Bonds & Notes Payable Accounting: Entries & Financial Disclosures

Instructor: Douglas Stockbridge

DJ Stockbridge is currently pursuing a Masters degree in Accounting.

This lesson discusses accounting entries for bonds and notes payable from the inception to interest payments to the maturity date. We'll describe the impact of the accounting entries on the income statement, balance sheet, and cash flow statement.

Bonds & Notes Payable

Imagine you own a DVD rental store, a brick and mortar business. Surprisingly, business has been strong recently, and you need to expand to a larger location. You've picked out the perfect spot. It has a nice location and you won't need to do any renovations inside the building. The only problem is the price is a little high. You need to come up with an additional $50,000 to buy the building.

So, you turn to the local bank, Main Street Bank, for a loan. You do not like the idea of owning debt for a long time, so you insist on a 3-year loan. The bank will charge you 5% interest over that time with annual interest payments. You are curious about what kind of impact the loan will have on your financial statements, so before signing the loan contract you meet with your accountant to go over the finances.

In this lesson, we'll walk through the accounting entries for the loan. For each entry, we'll describe the impact it has on the financial statements. First, it is worth mentioning bond and note payables are very similar, with one slight difference. Some people tend to use the term bond payable with bonds that have longer maturities (+5 years), and notes payable for obligations that have shorter maturities (<5 years). It is really a case of personal preference. We'll record the loan as a note payable in this lesson.

Inception

The day the note payable is issued and you get the cash from the bank is called the inception date. We will need to record the cash you get and the new liability. Let's assume you receive the proceeds of the note payable on January 1, 2017.

  • The journal entry will be:


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In plain English, you received $50,000 in cash and recorded a liability because the $50,000 is not yours. It belongs to the bank and you will need to pay it back in 3 years.

  • Impact on the income statement: There is no impact because no time has elapsed. The income statement is composed of 'change' accounts that record the changes between balance sheets.
  • Impact on the balance sheet: You received cash of $50,000, so current assets increase by $50,000 and so too do your liabilities. Notice how the balance sheet remains balanced, assets still equal liabilities plus shareholders' equity.
  • Impact on the cash flow statement: Cash flow from financing operations will increase by $50,000 to account for the cash that came in for the loan.

Interest Payment

On December 31, 2017, a year has passed by since the note payable was issued. An interest payment is due from you to the bank. The payment due is $50,000 x 5% = $2,500. We debit interest expense and credit cash.

  • The journal entry is:


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In plain English, we paid $2,500 of interest for that year for borrowing the money.

  • Impact on the income statement: We include interest expense, which reduces net income, by $2,500.
  • Impact on the balance sheet: Cash is reduced by $2,500, and so too is retained earnings (because of the lower net income).
  • Impact on the cash flow statement: We paid cash of $2,500. Cash flow from operations will be lower by that amount.

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