ch. 13 accounting for notes and interest - … sheet presentation of notes payable current...
TRANSCRIPT
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Ch. 13 Accounting for Notes and Interest
1. Promissory note
2. Notes Payable and Interest Expense
3. Notes Receivable and Interest Income
4. Discounting a Note
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Promissory Notes
A promissory note is a written promise to pay a sum of
money at a definite time in the future.
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Payee
Time
Pay to the order of
Principal
Interest Rate
Due date Payable at
Maker
Date
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Parts of a Promissory Notes
• The date of the note
• The time or term of the note
• The words pay to the order of make the note negotiable.
Negotiable means that the note, like a check, can be transferred by
endorsement to another party
• The payee of the note is the person who will be paid when the note
reaches its payment date
• The principal is the amount borrowed or the amount of credit
extended
• Interest is the charge for credit
• The due date is the date the note is due for payment
• The maker of the note is the person who has signed the note and
promises to pay
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Determining the Due Date of Note
A 60-day note is issued on March 15
The note would mature 60 days from March 15:
The due date of the note is May 14
Number of days remaining in March (31-15) 16
Number of Days in April 30
Total days at end of April 46
Days in May to reach 60 14
Term of note 60
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Calculating Interest The following formula is used to calculate interest:
Interest = Principal x Rate x Time
Assume a $4,000, 60-day note has an interest rate of 10%
The total interest would be:
$66.67 = $4,000 x .10 x 60/360
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Notes Payable and Interest Expense
Notes payable may be issued in various situations. The most
common include the following:
Note issued to a supplier for an extension of time to pay an
existing account payable
Note issued directly for the purchase of merchandise or other
property
Note issued for a loan of cash
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Balance Sheet Presentation of Notes Payable
Current Liability: A note is to be paid within a year
Long-Term Liability: A note not due for payment within the year
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Note Payable Issued for an Extension of Time
Assume on June 17 Julie Kearney purchased $700 worth of
merchandise from Kevin Walsh
Terms of the purchase were n/30
General Journal
Date Account Title P.R. Debit Credit
Jun. 17 Purchases 700
Accounts Payable – Kevin
Walsh 700
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Note Payable Issued for an Extension of Time
On July 17, Julie contacted Kevin for an extension of
time to make payment. Kevin requests a promissory
note at 9% and allows Julie 30 days to make
payment.
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General Journal
Date Account Title P.R. Debit Credit
Jul. 17 Accounts Payable - Kevin
Walsh 700
Notes Payable 700
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Payment of a Note at Maturity
Assume on August 16 Julie pays the principal and
interest due on the July 17 note.
Julie made the following entry to record the payment of
the note and interest:
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General Journal
Date Account Title P.R. Debit Credit
Aug. 16 Notes Payable 700.00
Interest Expense 5.25
Cash 705.25
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Note Issued for Merchandise
On March 23, Robert Griffin purchased $2,000 of
merchandise from Southland Foods and issued a 30-day,
12% note.
Robert made the following entry to record the purchase:
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General Journal
Date Account Title P.R. Debit Credit
Mar. 23 Purchases 2,000
Notes Payable 2,000
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Note Issued for Merchandise
On April 22, Robert pays the principal and interest due on
the note and records the following entry:
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General Journal
Date Account Title P.R. Debit Credit
Apr. 22 Notes Payable 2,000
Interest Expense 20
Cash 2,020
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Note Issued for a Loan of Cash
On August 8, Wilcox Company borrowed $5,000 for 90
days at 10% from the Columbus National Bank.
Wilcox made the following entry to record the loan:
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General Journal
Date Account Title P.R. Debit Credit
Aug. 8 Cash 5,000
Notes Payable 5,000
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Note Issued for a Loan of Cash
On Nov. 6, Wilcox Company pays the principal and
interest due on the note and records the following entry:
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General Journal
Date Account Title P.R. Debit Credit
Nov. 6 Notes Payable 5,000
Interest Expense 125
Cash 5,125
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Discounting a Note Payable
The practice of a lending institution to deduct the interest from the
principal at the time of borrowing.
On August 8, Wilcox Company issues a $5,000, 90-day, note which
the bank discounts at 10%.
The bank deducts the interest immediately and Wilcox Company
receives the face amount of the note, less the interest.
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Discounting a Note Payable
The amount received is known as the proceeds.
Wilcox Company records the following entry on August 8:
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General Journal
Date Account Title P.R. Debit Credit
Aug. 8 Cash 4,875
Interest Expense 125
Notes Payable 5,000
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Discounting a Note Payable
On Nov. 6, Wilcox Company pays the principal and records
the following entry:
Interest on a discounted note is recorded at the time of
discounting, not at the time of payment.
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General Journal
Date Account Title P.R. Debit Credit
Nov. 6 Notes Payable 5,000
Cash 5,000
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Notes Receivable and Interest Income
Note Receivable
An asset to the person or business receiving the note
An asset because it represents a definite dollar amount that
will be collected at some point in the future
Interest Income
Interest earned on the note
Classified as a non-operating revenue account
Non-operating Revenue: revenue earned from a source
other than the normal operations of the business
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Advantages of a Note Receivable Over an Accounts Receivable
A note is a formal written promise, serving as proof
of a transaction
A note can bear interest, which is additional
revenue
A note is negotiable; it can be transferred by
endorsement to obtain cash or other assets
A note can be pledged (used) as security for a loan
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Reasons to Accept a Note
Allow extension of time for customer to pay an
account receivable
In exchange for sale of merchandise or other assets
For a loan of cash to
Employees
Customers
Other Businesses
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On July 17, Julie requests an extension of time to pay the amount due.
Kevin agrees to accept a 30-day, 9% note for $700 to settle the account.
Kevin prepares the following journal entry:
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General Journal
Date Account Title P.R. Debit Credit
Jul. 17 Notes Receivable 700
Accounts Receivable – Julie
Kerney 700
Example
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Example
Collection of a Note at Maturity
Assume on August 16 Kevin receives the principal
and interest due on the July 17 note.
Kevin makes the following entry to record the receipt
of the note and interest:
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General Journal
Date Account Title P.R. Debit Credit
Aug. 16 Cash 705.25
Notes Receivable 700.00
Interest Income 5.25
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Example
Note Received for Merchandise
On March 23, Southland Foods sells merchandise to
Robert Griffin and accepts a $2,000, 30-day, 12% note.
Southland Foods makes the following entry to record
the sale:
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General Journal
Date Account Title P.R. Debit Credit
Mar. 23 Notes Receivable 2,000
Sales 2,000
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Example
On April 22, Southland receives the principal and interest due on the note and records the following entry:
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General Journal
Date Account Title P.R. Debit Credit
Apr. 22 Cash 2,020
Notes Receivable 2,000
Interest Income 20
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Example
Note Received for a Loan of Cash
On April 1, Wynn Hanks, an employee of Southland
Foods, requested and was granted a $500 loan
from the company.
Wynn was required to sign a 90-day, 12% note in
return for the loan.
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General Journal
Date Account Title P.R. Debit Credit
Apr. 1 Notes Receivable 500
Cash 500
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Example
On June 30, Southland Foods receives the principal and interest due on the note and records the following entry:
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General Journal
Date Account Title P.R. Debit Credit
Jun. 30 Cash 515
Notes Receivable 500
Interest Income 15
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Discounting a Note Receivable
If money is needed before a note receivable matures,
the note can be discounted to a bank or finance
company.
In discounting a note, the bank deducts an interest
charge — the bank discount — from the maturity value
of the note to determine the amount of proceeds to be
received by the original payee of the note.
The maker of the note is then directed to pay the bank
the maturity value of the note on its due date.
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Steps in Discounting a Note Receivable
1. Calculate the maturity value of the note
2. Calculate the due date of the note
3. Calculate the discount period
4. Calculate the amount of the bank discount
5. Calculate the proceeds
6. Journalize the transaction
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Example
Discounting a Note Receivable
Assume Peter Rosenberg received a $9,000, 60-day, 6%
note on account from a customer on July 14.
Peter discounted the note at the First Savings Bank on
August 3.
First Savings Bank charges a discount rate of 12%.
Step 1: The interest on the note
= $9,000 x .06 x 60/360 = $90.
The maturity value = $9,000 + $90 = $9,090
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Example
Step 2: The due date of the note is 60 days after July 14,
or September 12
Step 3: The discount period = the number of days the
bank holds the note from July 14. From July 14
until August 3 = 20 days. Therefore the bank holds
the note for 40 days
Step 4: The amount of the bank discount
= $9,090 x .12 x 40/360 = $121.20
Step 5: The cash proceeds equals the maturity value of
the note less the bank discount, or $9,090 -
$121.20 = $8,968.80 28
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Journal Entry to Record Discounting a Notes Receivable
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General Journal
Date Account Title P.R. Debit Credit
Aug. 3 Cash 8,968.80
Interest Expense 31.20
Notes Receivable 9,000.00
Since the cash proceeds are less than the face value of the note,
interest expense is debited for the difference.
If the cash proceeds had exceeded the face value of the note,
interest income would be credited for the difference.
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Contingent Liability on Discounted Notes When a note receivable is discounted, the payee must endorse
the note, thereby transferring ownership to the bank.
The endorsement also means that the payee agrees to pay the
bank the full maturity value of the note should the maker fail to
make payment when the note falls due.
A contingent liability is a possible liability, such as on a
discounted note of a customer, that may become a real liability if
certain events occur.
If a balance sheet is prepared during a time when notes have
been discounted, the balance sheet should show the amount of
the contingent liability in a footnote.
This is required under the adequate disclosure principle, which
states that financial statements must disclose all relevant data
about the financial position of the company.
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Reasons Notes Are Not Paid at Maturity
The maker is unable to pay the note on its due date and requests
an extension of time
The note is dishonored, maker simply doesn’t pay
Notes Renewed at Maturity
If the maker of a note is unable to pay the note at maturity, the
payee may be willing to renew all or part of the note.
When a note is renewed, the old note is canceled and a new note
is created.
The maker will usually pay the interest for the period of the
original note.
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Example Note Renewed at Maturity
Assume Julie Kearney owes Kevin Walsh a $700 note plus
interest of $5.25.
On August 16, the maturity date, Julie asks Kevin if she can
renew the note for another 30 days and pay the interest.
Kevin Walsh records the following entry to receive the interest
income and renew the note:
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General Journal
Date Account Title P.R. Debit Credit
Aug. 16 Cash 5.25
Notes Receivable (new) 700.00
Notes Receivable (old) 700.00
Interest Income 5.25
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Dishonored Note
A note not paid for or renewed
A worthless asset, but the payee of the note still has a
claim against the maker for the full maturity value of
the note
Since a dishonored note loses its legal status as a note
receivable, the payee transfers the amount due from
the Note Receivable account to the Accounts
Receivable account
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Example
Dishonored Note
Assume on August 16, Julie dishonors her note to
Kevin Walsh.
Kevin would prepare the following entry:
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General Journal
Date Account Title P.R. Debit Credit
Aug. 16 Accounts Receivable - Julie
Kearney 705.25
Notes Receivable 700.00
Interest Income 5.25
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Collection of a Dishonored Note
The payee has a legal right to continue to charge the
payor interest after the note was dishonored.
The interest is figured on the maturity value of the
note.
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Example Collection of a Dishonored Note
Assume in the previous slide Julie pays Kevin the amount due on
the note 30 days after the maturity date.
Kevin charges Julie 9% interest for the additional 30 days.
The additional interest is computed as
$705.25 x .09 x 30/360 = $5.29.
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On September 15, Kevin would prepare the following entry to
record the dishonored note:
General Journal
Date Account Title P.R. Debit Credit
Sep. 15 Cash 710.54
Accounts Receivable – Julie
Kearney 705.25
Interest Income 5.29
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Dishonored Discounted Note
When a note is discounted, the maker is directed to
pay the bank the full maturity value of the note on its
due date.
If the payor fails to make payment to the bank, the
bank will notify the endorser and ask for the full
maturity value and, usually, a protest fee.
A protest fee is a fee a bank charges the payee when
the note is dishonored by the maker.
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Example
Dishonored Discounted Note
Assume on Sept. 12, a discounted note with a principal
amount of $9,000 and a maturity value of $9,090 is
dishonored by the payor.
The bank notifies the payee that the note was dishonored
and charges the payee a protest fee of $100.
The payee will record the following journal entry:
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General Journal
Date Account Title P.R. Debit Credit
Sep. 12 Accounts Receivable - Payor 9,190
Cash 9,190
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Example
Collection of a Dishonored Discounted Note
Assume in the previous slide, that the payor pays the
amount due on the account on October 12.
The payee charges 6% interest for 30 days of extra
time.
The payee would record the following journal entry:
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General Journal
Date Account Title P.R. Debit Credit
Oct. 12 Cash 9,235.95
Account Receivable – Payor 9,190.00
Interest Income 45.95