No-Face, No-Interest Notes Payable
A no-face, no-interest note payable is issued for the present value of the amount the borrower receives from the lender, which is less than the face value (future value) of the note. The difference between the face value and present value of the note is called a discount, which represents the total interest to be paid over the life of the loan.
To determine the present value of the amount borrowed and figure the discount, use a present value of $1 table. This table assumes a single payment and that you need to compute the present value of that payment. Search the web to find present value tables for a single payment and for multiple payments (annuities). Take the following steps, which assume a single payment:
Using a present value of $1 table, find the factor at the intersection of the loan percentage and period.
For example, for a five-year loan at 8 percent annual interest, skim down the Periods column (on the left) until you find 5, and then follow that row to the right until you hit the 8.00% column. In this case, the factor inside the intersection of row 5 and column 8.0% is 0.6805. If the decimal is extended one more place, the more precise factor is 0.68058. Use that more precise factor for this analysis.
Multiply the present value factor you found in Step 1 by the future value of the loan amount to find the present value.
In this example, the face amount (future value) of the loan amount is $20,000, so to find the present value of $20,000, take $20,000 x 0.68058 = $13,611.60 (rounded to $13,612). This is the present value of $20,000, discounted at 8 percent for five years.
Subtract the present value from the future value to determine the discount.
The discount is $20,000 face amount (future value) – $13,612 (present value) = $6,388.
Periods 7.0% 7.5% 8.0% 8.5% 1 0.9345 0.9302 0.9259 0.9216 2 0.8734 0.8653 0.8573 0.8494 3 0.8162 0.8049 0.7938 0.7829 4 0.7628 0.7488 0.7350 0.7215 5 0.7129 0.6965 0.6805 0.6650
The figure shows how to journalize this transaction.
The discount on a notes payable account is a contra liability account. It follows the note payable, amortized over the five-year life. The process of amortization moves the discount balance (in the balance sheet) to the income statement via interest expense by using the effective interest method. The following figure gives you a bird’s-eye view on how this works, assuming that the effective interest rate is 8 percent.
Journalize the first year by debiting interest expense for $1,089 and crediting discounts on notes payable for the same amount. For the second year, debit interest expense for $1,176 and credit discounts on notes payable for the same amount — and so on for the remaining three years. Note these points regarding amortization:
The carrying amount of the note increases to face amount ($20,000) over the life of the note payable (five years).
The entire discount balance ($6,388) is moved to interest expense over the same five-year life of the note payable.