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Chapter 14

Notes Receivable and Notes

Payable

© 2010 Prentice Hall Business

Publishing, College Accounting: A

Practical Approach , 11e by Slater

Learning Objective 1

Determining interest calculations and maturity dates on notes

LO-1


Publishing, College Accounting: A

Practical Approach, 11e by Slater

Promissory Note









Interest - cost of using money for a period of time

Formal written promise by a borrower to pay a certain sum at a fixed future date

Note payable – amounts the company owes to others

Note receivable – amounts owed to a company by others

LO-1




Promissory Note









Principal - amount being borrowed

Term - Amount of time money is being borrowed

Payee - company or person to whom the note is payable

Annual interest rate - rate being charged to borrower



Maturity date - due date of promissory note



Maker - the one promising to pay the note plus interest when it comes due

LO-1




Refer to Problem 14B-2

Principal

Term

Payee

Annual

Interest

Rate




Maturity

Date

Maker

LO-1

Calculate Interest

Interest = Principal x Rate x Time



Calculate interest for exact number of days based on 360-day year

Interest = $40,000 x 11% x (90/360)

= $1,100

LO-1




Determine Maturity Date

Days in term on note

Number of days remaining in June

(30 days – 2)

Days left on note after June

Days in July

August

Due date: August 31

LO-1




90

28

62

31

31

Maturity Date by Number of

Months



If note is expressed in months, count the months from the date of issue, regardless of number of days in each month.



A note issued on January 31 for 3 months, has a maturity date of April 30.

LO-1





Journalizing entries to record renewal of a note, dishonoring of a note, eventual receipt of payment, and note given in exchange for Equipment purchased

LO-2




Time Extension of a Note









At the end of a credit period, a borrower may ask for an extension.

A time frame and interest rate are agreed upon between buyer and seller.

Accounts Receivable and Accounts

Payable both decrease.

Notes Receivable and Notes Payable both increase.

LO-2




Dishonored Note





A note that was not paid at maturity by the maker

Also known as defaulting

LO-2





The initial sale of merchandise on books of buyer and seller

LO-2





A shift in assets for seller and a shift in liabilities for buyer

LO-2




Renewing & Dishonoring Notes



We will use Problem 14B-1 to illustrate the journal entries.

LO-2




Time Extension with a Note




LO-2

Time Extension with a Note




LO-2

Note Due and Paid at Maturity

Interest = Principal x Rate x Time

= $6,000 x .09 x (90/360)

= $135

Maturity Value = Principal + Interest

= $6,000 + 135

= $6,135

LO-2








LO-2





LO-2

Dishonored Note

Assume Connors Co. dishonors the note, rather than paying on November 8.




LO-2





LO-2

Dishonored Note

Connors Co. pays the note on November 16.




LO-2





LO-2

Note Given in Exchange for

Equipment Purchased



Seller

◦ Debit Notes Receivable

◦ Credit Sales



Buyer

◦ Debit Equipment

◦ Credit Notes Payable

LO-2





Discounting an interest-bearing note receivable and recording a discounted note that has been dishonored

LO-3




Co. received a $40,000, 90 day, 11% note from Fletcher Co. dated June 2. Apples discounted note at 12% discount rate.

We will calculate:









Maturity value,

# of days bank holds note until maturity

Bank discount

Proceeds

LO-3




Discounting a Note





The process of transferring the note to a bank before the maturity date

The company receives the maturity value less bank charges for holding note from date of discounting to maturity date

LO-3




Discounting a Note







The time period the bank holds the note is the discount period.

The amount the bank charges the company is the bank discount.

The actual money a company receives is called the proceeds.

LO-3




14B-2 Discounting a Note

Step 1: Find the maturity value of the note.

Interest = Principal x Rate x Time

$40,000 x 11% x (90/360) = $1,100

Maturity Value = Principal + Interest

$40,000 + 1,100 = $41,100

LO-3





Step 2: Calculate the discount period.

(Discount period – number of days from the date of discounting until the maturity date)

90 days Note

-44 days Expired before discounting

46 days That bank holds note

LO-3





Step 3: Calculate the bank discount (what the bank charges Apples Co. for holding the note until maturity)

Maturity Value

X Bank Discount Rate

X(No. of days bank holds note/ 360 days)

Bank Discount

LO-3





Step 3: Calculate the bank discount (what the bank charges Apples Co. for holding the note until maturity)

$41,100 x 12% x (46/360) = $630.20

LO-3





Step 4: Calculate the proceeds (what Apples receives from the bank)

Proceeds = Maturity Value – Bank Discount

= $41,100 - 630.20

= $40,469.80

LO-3




Journalize Discounting a Note




LO-3






If proceeds are less than the face of the note, recognize Interest Expense for the difference between the proceeds and the face.

Sometimes companies have to discount notes very early into their maturity due to financial hardships.

LO-3





What if Apples Company would have discounted the note after only 3 days?



First we go back to Step 2

90 days Note

- 3 days Expired before discounting

87 days That bank holds note

LO-3







Next, we go to Step 3

Calculate the bank discount

$41,100 x .12 x (87/360) = $1,191.90

Bank

Discount







Finally, we go to Step 4

Calculate the proceeds

(Maturity value – bank discount)

$41,100 – 1,191.90 = $39,908.10




When a Discounted Note is

Dishonored

The company who endorses the note is liable to the bank for the maturity value of the note until the note is paid –

Contingent Liability

LO-3




Discounting a Note

We will use 14B-3 to illustrate these concepts.

LO-3




Problem 14B-3

Discounting One’s Own Note



Joye discounted its own $25,000, 90-day note at National Bank at 10%.

Bank Discount =

Maturity value x Rate x (Discount Period/360)

$25,000 x 10% x (90/360)=

$625

LO-3




Problem 14B-3

Discounting One’s Own Note

Proceeds = Maturity Value – Discount

= $25,000 - 625

= $24,375






Problem 14B-3



Discount on Notes Payable

Amount of interest deducted in advance by the lender

Reduces Notes Payable to actual Cash value

Partial Balance Sheet

Current liabilities:

Notes Payable $25,000

Discount on Notes Payable 625

$24,375

LO-3





Handling adjustments for Interest

Expense and Interest Income

LO-4




Interest: The Need for Adjustments

On December 3, 20X4, Rochester

Company received a $6,000, 60-day, 11% note from Larry Company in payment of account past due.

LO-4





Larry Co

.

Accounts Payable

Notes Payable




LO-4


Dec. 3,

Jan. 31,




Adjusting entry is required to record interest incurred or earned to date.

LO-4


Step 1: Calculate interest on the note:

$6,000 x .11 x 60/360 = $110.00

Step 2: Calculate the number of days the note has already run before the end of the current period

Dec. 31- Dec. 3 = 28 days

LO-4





Step 3: Calculate interest incurred (earned) for this period.

28/60 x $110 = $51.33

Step 4: Prepare the adjusting journal entries.

LO-4




Interest: the Need for

Adjustments

Larry Co .




LO-4

On Due Date




LO-4

Adjusting Entries

From previous example: Joye discounted its own $25,000, 90-day note at National Bank at 10% on December 1, 20X4.

LO-4




Adjusting Entries

As of December 31, 30 days or 1/3 of the term of the note has passed.

LO-4




On Due Date




LO-4

End of Chapter 14


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Practical Approach , 11e by Slater

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End of Chapter 14

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