journal entry on the books of the vendor is:

Dr. Note receivable 1,000
Cr. Accounts receivable 1,000

To record the signing of a notes payable to replace the accounts receivable of Customer X

The customer will record the signing of the note as follows:

Dr. Accounts payable 1,000
Cr. Notes payable 1,000

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