Review Materials

Prepared by:
Junior Philippine Institute of
Accountants UC-Banilad Chapter
F.Y. 2019-2020
NOTES PAYABLE
 Introduction
Many people sign a note to pay for the purchase of a vehicle over a certain period of time. The note
may be with a company like Ford Motor Credit or a financial institution. In this chapter, you will learn
about notes payable.

What is a PROMISSORY NOTE?

A promissory note, often shortened to note, is a written promise to pay a certain amount of money
at a specific time. Promissory notes are formal documents that are evidence of credit granted or
received.

 NOTES PAYABLE

A note payable is a promissory note that a business issues to a creditor when it borrows or buys
on credit.
Figure 1. Promissory note

o Laws require a promissory note to contain certain information.

 The Maturity Date of a Note

When a note is signed, the maker of the note agrees to repay the amount of the note within a certain
period of time, usually stated in days, months, or years. This time period is the term of the note.

Both the term and the issue date (date on which the note is signed) are needed to determine the
maturity date (due date) of a note.

In the note in Figure 1., Michael Brown, manager of On Your Mark Athletic Wear, agreed to pay
Athletic Equipment Inc. the principal plus interest 90 days from September 14. To determine the
maturity date:
Continuation…

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 The Maturity Date of a Note

Some businesses and banks use time calendars to calculate a note’s maturity date. Figure 2 shows
an example of a time calendar. The time calendar has two sets of days: (1) the day of the month (left
and right columns), and (2) the day of the year, by month (middle column).

To calculate a maturity date using the time calendar, follow these steps:
1. Locate the issue date of the note (for example, 14) in the Day of month column. Move across the
month columns to the issue month (September). In our example September 14 is the 257th day
of the year.

2. Add the number of days in the term of the note (90) to the day of the year. The sum of the two
numbers is 347 (257 + 90).

3. Find the number 347 in the month columns. The 347th day of the year is in December. The
maturity month is December. Move across to the Day of month column. The 347th day of the year
corresponds to the 13th day of the month. The due date of the note is December 13.
Figure 2. Time Calendar
Maturity Date of a Note

Day of

Day of
month

month
Jan. Feb. Mar. Apr. May June July Aug. Sept. Oct. Nov. Dec.

1 1 32 60 91 121 152 182 213 244 274 305 335 1

2 2 33 61 92 122 153 183 214 245 275 306 336 2
3 3 34 62 93 123 154 184 215 246 276 307 337 3
4 4 35 63 94 124 155 185 216 247 277 308 338 4
5 5 36 64 95 125 156 186 217 248 278 309 339 5
6 6 37 65 96 126 157 187 218 249 279 310 340 6
7 7 38 66 97 127 158 188 219 250 280 311 341 7
8 8 39 67 98 128 159 189 220 251 281 312 342 8
9 9 40 68 99 129 160 190 221 252 282 313 343 9
10 10 41 69 100 130 161 191 222 253 283 314 344 10
11 11 42 70 101 131 162 192 223 254 284 315 345 11
12 12 43 71 102 132 163 193 224 255 285 316 346 12
13 13 44 72 103 133 164 194 225 256 286 317 347 13
14 14 45 73 104 134 165 195 226 257 287 318 348 14
15 15 46 74 105 135 166 196 227 258 288 319 349 15
16 16 47 75 106 136 167 197 228 259 289 320 350 16
17 17 48 76 107 137 168 198 229 260 290 321 351 17
18 18 49 77 108 138 169 199 230 261 291 322 352 18
19 19 50 78 109 139 170 200 231 262 292 323 353 19
20 20 51 79 110 140 171 201 232 263 293 324 354 20
21 21 52 80 111 141 172 202 233 264 294 325 355 21
22 22 53 81 112 142 173 203 234 265 295 326 356 22
23 23 54 82 113 143 174 204 235 266 296 327 357 23
24 24 55 83 114 144 175 205 236 267 297 328 358 24
25 25 56 84 115 145 176 206 237 268 298 329 359 25
26 26 57 85 116 146 177 207 238 269 299 330 360 26
27 27 58 86 117 147 178 208 239 270 300 331 361 27
28 28 59 87 118 148 179 209 240 271 301 332 362 28
29 29 ... 88 119 149 180 210 241 272 302 333 363 29
30 30 ... 89 120 150 181 211 242 273 303 334 364 30
31 31 ... 90 ... 151 ... 212 243 ... 304 ... 365 31

NOTE: For leap years, after February 28, the number of the day is one greater than that given in the table.
 Calculation of Interest on a Note
How Do You Calculate Interest on a Note?

Interest is the fee charged for the use of money. The interest rate is the interest stated as a
percentage of the principal. The interest on a promissory note is based on three factors; principal,
interest rate, and term of the note.

Calculating Interest Using a Formula

 The formula used to calculate interest follows:
Interest = Principal x Interest Rate x Time

Interest rates are usually stated on an annual basis, that is, on a borrowing period of one year. To
find the interest on a one-year promissory note, multiply the principal by the interest rate. The interest
on an 11.5%, one-year $2,500 promissory note is $287.50 ($2,500 x .115 = $287.50).
 Calculation of Interest on a Note
 If the term of a promissory note is less than one year, the time in the calculation is expressed as a
fraction of one year. The fraction may be stated in days or months. For example, on September 14
On Your Mark signed a note for $2,500 at 11.5% interest for 90 days. Since the term of the note is
expressed in days, 365 days is used as the denominator of the time fraction. The interest is
calculated as follows:

Principal x Interest Rate x Time = Interest

$2,500 x .115 x 90/365 = $70.89

The interest on the note shown in Figure 1. is $70.89.

On the maturity date, On Your Mark will repay the maturity value of the note. Maturity value is
the amount due at the due date. In our example the maturity value is $2,570.89 ($2,500.00 +$70.89).

If the term of this note had been three months instead of 90 days, the denominator of the time
fraction would be 12. The interest would be calculated as follows:
Principal x Interest Rate x Time = Interest
$2,500 x .115 x 3/12 = $71.88

The maturity value would be $2,571.88 ($2,500.00 + $71.88).

 Calculating Interest Using an Interest Table

To calculate interest, businesses and banks often use an interest table similar to the one in Figure 3.
We use On Your Mark’s note to illustrate.

• Find the term of the note in the Day column, 90.

• Follow the row across until you reach the column for the interest rate, 11.5%. Where the Day row
and the Interest column meet is a factor, 2.835616. The factor is based on a principal amount of
$100.
• Divide the principal of the note by 100. The result is 25 ($2,500 ÷ 100).
• Multiply the result by the factor to find the interest. The interest is $70.89 (25 × 2.835616).

In this example the interest calculated using both the equation and the interest table are the same.
Sometimes small differences occur due to rounding.
Figure 3.
Interest Table
11.50 % 11.75 % 12.00 % 12.25 % 12.50 % 12.75 %
DAY INTEREST DAY INTEREST DAY INTEREST DAY INTEREST DAY INTEREST DAY INTEREST

30 0.945205 30 0.965753 30 0.986301 30 1.006849 30 1.027397 30 1.047945

60 1.890411 60 1.931507 60 1.972603 60 2.013699 60 2.054795 60 2.095890
90 2.835616 90 2.897260 90 2.958904 90 3.020548 90 3.082192 90 3.143836
120 3.780822 120 3.863014 120 3.945205 120 4.027397 120 4.109589 120 4.191781
150 4.726027 150 4.828767 150 4.931507 150 5.034247 150 5.136986 150 5.239726
180 5.671233 180 5.794521 180 5.917808 180 6.041096 180 6.164384 180 6.287671

210 6.616438 210 6.760274 210 6.904110 210 7.047945 210 7.191781 210 7.335616
240 7.561644 240 7.726027 240 7.890411 240 8.054795 240 8.219178 240 8.383562
270 8.506849 270 8.691781 270 8.876712 270 9.061644 270 9.246575 270 9.431507

300 9.452055 300 9.657534 300 9.863014 300 10.068493 300 10.273973 300 10.479452
330 10.397260 330 10.623288 330 10.849315 330 11.075342 330 11.301370 330 11.527397
360 11.342466 360 11.589041 360 11.835616 360 12.082192 360 12.328767 360 12.575342

365 11.500000 365 11.750000 365 12.000000 365 12.250000 365 12.500000 365 12.750000
366 11.531507 366 11.782192 366 12.032877 366 12.283562 366 12.534247 366 12.784932
 NOTES PAYABLE

In this section you will journalize transactions involving notes payable. Recall that a note
payable is a promissory note issued to a creditor. For example, a business may issue a note payable
to borrow money from a bank. Notes that a business issues are recorded in the Notes Payable
account. Notes Payable is a liability account; its normal balance is a credit. When the due date of a
note extends beyond one year, the note is classified as a long-term liability. Long-term liabilities
are debts that become due after one year.
Businesses frequently issue two types of notes: interest-bearing notes and non-interest-bearing
notes. We consider both types of notes in this section.

 INTEREST-BEARING NOTES PAYABLE

A note that requires the principal plus interest to be paid on the maturity date is called an
interest-bearing note payable . The note issued by On Your Mark (in previous section) is an
interest-bearing note. Its maturity value is $2,570.89 ($2,500.00 principal + $70.89 interest).
Recording the Issuance of an Interest-Bearing Note Payable

Let’s record On Your Mark’s interest-bearing note payable as an example.

Business Transaction
On April 3 On Your Mark borrowed $7,000 from State Street Bank and issued a 90-day, 12% note
payable to the bank, Note 6.

ANALYSIS Identify 1. The accounts affected are Cash in Bank and Notes Payable.
Classify 2. Cash in Bank is an asset account. Notes Payable is a liability account.
+/— 3. Cash in Bank is increased by $7,000. Notes Payable is increased by
$7,000.

DEBIT-CREDIT RULE 4. Increases to asset accounts are recorded as debits. Debit Cash in Bank
for $7,000.
5. Increases to liability accounts are recorded as credits. Credit Notes
Payable for $7,000.

T ACCOUNTS 6. Cash in Bank Notes Payable

Debit Credit Debit Credit

+ — — +
7,000 7,000
DEBIT-CREDIT RULE 4. Increases to asset accounts are recorded as debits. Debit Cash in Bank
for $7,000.
5. Increases to liability accounts are recorded as credits. Credit Notes
Recording the Issuance of an Interest-Bearing Note Payable
Payable for $7,000.

T ACCOUNTS 6. Cash in Bank Notes Payable

Debit Credit Debit Credit

+ — — +
7,000 7,000

JOURNAL ENTRY 7.
Recording the Payment of an Interest-Bearing Notes Payable

The maturity date of On Your Mark’s note payable to State Street Bank is July 2. You can verify this
by using the time calendar in Figure 2. The interest is $207.12, calculated as follows:

Principal × Interest Rate × Time = Interest

$7,000 × .12 × 90/365 = $207.12
The maturity value of the note is $7,207.12 ($7,000.00 principal + $207.12 interest).

Business Transaction
On July 2 On Your Mark issued Check 3892 for $7,207.12 payable to State Street Bank in payment of the
note payable issued April 3.

ANALYSIS Identify 1. The accounts affected are

Notes Payable, Interest
Classify Expense, and Cash in Bank.
2. Notes Payable is a liability
+/— account. Interest Expense
is an expense account. Cash
in Bank is an asset account.
3. Notes Payable is decreased
by $7,000. Interest Expense
is increased by $207.12. Cash
in Bank is decreased by
$7,207.12.
Recording the Payment of an Interest-Bearing Notes Payable
Non-Interest-Bearing Notes Payable

How Is Interest Paid on a Non-Interest-Bearing Note?

Sometimes a bank requires a borrower to pay the interest on a note in advance. On the issue date,
the bank deducts the interest from the face value of the note. This reduces the amount of money
the borrower receives. When interest is deducted in advance from the face value of the note, the
note is called a non-interest-bearing note payable.

The note is “non-interest-bearing” because no interest rate is stated on the note. The interest
deducted in advance is called the bank discount . The interest rate used to calculate the bank
discount is called the discount rate. The cash received by the borrower is called the proceeds .
The proceeds equal the face value of the note minus the bank discount. For a non-interest-bearing
note payable, the maturity value is the same as the face value. This is because the interest is
deducted from the face value on the issue date. Figure 4 shows an example of a non-interest-
bearing note payable.
Figure 4.
Non-Interest-Bearing Notes Payable

NOTE 13

$ 1,500.00 Date June 12 20 --

Ninety days after date I promise to pay to

First Federal Bank the sum of

One thousand five hundred dollars.

Due date September 10, 20--

Michael Brown
 Calculating Non-Interest-Bearing Notes Payable

Let’s calculate the proceeds of the non-interest-bearing note payable shown in Figure 4. The note
was discounted at a rate of 12% by First Federal Bank, Note 13.

The first step in calculating the proceeds on a non-interest-bearing note is to calculate the bank
discount. This is the interest on the note. (Notice that the formula is similar to the one used to compute
interest on an interest-bearing note.)

Face Value × Discount Rate × Time = Bank Discount

$1,500 × .12 × 90/365 = $44.38

The bank discount is subtracted from the face value of the note to determine the proceeds. The
proceeds are $1,455.62 ($1,500.00 — $44.38).
 Recording the Issuance of a Non-Interest-Bearing
Notes Payable

The bank discount is recorded in a contra liability account called Discount on Notes Payable. The
normal balance of Discount on Notes Payable is a debit. The bank discount is the future interest
expense on the note. However, the bank discount is not recorded in an expense account until the note
matures and the interest expense has been incurred.
÷
Now that we calculated the discount, let’s record the issuance of the non-interest-bearing note for On
Your Mark. Business Transaction
On June 12 On Your Mark signed a $1,500, 90-day non-interest-bearing note payable that First Federal
Bank discounted at a rate of 12%, Note 13.

ANALYSIS Identify 1. The accounts affected are Cash in

Bank, Discount on Notes
Classify Payable,
and Notes Payable.
+/— 2. Cash in Bank is an asset
account. Discount on
Notes Payable is a contra
liability account. Notes
Payable is a liability
account.
3. Cash in Bank is increased by
$1,455.62. Discount on Notes
21 Payable is increased by
$44.38. Notes Payable is
increased by $1,500.00.
Recording the Issuance of a Non-Interest-Bearing
Notes Payable
 Businesses report the Discount on Notes Payable account on the balance sheet as a
deduction from Notes Payable. The difference between the Notes Payable account and the
Discount on Notes Payable account is the book value of notes payable. Figure 5 shows the
Liabilities section of the balance sheet for On Your Mark on June 30. It shows that the book value
of notes payable is $1,455.62 ($1,500 — $44.38).

Figure 5. Reporting Non-Interest-Bearing Notes Payable on the Balance Sheet

Recording the Payment of a Non-Interest-Bearing
Notes Payable

When the non-interest-bearing note payable matures and is due, On Your Mark will
• pay First Federal Bank $1,500, the face value of the note, and
• record the interest expense by transferring the bank discount to interest expense.

We will look at each of these individually and as a compound journal entry.

Please proceed to the next page….

 Recording the Payment of a Non-Interest-Bearing
Notes Payable
Business Transaction
On September 10 On Your Mark issued Check 4241 for $1,500 to First Federal Bank in payment of the
June 12 non-interest-bearing note payable.

Identify 1.The accounts affected are Notes Payable and Cash in Bank.
ANALYSIS
Classify 2.Notes Payable is a liability account. Cash in Bank is an asset
account.
+/— 3.Notes Payable is decreased by $1,500. Cash in Bank is decreased by $1,500.

4.Decreases to liability accounts are recorded as debits. Debit Notes Payable for
DEBIT-CREDIT RULE
$1,500.
5.Decreases to asset accounts are recorded as credits. Credit Cash in Bank for
$1,500.

T ACCOUNTS 6. Notes Payable Cash in Bank

Debit Credit Debit Credit

— + + —
1,500 1,500

JOURNAL ENTRY 7.
When a non-interest-bearing note payable matures, the amount of the bank discount is recognized as
an expense. The bank discount is transferred from the Discount on Notes Payable account to the
Interest Expense account. As the following T accounts demonstrate, Interest Expense is debited
for $44.38 and Discount on Notes Payable is credited for $44.38. When this transaction is
recorded, the balance of the Discount on Notes Payable account is reduced to zero.

You could record two separate journal entries:

1. the payment of the non-interest-bearing note payable (in the cash payments journal), then
2. the interest expense (in the general journal)
 It is simpler, however, to prepare one compound entry in the general journal as shown.

The Interest Expense account is classified as an other expense account.

An other expense is a non-operating expense. This means that the expense does not result
from the normal operations of the business. Other expenses appear in a separate section on the
income statement, as deductions from operating income.

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 End of the Topic
Please see complementary test bank for
practice problems and theories.

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 Dear, you.
Always be in pursuit for
the one you have not yet
become. Keep going!
Love,
Your UCB-JPIA family

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Reference:
McGraw-Hill, G. (n.d.). Glencoe Accounting: First Year
Course, Student Edition. Retrieved August 22, 2020,
from https://b-ok.xyz/book/688011/9a44cc
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