Meaning of Notes Payable
Notes payable form the largest portion of the current liability section on the company’s financial statements. It represents the purchases that are unpaid by the enterprise.
In the cash conversion cycle, companies match the payment dates with Notes receivables making sure that receipts are made before making the payments to the suppliers. The lower the Notes payable days the better. It reflects that the company can realize the cash in a good fashion.
An example would be: The Bold Fashions Ltd bought textile garments from Sri Textile traders as raw materials on credit. The Bold Fashions here got the inventory as a current asset while creating a short-term obligation on the other hand.
Nature of Notes Payable
The nature of Notes payable matches with current liabilities. The common characteristics below conclude why Notes payable is within current liability:
- Both are short term obligations to meet within the year.
- Notes payable is a subset of current liability.
- The major portion of working capital requires the management of Notes receivable and Notes payable, both contributing to a healthy cash conversion cycle and so does current liabilities as a whole.
- Both Notes payable and current liabilities are the results of a past transaction that obligates the entity.
Current liabilities are one of two-part of liabilities and hence, Notes payable are liabilities. The nature of Notes payable does not match with those of assets or equity in nutshell.
Notes payable fall under current liabilities section which falls under liabilities part of the Balance sheet as shown below:
| Liabilities and capital | Amount ($) | Assets | Amount ($) |
| Shareholders’ equity | X | Non – Current Assets | X |
| Non-current liabilities | X | ||
| Current Assets | X | ||
| Current Liabilities | X | ||
| Notes Payable | X | ||
| Other current Liabilities Salaries payable | X | ||
| XXX | XXX |
Contents of Notes payable
The information on a general format of notes payable include the following:
- Issuer or Maker: The individual who promises to make the payment
- Payee: The individual who is promised to be paid to.
- Principal or face value: The amount being borrowed.
- Term of note: The period of notes payable.
- Issue date: The date on which the promissory note is written.
- Interest rate
- Maturity date: The due date on which the note payables has to be matched with payment.
All these components play a vital role in making appropriate journal entries.
Journal Entries for Notes Payable
Let’s discuss the various instances of notes payable with examples in each of the following circumstances:
- Issued Notes Payable for cash
If Ram Inc issues notes payable for $30,000 due in 3 months at 8% p.a. to obtain loan. The interest would be $ 30,000 * 3/12 * 8% = $600.
The relevant journal entry would be
| Date | Particulars | Debit ($) | Credit ($) |
| Cash | 30,000 | ||
| Notes Payable | 30,000 | ||
| (To record notes payable issued for cash) |
- Issuance of notes payable to extend the period of the loan.
When there is a liquidity crunch, fresh notes payable have to be issued for extended credit terms. Suppose Ram Inc issues notes payable for the overdue supplier to extend the loan for 3 more months, the required journal entry would be:
| Date | Particulars | Debit ($) | Credit ($) |
| Accounts payable | 30,000 | ||
| Notes Payable | 30,000 | ||
| (To record extension of loan with fresh terms) | |||
| Interest expense | 600 | ||
| Interest payable | 600 | ||
| (To record interest expense) | |||
| End of 3rd month | Notes Payable | 30,000 | |
| Interest payable | 300 | ||
| Cash | 30,300 | ||
| (To record payment of notes payable) |
- Discount on notes payable
There is no premium in case of issue of notes payable. Notes payable is an instrument to extend loans or to avail fresh credit in the company.
Suppose Ram Inc issued a note payable for 29,200 payables in 1 year and received cash of $27,548. The 29,200 is the total amount to be repaid and interest assumed to be included in this amount is 29,200 – 27,548 = $1652.
This has been assumed to be calculated with a discount rate of 6% and the difference between present value and future value is deemed as a discount.
The journal entry is also required when the discount is charged as an expense.
| Date | Particulars | Debit ($) | Credit ($) |
| Cash | 27,548 | ||
| Discount on notes payable | 1,652 | ||
| Notes payable | 29,200 | ||
| (To record issue of notes payable at a discount) | |||
| Interest expense (1652/12) | 138 | ||
| Discount on notes payable | 138 | ||
| (To record discount as expense) |
Other interest expense entries shall be made as usual.
