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Notes Payable in Accounting: Definition & Examples

Instructor: Anthony Aparicio

Tony taught Business and Aeronautics courses for eight years; he holds a Master's degree in Management and is completing a PhD in Organizational Psychology

Notes payable are debts established by a company through the use of promissory notes. This lesson will provide additional details and examples, including differences from accounts payable.

Notes Payable

Businesses use money to purchase inventory, equipment, land, buildings, or many other things to help them to expand or become more profitable. Even though we may think that businesses have endless supplies of money from our purchases, the amount of available cash that companies have may not be enough to cover costs and expand at the same time. When businesses need to borrow money, they may go to a bank and sign a promissory note. A promissory note is a written agreement from the business to borrow money for a certain amount of time and interest rate. Promissory notes are the basis for the account called Notes Payable.

Notes Payable is the name of the account that a bookkeeper or accountant uses when documenting the borrowing of money. The general ledger account keeps track of the amount owed and any payments made towards the principal of the loan. General ledgers in accounting track all of the major accounts and are used to provide the information used in financial reporting.

Accounting Transactions

As a reminder, the accounting equation consists of three types of accounts: assets, liabilities, and equity. Notes Payable is a liability (debt) account that normally has a credit balance. When money is borrowed from the bank, the accountant will debit the Cash account to reflect the increase in the amount of cash and credit the Notes Payable account to show the corresponding debt.

Notes Payable can either be categorized as current or non-current accounts depending how the length of the loan. For example, a short-term loan to purchase additional inventory in preparation for the holiday season would be classified as a current liability, because it will likely be paid off within one year. The purchase of land, buildings, or large equipment will commonly be categorized as non-current liabilities, because the long-term loans will be paid over the course of many years.

Differences from Accounts Receivable

Notes Payable and Accounts Payable are different because Notes Payable are based on written promissory notes, while Accounts Payable are not. Accounts Payable involve regular debts made from such things as purchasing supplies or materials on credit. These accounts are typically settled (paid off) within 30 days and usually do not involve interest payments.

Example

You own a moving company and need to purchase a large moving truck in order to keep up with customer demand. After conducting some research, you find that the moving truck that best works for your company costs $75,000. Your business does not have that much cash available for the purchase so you decide to go to the bank to get a loan for the vehicle.

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