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Notes Payable
Key Topics to Know
Short-term Notes Payable:
- Term of one year or less
- Interest rate stated per year, not for the term of the note
- Typically one payment is made at maturity that includes both principal and interest
- Interest expense must be accrued at the end of an accounting period Long-term Notes Payable:
- Term of longer than one year
- Interest rate stated per year, not for the term of the note
- Periodic payments are made throughout the term of the note
- Payments include both principal and interest
- Principal portion of the payment is “going forward”, reducing the amount outstanding for the next period; Interest portion of the payment is “in arrears”, being calculated of the outstanding balance of the note for the period just ending
- Interest expense must be accrued at the end of an accounting period
Practice Problems
Problem #1- Entries for a short-term note payable T Company purchases inventory using a 60-day, 12% note for $15,000, dated December 1. The maker honors the note at maturity. Required: a) What is the journal entry to record the issuance of the note? b) What is the maturity date of the note? c) What is the maturity value of the note? d) What is the journal entry on December 31? e) What is the journal entry on the maturity date? Problem #2 - Entries for a short-term note payable On June 1, Jasper Company signed a $25,000, 120-day, 6% note payable to cover a past due account payable. Required: a) What is the total amount of interest to be paid on this note? b) Prepare the journal entries to record payment of the note. c) Prepare the company's journal entry to record the note's issuance. Problem #3 – Entries for a long-term note payable On January 1, Year 1 W Company borrowed $70,000 cash by signing a 9% installment note that is to be repaid with four annual year-end payments of $21,607, the first of which is due on December 31, Year 1. Required: a) Prepare the company's journal entry to record the note's issuance. b) Prepare the journal entries to record the first and second installment payments.
Multiple Choice Questions
1. Q^ Company issued a $20,000 note to the^ Capital Bank on August 1.^ The note
carried a one-year term and a 12% rate of interest. The adjusting entry on Fallon's books to record accrued interest expense on December 31 will a) Decrease assets and decrease retained earnings by $1,000. b) Increase liabilities and decrease equity by $800. c) Increase liabilities and decrease equity by $1,000. d) Decrease equity and increase liabilities by $2,400.
2. On October 1,^ B Company^ borrowed $10,000 from F^ Bank by signing a one-
year, 6% note. On December 31, B Company failed to make the adjusting entry to accrue the related interest. This error will cause: a) Net income for the current year to be overstated and liabilities for the current year to be overstated. b) Net income for the current year to be understated and net income for the next year to be overstated. c) Net income for the next year to be understated and liabilities for the current year to be understated. d) Net income for the current year to be understated and liabilities for the current year to be overstated.
3. H Company^ borrowed $10,000 from^ T Bank^ on March 1.^ H Company^ is to
repay the principal and interest on February 28 of the next year The interest rate is 8%. If the year-end adjustment is properly recorded, what will be the effects of the accrual on H Company's current year financial statements? a) Increase assets and increase liabilities b) Increase assets and increase revenues c) Increase liabilities and increase expenses d) No effect
4. Which of the following best describes the accrual of interest?
a) Assets and stockholders' equity decrease. b) Assets and liabilities decrease. c) Net income and expenses decrease. d) Expenses and liabilities increase.
5. P^ Company borrowed^ $25,000 cash on October 1^ and signed a nine-month,
8% interest-bearing note payable with interest payable at maturity. The amount of interest expense to be reported in the year the note matures is: a) $1, b) $ c) $ d) $
6. M Company^ borrowed $50,000 cash on April 1,^ and signed a one-year 12%,
interest-bearing note payable. The interest and principal due on March 31 of the following year will be: a) $50, b) $51, c) $54, d) $56,
7. In each succeeding payment on an installment note:
a) The amount that goes to decreasing the carrying value of the note increases. b) The amount that goes to decreasing the carrying value of the note decreases. c) The amount that goes to decreasing the carrying value of the note is unchanged. d) The amounts paid for both interest and principal increase proportionately.
8. In each succeeding payment on an installment note:
a) The amount of interest expense increases. b) The amount of interest expense decreases. c) The amount of interest expense is unchanged. d) The amounts paid for both interest and principal increase proportionately.
9. On July 1, R Company^ borrowed $250,000 cash by signing a 10-year, 8%
installment note requiring equal payments each June 30 of $37,258. What is the appropriate journal entry to record the issuance of the note? a) Debit Cash $250,000; debit Interest Expense $37,258; credit Notes Payable $287,258. b) Debit Notes Payable $250,000; credit Cash $250,000. c) Debit Cash $37,258; credit Notes Payable $37,258. d) Debit Cash $250,000; credit Notes Payable $250,000.
10. On January 1, Year 1, S^ Company borrowed $100,000 on a 10-year, 7%
Solutions to Practice Problems
- a) Inventory 15, Problem #1 - Entries for a note payable - Notes Payable 15,
- c) The maturity value of the note is $15, b) The maturity date of the note is January 30.
- d) Interest expense - Interest payable
- e) Notes payable 15,
- Interest expense
- Interest payable - Cash 15,
- a. $25,000* 0.06 * 120/360 = $ Problem #2 - Entries for a short-term note payable
- b. 6/1 Accounts payable 25, - Notes payable 25,
- c. 9/29 Notes payable 25, - Interest expense - Cash 25,
Problem #3 – Entries for a long-term note payable a) Year 1 Jan. 1 Cash 70, Notes Payable 70, b) Year 1 Dec. 31 Notes Payable 15, Interest Expense ($70,000 * 0.09) 6, Cash 21, Year 2 Dec. 31 Notes Payable 16, Interest Expense ($54,693 * 0.09) 4, Cash 21,60 7 Problem #4 – Amortization table for a long-term note payable Period End Beginning Balance Interest Expense Notes Payable Cash Paid Ending Balance 12/31/Yr 1 $210,000 $16,800 $64,687 $81,487 $145, 12/31/Yr 2 145,313 11,625 69,862 81,487 75, 12/31/Yr 3 75,451 6,036 75,451 81,487 0
