Notes payables are the legally bound instruments between two parties in which one party issues the note payable to the other party and receives interest payments after specific periods or at an agreed time, while the other party receives the note payable and pays interests and principals.
Notes payables are long term loans received by a company which means they are payable after one year. Notes payables are placed under the long-term liabilities section of the balance sheet.
If the receiving company of notes payables defaults on paying the principal payments, the issuer will recognize a provision while eliminating the loan receivable.
In accounting terms, notes payable also referred to as promissory notes, is a liability account in which the company recognizes the face value of the note payable.
Balancing figures in the notes payables accounts represent the amount that is still to be paid. In line with the notes payable, a new corresponding account for interest payable is created which records the interest expense that has occurred but is not yet paid.
Notes payables will be presented in the financial statements at two places. The current portion payable by the company will be placed under the current liability. Notes payables that do not fall under the one-year term are placed under non-current or long-term liability.
However, the critical information about the notes payables such as interest rates, the total amount of the notes payables, terms, duration, etc. should be disclosed under the notes section of the financial statements.
Transfer from accounts payable:
Liability is created when the company takes a loan under notes payable or when the period of the credit extends over its period.
It is possible sometimes that the company signs a note with the vendor company for the outstanding invoice hence generating a note payable.
This extension of credit by the company with the vendor by proper authorization will transfer the liability from accounts payable to notes payables.
When a company takes loans by notes payable, they have to record many accounting double entries to correctly maintain their books.
As the company will have to pay periodical interest payments, they will have to recognize these interest payments too.
For example, let’s say ABC company want to extend their credit facility by $10,000, thus they will consult with a finance provider.
The terms include an interest rate of 5% and a duration of 2 years. When the $10,000 loan is received, the company will perform the following double entry.
Credit_Long term liability: $10,000
Let’s say the terms of the loan include periodical payments every 3 months. After every three months, they will have to pay the principal as well as the interest of 5 percent on loan amount.
After three months, they will have to record the following double entry in their books
Debit_Long term liability: 312
Debit_Interest Expense: 50
Let’s say the next period approaches but the company does not pay interest for the first period. This will accumulate interests for both the periods in interest payable account.