promissory note accounting

ACCOUNTING FOR

PROMISSORY

NOTES

PROMISSORY NOTE

• A negotiable instrument

• An unconditional promise to pay a sum certain in

money at a determinable future time, made by a

maker, to a payee.

• May either be:

• Interest-bearing

• Non-Interest bearing

PROMISSORY NOTE

Manila, Philippines

P150,000.00

July 1, 20x3

PROMISSORY NOTE

FOR VALUE RECEIVED, I promise to pay Allen Molina the

amount of One Hundred Fifty Thousand Pesos (P150,000.00) on

August 30, 20x3 plus interest at the annual rate of 12%

(Signed) Hannah Marie Sy

COMPONENTS OF A

PROMISSORY NOTE

• MAKER

• The party who made the promissory note and

eventually signs on it

• The party who makes a promise to pay the agreed

amount at a specified future date

• The debtor in the transaction

COMPONENTS OF A

PROMISSORY NOTE

• PAYEE

• The person or business to whom the promise of future

payment was made.

• The recipient of the promissory note

• The creditor in the transaction

COMPONENTS OF A

PROMISSORY NOTE

• PRINCIPAL AMOUNT/ PRINCIPAL

• The amount loaned or borrowed by the maker of the

promissory note

COMPONENTS OF A

PROMISSORY NOTE

• INTEREST

• The opportunity cost involved in the lending

transaction

• Represents a revenue on the part of the payee, for

money lent

• Represents a cost or expense on the part of the maker

for money borrowed.

COMPONENTS OF A

PROMISSORY NOTE

• INTEREST PERIOD

• The period of time during which the interest on the

note is to be computed

• Extends from the date of the note until the maturity

date

COMPONENTS OF A

PROMISSORY NOTE

• INTEREST RATE

• The percentage rate multiplied to the principal and the

term of the note in order to arrive at the interest earned

or incurred for the period.

COMPONENTS OF A

PROMISSORY NOTE

• MATURITY DATE

• The date on which final payment on the promissory

note is due.

COMPONENTS OF A

PROMISSORY NOTE

• MATURITY VALUE

• The sum of the PRINCIPAL and INTEREST due at

the maturity date of the promissory note

• The amount that the payee expects to receive, and the

maker expects to pay

COMPONENTS OF A

PROMISSORY NOTE

• PLACE OF ISSUE

• The location, specifically the city or town in which the

maker issued the promissory note

SOURCES OF A PROMISSORY

NOTE

• The entity renders services or sells goods to a client, in

return the client issued a promissory note in settlement of

the account.

• The client has an outstanding account that is going to be

due, however, he does not have sufficient cash to pay. In

return, he offers to issue a promissory note

• A loan is extended to a borrower who issues a promissory

note

ILLUSTRATION

PROMISSORY NOTE ARISING FROM SERVICES

RENDERED TO CLIENTS

Notes Receivable XXXXXX

Service Income XXXXX

To record the receipt of promissory

note for services rendered.

ILLUSTRATION

PROMISSORY NOTE ISSUED BY A CLIENT TO

EXTEND HIS ACCOUNT


Accounts Receivable XXXXX


note as settlement of a previous account.

ILLUSTRATION

PROMISSORY NOTE RECEIVED IN

CONSIDERATION OF A LOAN GRANTED


Cash XXXXX


note for money lent.

INTEREST ON PROMISSORY

NOTES

• A promissory note may either be

• Interest-Bearing- a promissory note which provides for the

separate payment of interest together with the principal at

maturity date.

• Non-Interest Bearing- a promissory note that does not

require a separate payment for interest at maturity date

INTEREST- represents an opportunity cost

INTEREST ON PROMISSORY

NOTES

• SIMPLE INTEREST COMPUTATION FORMULA:

• I = PRT

• Interest = Principal X Rate X Time

INTEREST COMPUTATION

ON PROMISSORY NOTES

• The PRINCIPAL AMOUNT is the amount stated on the

face of the promissory note

• The rate, if silent, is assumed to be ANNUAL.

• The most critical factor in interest computation,

COMPUTING FOR THE TIME/ PERIOD IN

WHICH INTEREST WAS EARNED


ON PROMISSORY NOTES

• HOW TO PROPERLY COUNT THE DAYS EARNED IN A PROMISSORY NOTE?

• Let us use the earlier example, in which the promissory note was issued July 1, 20x3 and due August 30, 20x3

Number of Days in July 31 Date of the Note (1) Number of remaining days in July 30

Number of Days needed in August 30

Total Number of Days from July 1 60


ON PROMISSORY NOTES

• HOW TO PROPERLY COUNT THE DAYS EARNED IN A PROMISSORY NOTE?

• Assume a promissory note was issued September 15, 20x3 and due December 31, 20x3

Number of Days in Sept 30 Date of the Note (15) Number of remaining days in Sept 15

Number of Days needed in October 31

Number of Days needed in Nov 30

Number of Days needed in Dec 31

Total Number of Days from Sept 1 107


ON PROMISSORY NOTES

• Continuing the earlier illustration on which a

promissory note with P150,000 principal was received

and an interest of 12% annually was stipulated:

• Interest = Principal X Rate X Time

= P150,000 X 0.12 X 60/360

INTEREST = P3,000


ON PROMISSORY NOTES

• Continuing the earlier illustration on which a

promissory note with P150,000 principal was received

and an interest of 12% annually was stipulated:

• Principal P150,000

Interest 3,000

Maturity Value P153,000


ON PROMISSORY NOTES

• The entry to record the collection of the promissory

note at maturity date:

Cash 153,000

Notes Receivable 150,000

Interest Income 3,000

To record the collection of the note at

maturity date

DISCOUNTING

CUSTOMER’S NOTE

DISCOUNTING NOTES

RECEIVABLE

• Endorsing or selling the promissory note before its

maturity date

• The purpose is to generate quick cash to finance some

needs of the entity

• When payee discounts a promissory note, the payee

receives lesser proceeds compared to that of the

maturity value

DISCOUNTING NOTES

RECEIVABLE

• When the payee endorses or discounts the promissory

note to a bank prior to maturity, the bank advances to

the payee a sum of money computed at the date of

discounting and at the discount rate of the bank

• May either be:

• With recourse

• Without recourse

DISCOUNTING CUSTOMER’S

NOTE WITH RECOURSE

• The bank holds a recourse or a right against the seller of the note or the payee

• In effect, the seller of the note guarantees that at maturity date, the maker will pay the sum to the bank, thus a need to recognize a contingent liability exists.

• There are two possibilities when a customer’s note has been discounted with recourse

• Maker honors the note

• Maker dishonors the note


NOTE WITH RECOURSE

Example:

Maria De Leon received a 60-day 12% P15,000

promissory note from Alvin Ban on July 1, 2013. On

August 4, 2013 Maria De Leon endorses the note to BPI

for discounting.

Two possible scenarios at MATURITY DATE:

Alvin Ban honors the promissory note

Alvin Ban dishonors the promissory note

The main issue in discounting a customer’s note would be

the COMPUTATION OF PROCEEDS TO BE

RECEIVED at the date of discounting.

In computing the proceeds, THREE DATES must be

remembered:

1. Date of the note

2. Date of discounting

3. Maturity date of the note


NOTE WITH RECOURSE

ILLUSTRATION: DISCOUNTING

OF CUSTOMER’S NOTE

• Illustration:

On July 1 2013, Allen Molina received a 60-day 12%

P150,000 promissory note from Hannah Marie Sy. On

July 27, 2013 Allen discounted the promissory note with

PNB. At that time the discount rate was 14%



• 1. Determine the MATURITY VALUE of the note

Principal P XXXXX

Interest XXXXX

Maturity Value P XXXXX

• Applying the illustration:

Principal P 150,000

Interest(150,000*0.12*60/360) 3,000




• 2. Determine the DISCOUNT PERIOD

No. of Days in July 31

Date of Discounting (27)

No. of Days remaining in July 4

Days in August before Maturity 30

DISCOUNT PERIOD 34

60 DAYS

Date of

Note:

July 1,

20x3

Date of

Discounting:

July 27,

20x3

Maturity

Date:

August

30, 20x3

26

Days

34

Days

DISCOUNT PERIOD



3. Compute for the DISCOUNT.

DISCOUNT FORMULA:

DISCOUNT = MATURITY VALUE X DISCOUNT RATE X

DISCOUNT PERIOD



Applying the illustration:

Maturity Value: P153,000

Discount Rate: 14%

Discount Period: 34 Days

DISCOUNT:

= P153,000 X 0.14 x 34/360

= P2,023





• 4. Determine the NET PROCEEDS FROM

DISCOUNTING

Formula:

Maturity Value PXXXXX

Discount (XXXXX)

Net Proceeds PXXXXX



• 4. Determine the NET PROCEEDS FROM

DISCOUNTING

Formula:


Discount (2,023)

Net Proceeds P150,977

JOURNAL ENTRIES

JOURNAL ENTRIES

ASSUMPTION 1: HANNAH MARIE SY HONORED

THE NOTE

JOURNAL ENTRIES

ASSUMPTION 2: HANNAH MARIE SY

DISHONORED THE NOTE AND THE BANK

CHARGED A PROTEST FEE OF P1,000

PRESENTATION OF THE NOTES RECEIVABLE

DISCOUNTED ON THE FINANCIAL

STATEMENTS

• Generally, it is presented as a CONTINGENT

LIABILITY ON THE CURRENT LIABILITY side of

the STATEMENT OF FINANCIAL POSITION

Current Liabilities:

Notes Receivable Discounted P XXXXX

DISCOUNTING

OWN NOTE

DISCOUNTING OWN NOTE

• A transaction wherein the maker issues a promissory

note to borrow a sum of money

• A liability in the form of a Note Payable is being

incurred

• The concept of discounting implies, that the INTEREST

IS DEDUCTED IN ADVANCE, thus the PROCEEDS

from discounting were already reduced by the interest

PRO-FORMA ENTRIES

• To record the discounting of own-note:

Cash xxxxx

Discount on Notes Payable xxxxx

Notes Payable xxxxx

*Discount on Notes Payable: computed using the interest

formula I = PRT

*Cash- proceeds from discounting

Principal Pxxxxx

Discount (xxxxx)

Cash Proceeds Pxxxxx

ILLUSTRATION:

• On September 1, 2013 James Morth discounted its own

30-day 12% P10,000 note with Mary Dela Cruz

Cash 9,900

Discount on Notes Payable 100

Notes Payable 10,000

To record the discounting of promissory note

FINANCIAL STATEMENTS

PRESENTATION

• *Discount on Notes Payable is presented as a Contra-

Liability account, as a deduction to Notes Payable

Notes Payable P xxxxx

Discount on Notes Payable (xxxxx)

Amortized Cost Pxxxxx

AMORTIZATION OF DISCOUNT

ON NOTES PAYABLE

• Amortization- refers to the reduction of an amount over

a period of time

• Usually prepared at the END of the accounting period

• Pro-Forma Entry to Record Amortization of Discount

Interest Expense xxxxx

Discount on Notes Payable xxxxx

promissory note accounting

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