college accounting

College AccountingCollege Accounting

Heintz & ParryHeintz & Parry2020thth Edition Edition

Heintz & ParryHeintz & Parry2020thth Edition Edition

ChapterChapter 1717

Accounting for Notes and Interest

Accounting for Notes and Interest

1

Describe a

promissory note.

PROMISSORY NOTEPROMISSORY NOTE

• A written promise to pay a specific sum at a definite future date

• Also called a “note”

• Often used when credit is extended for 60 days or more, or when large amounts of money are involved

©2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.


$ 2,500.00 PRINCIPAL



$ 2,500.00 June 9, 20 - -Date of the note



$ 20

AFTER DATE I PROMISE TO PAY TO

Term of

the note2,500.00 June 9, - -

Ninety Days



$ 20

AFTER DATE PROMISE TO PAY TO

THE ORDER OF Central Bank PAYEE

2,500.00 June 9, - -

Ninety Days I



$ 20


THE ORDER OF

Two Thousand Five Hundred and 00/100

PAYABLE AT Central Bank

WITH INTEREST AT 9% per Annum from Date

INTERESTRATE

June 9, - -

Ninety Days I

Central Bank

Notes may beinterest bearing or

non-interest bearing.

2,500.00



$ 20


THE ORDER OF

PAYABLE AT

WITH INTEREST AT

No. 2307 Due Sept. 7, 20--

2,500.00 June 9, - -

Ninety Days I

Central Bank


Central Bank

9% per Annum from DateMATURITY

DATE



$ 20


THE ORDER OF

PAYABLE AT

WITH INTEREST AT

No. Due Sarah Morney

2,500.00 June 9, - -

Ninety Days I

Central Bank


Central Bank

9% per Annum from Date

2307 Sept. 7, 20--MAKER

OF NOTE

2

Calculate interest on and

determine the due date of

promissory notes.

TERM OF THE NOTETERM OF THE NOTE

• The months or days from the date of issue to the date of maturity

• Used to calculate TIME:– The term of the note stated as a

fraction of a year• Note: It is common to use 360 days as a

year

When the term of note isexpressed as months,

TIME is calculated in months.

TERM OF THE NOTETERM OF THE NOTE

• The months or days from the date of issue to the date of maturity

• Used to calculate TIME:– The term of the note stated as a

fraction of a year• Note: It is common to use 360 days as a

year

When the term of the note is expressedas days, the TIME is calculated using

the exact number of days.

COMPUTING THE DUE DATECOMPUTING THE DUE DATE

EXAMPLE: The note signed by Sarah Mornay is dated June 9, 20-- and is due

in 90 days.

STEP #1Start with the month the note was issued.

Days in June 30


Days in June 30

Subtract the date the note was issued(do not count the date of issuance).

Deduct date of note (June 9) 9Days remaining in June 21


in 90 days.


Days in June 30Deduct date of note (June 9) 9Days remaining in June 21Add: Days in July 31

Days in August 31

STEP #2 Add to the result of step #1 the number of days in as many months as possible without

exceeding the time of the note.


in 90 days.



Days in August 31

By the end of August, 83 days of the note have past.


in 90 days.



Days in August 31

STEP #3Subtract the result of step #2

from the time of the note (90 – 83).


in 90 days.



Days in August 31

The result is the date of the month the note is due.


in 90 days.



Days in August 31Maturity date, September 7 7

The 90th day (Sept. 7th) is called the maturity date.


in 90 days.



Days in August 31Maturity date, September 7 7

Total time in days 90


in 90 days.

CALCULATING INTERESTCALCULATING INTEREST

FORMULA:

PRINCIPAL RATE TIME

$2,500.00 9% 90/360

$56.25interest

EXAMPLE: The note signed by Sarah Mornay has a principal of $2,500, an

annual interest rate of 9%, and is due in 90 days.

CALCULATING INTERESTCALCULATING INTEREST

FORMULA:

PRINCIPAL RATE TIME

$2,000.00 8% 3/12

EXAMPLE: A $2,000, 8% note due in 3 months

$40interest

3

Account for notes

receivable transactions

and accrued interest.

NOTES RECEIVABLE TRANSACTIONS

NOTES RECEIVABLE TRANSACTIONS

• Seven types:– Note received from a customer in

exchange for assets sold– Note received from a customer to

extend time for payment of an account– Note collected at maturity– Note renewed at maturity– Note discounted before maturity– Note dishonored– Collection of dishonored note

NOTE RECEIVED IN EXCHANGE FOR ASSETS

NOTE RECEIVED IN EXCHANGE FOR ASSETS

EXAMPLE: On June 1, Linesch Hardware Co. sells an industrial mower to

Williams Manufacturing for $8,500 in exchange for a 180-day, 9% note

signed by Williams.


GENERAL JOURNALGENERAL JOURNAL

DATE DESCRIPTION PR DEBIT CREDIT

1

2

3

4

5

6

7

8

9

10

11

June 1 Notes Receivable 8,500

Sales 8,500

Received note for

merchandise sale

This is simply a sale in which the buyer signs a note (a promise to pay).

Note that the seller will receive interest as well as principal.

20--




1

2

3

4

5

6

7

8

9

10

11

Nov. 28 Cash 8,882.50

Notes Receivable 8,500.00

Received principal and interest

Assume 180 days later, Williams Manufacturing pays the maturity value

of the note (principal plus interest).

20--

Interest Revenue 382.50

NOTE RECEIVED TO EXTEND TIME FOR PAYMENT


EXAMPLE: Accounts receivable customer, Michael Putter, owes $2,000 to Linesch Hardware Co. To settle this account, Putter signs a 90-day, 10%

note dated June 8.

Why would we want toaccept this note?



EXAMPLE: Accounts receivable customer, Michael Putter, owes $2,000 to Linesch Hardware Co. To settle this account, Putter signs a 90-day, 10%

note dated June 8.Two reasons to accept this note:1. The note is a formal, written

promise to pay– Can be converted to cash at a bank

if necessary

2. The note is likely to bear interest




1

2

3

4

5

6

7

8

9

10

11

June 8 Notes Receivable 2,000

Accts. Receivable/M. Putter 2,000

Received note to settle

account

Mr. Putter’s balance is removedfrom Accounts Receivable andplaced into Notes Receivable.

20--



EXAMPLE: What if accounts receivable customer, Michael Putter, gives a

check for $250 and a note for $1,750 instead?

Let’s look atthe journal

entry!




1

2

3

4

5

6

7

8

9

10

11

June 8 Cash 250

Accts. Receivable/M. Putter 2,000

Notes Receivable 1,750

Received cash and note

to settle account

20--

NOTE COLLECTED AT MATURITYNOTE COLLECTED AT MATURITY

• When a note receivable matures, it may be collected:

– By the payee– By the bank named in the note– By a bank where it was left for

collection


EXAMPLE: On September 6 (the due date), Putter pays the principal and

interest on the note.

$2,000Principal of note

Interest

$2,000 × 10% × 90/360

50


EXAMPLE: On September 6 (the due date), Putter pays the principal and

interest on the note.

$2,000Principal of note

Interest 50

$2,050Maturity value




1

2

3

4

5

6

7

8

9

10

11

Sept. 6 Cash 2,050


Interest Revenue 50

Received payment of note

with interest

20--


EXAMPLE: What if the note had been left at Planet Bank for collection instead?

Planet Bank would collect the maturity value from Putter, subtract out a service charge, and deposit the

remainder in Linesch’s account.




1

2

3

4

5

6

7

8

9

10

11

Sept. 6 Cash 2,040

Notes Receivable

10

Interest Revenue

2,000

Received payment of note

with interest less collection

Collection Expense

50

fee

20--

NOTE RENEWED AT MATURITYNOTE RENEWED AT MATURITY

EXAMPLE: What if Mr. Putter had been able to pay the interest due on the note

and asked to renew the note?

Linesch Hardware Co. would collect the interest, and accept a new note to

replace the original note.




1

2

3

4

5

6

7

8

9

10

11

Sept. 6 Cash 50

Notes Receivable (old note)

2,000

Interest Revenue

2,000

Received new note plus

interest on old note

Notes Receivable (new note)

50

20--


EXAMPLE: What if Mr. Putter had been able to pay the interest due on the note, pay $500 on the principal, and asked to

renew the balance of the note?

Linesch Hardware Co. would collect the interest and partial payment, and

accept a new note to replace the original note.




1

2

3

4

5

6

7

8

9

10

11

Sept. 6 Cash 550

Notes Receivable (old note)

1,500

Interest Revenue

2,000

Received new note plus

partial payment and interest

Notes Receivable (new note)

50

on old note

20--

NOTE DISCOUNTED BEFORE MATURITY


• If a business needs cash before the due date of a note, it can endorse the note and transfer it to a bank– The bank charges an interest fee called

a “bank discount” • For the time between the date of

discounting and the due date of the note

– The difference between the maturity value and the bank discount is called the “proceeds”



EXAMPLE: Assume the $2,000, 10%, 90-day note from Putter dated June 8 is discounted at the bank on July 8 at a

rate of 12%.

Calculatingthe discount and

proceeds is a four-step process.




rate of 12%.Step #1 Compute the maturity value of the note.

Face + Interest = Maturity Value$2,000 + $50 $2,050=



EXAMPLE: Assume the $2,000, 10%, 90-day note from Putter dated June 8 is

discounted at the bank on July 8 at a rate of 12%.Step #2 Compute the number of days in

the discount period—from the discount date to the due date.

Days in July 31Less: Discount date 8

The discount date is notcounted in the discount period.




rate of 12%.Step #2 Compute the number of days in the discount period—from the discount date to the due date.

Days in July 31Less: Discount date 8Remaining days in July 23Plus days in August 31Plus due date (Sept.) 6Days in discount period 60




rate of 12%.Step #3 Compute the discount amount.Maturity

ValueDiscount

RateDiscount Period

Discount Amount

=

$2,050 12% 60/360 $41=




rate of 12%.Step #4 Compute the proceeds.

Maturity Value

Discount Amount =

$2,050 $41 =

––

Proceeds

$2,009

Let’s journalize thediscounting of this note.




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2

3

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5

6

7

8

9

10

11

July 8 Cash 2,009


Interest Revenue 9

Discounted note receivable

What if the proceeds are less thanthe face value of the note?

20--




1

2

3

4

5

6

7

8

9

10

11

July 8 Cash 1,992


Interest Expense 8

Discounted note receivable

The difference representsinterest expense.

20--

NOTE DISHONOREDNOTE DISHONORED

• The maker of the note does not pay or renew it at maturity

• The maker is still liable• The note loses its legal status• The payee transfers the amount due from

Notes Receivable to Accounts Receivable


EXAMPLE: Putter dishonors the $2,000, 10%, 90-day note.

Interest, although it has not been paid by the maker,is recognized as earned

by the payee.




1

2

3

4

5

6

7

8

9

10

11

Sept. 6 Accounts Receivable/Putter 2,050


The entire maturity value isdebited to Accounts Receivable.

Interest Revenue 50

Note receivable dishonored

20--


EXAMPLE: If Putter’s note had been discounted at the bank and then was

dishonored by the maker, the bank will require the PAYEE to pay the principal,

interest, and bank fees.

The payee then attempts torecover the maturity value

PLUS the bank fee from the maker.




1

2

3

4

5

6

7

8

9

10

11

Sept. 6 Accounts Receivable/Putter 2,060

Cash 2,060

Paid bank for dishonored

note, including a $10 bank fee.

20--

COLLECTION OF A DISHONORED NOTE

COLLECTION OF A DISHONORED NOTE

EXAMPLE: On October 16, the payee collects from Putter after the note had

been discounted and dishonored.

The maker pays the maturityvalue, bank fee, and additional

interest at 10% for the period sincedishonoring the note.




1

2

3

4

5

6

7

8

9

10

11

Oct. 16 Cash 2,082.89

Principal$2,000

Interest Bank Fee$50 $10 $2,060

$2,060 10% 40/360 $22.89

$2,060 $22.89 $2,082.89

++

++

=

× × =

+ =

20--




1

2

3

4

5

6

7

8

9

10

11

Oct. 16 Cash 2,082.89

Accounts Receivable 2,060.00


Collected dishonored note

with interest

20--


DateRcvd. Maker Time Due Date Amount

InterestNOTES RECEIVABLE REGISTER

20--Apr. 4 L. Peters 60 days June 3 400.00

Rate Amount

8% 5.33

21 J. Slaw 60 days June 21 600.00 9% 9.00

May 2 S. Alpart 30 days June 1 700.00 9% 5.25

19 L. Shein 90 days Aug. 17 800.00 9% 18.00

June 20 J. Slaw 60 days Aug. 19 500.00 9% 7.50

When a business has many notes,it may keep a notes receivable

register.


DiscountedInterest

NOTES RECEIVABLE REGISTER

Rate Amount8% 5.33

Bank DateDate

Collected RemarksJune 3

9% 9.00 June 20 Renewal for $500

9% 5.25 June 1 Sent for collection 5/30

9% 18.00

9% 7.50 Renewal of 4/21 note

ACCRUED INTEREST RECEIVABLEACCRUED INTEREST RECEIVABLE

• Revenue should be recognized when it is earned– Not always practical

• Interest is earned day by day

– It is common for interest to be recognized when the note is due

• If the note is received and due within a single accounting period

– If the note is received in one period and due in the next, accrued interest must be recorded at the end of the period


EXAMPLE: The fiscal year ends on June 30. Two notes from the notes receivable

register remain outstanding. Accrued interest on these notes must be

calculated and recognized.

PrincipalDate of Issue

Rate of Interest

Days from Issue Date to June 30

Accrued Interest June 30

$800.00 May 19 9% 42 $8.40

$800.00 × 9% × 42/360


EXAMPLE: The fiscal year ends on June 30. Two notes from the notes receivable

register remain outstanding. Accrued interest on these notes must be

calculated and recognized.

PrincipalDate of Issue

Rate of Interest

Days from Issue Date to June 30

Accrued Interest June 30

$800.00 May 19 9% 42 $8.40$500.00 June 20 9% 10 1.25

$9.65




1

2

3

4

5

6

7

8

9

10

11

June 30 Accrued Interest Receivable 9.65


Interest accrued on notes

receivable

20--

4

Account for notes payable

transactions and accrued

interest.

NOTES PAYABLE TRANSACTIONSNOTES PAYABLE TRANSACTIONS

• Five types:– Note issued to a supplier in exchange

for assets purchased– Note issued to a supplier to extend time

for payment of an account– Note issued as security for cash loan– Note paid at maturity– Note renewed at maturity

NOTE ISSUED IN EXCHANGE FOR ASSETS

NOTE ISSUED IN EXCHANGE FOR ASSETS

EXAMPLE: On June 1, Linesch Hardware Co. purchases a truckload of trees and shrubs from Evergreen Enterprises and

signs a $4,000, 90-day, 9% note in exchange.

The maker would recordthis as a note payable.




1

2

3

4

5

6

7

8

9

10

11

June 1 Purchases 4,000

Notes Payable 4,000

Issued note for inventory

purchase

20--

NOTE ISSUED TO EXTEND TIME FOR PAYMENT


EXAMPLE: $700 is owed to Bella & Co. on June 11. Bella & Co. agrees to accept a $700, 90-day, 10% note dated June 11.




1

2

3

4

5

6

7

8

9

10

11

June 11 Accounts Payable/Bella & Co. 700

Notes Payable 700

Issued note to settle account

The balance owed to Bella & Co.is removed from Accounts Payable and

placed into Notes Payable.

20--



EXAMPLE: A partial payment of $200 is made to Bella & Co. on June 11. A note is issued to Bella & Co. for the remaining

$500.


entry!




1

2

3

4

5

6

7

8

9

10

11

June 11 Accounts Payable/Bella & Co. 700

Notes Payable 500

Cash 200

Made partial payment and

issued note to settle account

20--

NOTE ISSUED AS SECURITY FOR CASH LOAN

NOTE ISSUED AS SECURITY FOR CASH LOAN

• Two types:• Interest-bearing notes

– The face value of the note is received in cash

– The maker pays face value plus interest at maturity

• Non-interest-bearing notes– Interest is deducted in advance, called

“discounting”– Face value minus interest is received in cash– The maker pays face value at maturity

INTEREST-BEARING NOTESINTEREST-BEARING NOTES

EXAMPLE: Borrowed $6,000 on June 16 from Planet Bank on a 60-day, 10.5%

note.


entry!




1

2

3

4

5

6

7

8

9

10

11

June 16 Cash 6,000

Notes Payable 6,000

Issued note for bank loan

20--

NON-INTEREST-BEARING NOTESNON-INTEREST-BEARING NOTES

EXAMPLE: A non-interest-bearing, 60-day note was issued for $6,000 on June 16.

The bank discounts at the rate of 10.5%.

The maker will not receivethe whole $6,000.

(10.5% $6,000 60/360 = $105 discount;$6,000 – $105 = $5,895)




1

2

3

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5

6

7

8

9

10

11

June 16 Cash 5,895

The maker receives the proceeds but promised to

pay the maturity value ($6,000).

20--




1

2

3

4

5

6

7

8

9

10

11

June 16 Cash 5,895

Notes Payable

Discount on Notes Payable 105

6,000


20--


Maker of the Note Balance SheetJune 30, 20--

Maker of the Note Balance SheetJune 30, 20--

AssetsCurrent assets

Liabilities

Notes payableLess: Discount on notes payable

Current liabilities$6,000

105 $5,895

The balance sheet shows the discount on notes payableas a reduction from the notes payable account.

STATED vs. EFFECTIVE INTEREST RATE


INTEREST-BEARING NOTE

NON-INTEREST-BEARING NOTE

$105/$6,000 = 1.75%

Interest rate for 60 days





$105/$6,000 = 1.75%

Effective rate

610.5%





$105/$6,000 = 1.75%

Interest-bearing notes:Effective rate = Stated rate

610.5%





$105/$6,000 = 1.75%

Non-interest-bearing notes:Effective rate Stated rate

610.5%

$105/$5,895 = 1.781% 610.686%

NOTE PAID AT MATURITYNOTE PAID AT MATURITY

EXAMPLE: The interest-bearing note is paid at maturity.

$6,000 10.5% 60/360 = $105 interest$6,000 + $105 = $6,105 paid




1

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7

8

9

10

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Aug. 15 Notes Payable 6,000

Cash

Interest Expense 105

6,105

Paid note with interest at

maturity

20--

NOTE PAID AT MATURITYNOTE PAID AT MATURITY

Now let’s look at the non-interest-bearing note at maturity.

A $6,000 maturity value is paid to thepayee. Discount on Notes Payable

becomes Interest Expense.




1

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3

4

5

6

7

8

9

10

11

Aug. 15 Notes Payable 6,000

Cash


6,000

Paid note at maturity


20--


EXAMPLE: The maker pays only $1,000 plus the $105 interest on the $6,000 note and signs a new $5,000, 60-day,

10.5% note.

The old note is removed,interest expense of $105 is recognized,

cash is reduced, and a new note is recorded.




1

2

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5

6

7

8

9

10

11

Aug. 15 Notes Payable (old note) 6,000

Cash


1,105

Paid interest and part of

Notes Payable (new note) 5,000

principal on old note and

issued new note

20--


NOTES PAYABLE REGISTERDate

Issued Maker Time Due Date AmountInterest

20--Apr. 14 L. Knoop 60 days June 13 2,000.00

Rate Amount

9% 30.00

13 Apex Bank 90 days Aug. 11 8,000.00 10% 200.00May

2 S. Bront 30 days July 2 1,500.00 11% 13.75June

Multiple notes are recordedin a notes payable register.


InterestNOTES PAYABLE REGISTER

Rate Amount9% 30.00

Date Paid Remarks

June 13

10% 200.00

Settled 2/14 invoice

11% 13.75 Settled 4/2 invoice

Amount2,000.00

8,000.00

1,500.00

ACCRUED INTEREST PAYABLEACCRUED INTEREST PAYABLE

EXAMPLE: Issued a $900, 60-day, 10% note on May 31. June 30 is the

company’s fiscal year end.

An adjusting entry is neededon June 30 to record the interest

accrued on the note fromMay 31 to June 30.




1

2

3

4

5

6

7

8

9

10

11

June 30 Interest Expense 7.50

Accrued Interest Payable 7.50

Interest accrued on note

payable

20--

ACCRUED INTEREST PAYABLEACCRUED INTEREST PAYABLE

EXAMPLE: If instead it was a $900, 60-day, non-interest-bearing note that

was discounted at the bank at 10%...

An adjusting entry is neededon June 30 to move the interest

for the period (May 31 to June 30)from Discount on Notes Payable

to Interest Expense.




1

2

3

4

5

6

7

8

9

10

11

May 31 Cash 885



Notes Payable 900

Journal entry to recordthe note’s issuance

20--




1

2

3

4

5

6

7

8

9

10

11

May 31 Cash 885



Notes Payable 900

June 30 Interest Expense 7.50

Discount on Notes Payable 7.50

Interest accrued on note

payable

20--

college accounting

Documents

term of note

accessible website

date of promissory notes

promissory notea

expressedas days

involved2011 cengage

note2011 cengage learning

daysi2011 cengage learning