Notes Payable Journal Entry
Overview
Notes payable is a promissory note that represents the loan the company borrows from the creditor such as bank. Likewise, the company needs to make the notes payable journal entry when it signs the promissory note to borrow money from the creditor.
The notes payable is an agreement that is made in the form of the written notes with a stronger legal claim to assets than accounts payable. The company usually issue notes payable to meet short-term financing needs.
As the notes payable usually comes with the interest payment obligation, the company needs to also account for the accrued interest at the period-end adjusting entry. This is due to the interest expense is the type of expense that incurs through the passage of time.
Hence, without properly account for such accrued interest, the company’s expense may be understated while its total asset may be overstated. Of cause, if the note payable does not pass the cut off period or the amount of interest is insignificant, the company can just record the interest expense when it makes the interest payment.
Notes payable journal entry
On the date of receiving the money
The company can make the notes payable journal entry by debiting the cash account and crediting the notes payable account on the date of receiving money after it signs the note agreement with its creditor.
| Account | Debit | Credit |
|---|---|---|
| Cash | 000 | |
| Notes payable | 000 |
The date of receiving the money is the date that the company commits to the legal obligation that it has to fulfill in the future. Likewise, this journal entry is to recognize the obligation that occurs when it receives the money from the creditor after it signs and issues the promissory note to the creditor. Hence, the notes payable journal entry will increase both total assets and total liabilities on the balance sheet of the company.
At period-end adjusting entry
At the period-end, the company needs to recognize all accrued expenses that have incurred but not have been paid for yet. These accrued expenses include accrued interest on notes payable, in which the company needs to make journal entry by debiting interest expense account and crediting interest payable account.
| Account | Debit | Credit |
|---|---|---|
| Interest expense | 000 | |
| Interest payable | 000 |
Payment of interest on notes payable
When the company makes the payment on the interest of notes payable, it can make journal entry by debiting the interest payable account and crediting the cash account.
| Account | Debit | Credit |
|---|---|---|
| Interest payable | 000 | |
| Cash | 000 |
In this journal entry, the company debits the interest payable account to eliminate the liability that it has previously recorded at the period-end adjusting entry.
Payment of notes payable
When the company makes the payment back to the creditor on the agreed date of the promissory note, it can make the journal entry for the payment of notes payable by debiting notes payable account and crediting the cash account.
| Account | Debit | Credit |
|---|---|---|
| Notes payable | 000 | |
| Cash | 000 |
This journal entry is made to eliminate (or reduce) the legal obligation that occurred when the company received the borrowed money after signing the note agreement to borrow money from the creditor.
Notes payable example
For example, on October 1, 2020, the company ABC Ltd. signs a $100,000, 10%, 6-month note that matures on March 31, 2021, to borrow the $100,000 money from the bank to meet its short-term financing needs. The company ABC receives the money on the signing date and as agreed in the note, it is required to back both principal and interest at the end of the note maturity.
What is the journal entry for the notes payable?
- on October 1, 2020, when the company ABC receives the money after signing the note agreement.
- on December 31, 2020, which is the period-end adjusting of the company ABC
- on March 31, 2021, when the company ABC pays back both principal and interest to the bank as agreed in the note.
Solution:
On October 1, 2020
On October 1, 2020, when the company ABC receives the money after signing the note agreement with the bank to borrow $100,000, it can make the notes payable journal entry as below:
| Account | Debit | Credit |
|---|---|---|
| Cash | 100,000 | |
| Notes payable | 100,000 |
In this journal entry, both total assets and total liabilities on the balance sheet of the company ABC increase by $100,000 as at October 1, 2020.
On December 31, 2020
On December 31, 2020, which is the period-end adjusting, the company ABC needs to account for the accrued interest of $2,500 ($100,000 x 10% x 3/12) on notes payable with the journal entry as below:
| Account | Debit | Credit |
|---|---|---|
| Interest expense | 2,500 | |
| Interest payable | 2,500 |
As the interest expense incurs through the passage of time, this journal entry is necessary to recognize the interest expense of $2,500 that has incurred for 3 months from October 1, 2020 to December 31, 2020. If the company does not make this journal entry, both total expenses on the income statement and total liabilities on the balance sheet will be understated by $2,500 as of December 31, 2020.
On March 31, 2021
Payment of interest on notes payable
On March 31, 2021, when the company pays the interest of $5,000 ($100,000 x 10% x 6/12), it can make the journal entry for the interest payment on notes payable as below:
| Account | Debit | Credit |
|---|---|---|
| Interest payable | 2,500 | |
| Interest expense | 2,500 | |
| Cash | 5,000 |
The debit of $2,500 in the interest payable account here is to eliminate the payable that the company has previously recorded at period-end adjusting entry on December 31, 2020. And the debit of another $2,500 in the interest expense account is to record the interest expense that has incurred for 3 months from January 1, 2021, to March 31, 2021, which is in the new accounting period for the company ABC.
Payment of notes payable
When the company pays back the $100,000 of borrowed money at the end of note maturity, it can make the payment of notes payable journal entry on March 31, 2021, as below:
| Account | Debit | Credit |
|---|---|---|
| Notes payable | 100,000 | |
| Cash | 100,000 |