No-Face, Interest Bearing Notes Payable
Now that you’ve tackled zero-interest-bearing notes payables, you can dig into interest-bearing notes. Assume that a note payable has a stated (face) interest rate of 6 percent. At that stated rate, interest on a $20,000 note is $1,200 per year ($20,000 x 0.06). The borrower pays interest to the lender at the end of each year.
Note that the stated interest rate on the note payable is 6 percent. However, both the cash interest payments ($1,200 per year) and the principal amount are discounted based on an 8-percent rate.
You know that the present value of the principal is $13,612. However, you also need to figure out the present value of the interest portion of the note.
Use the following table to find the present value of an annuity of $1 table. Because the interest paid is a series of payments for the same amount, the payments are referred to as an annuity. When you calculate the present value of the note payable, it’s the present value of a single amount.
The factor at the intersection of 8 percent and five years in the present value of an annuity of $1 table is 3.9927. The present value of the interest is $4,791 (rounded) ($1,200 x 3.9927). Add the two present value figures to get the carrying value of the note, which is $18,403 ($13,612 + $4,791). Subtract $18,403 from the face value of the note payable to get the discount of $1,597 ($20,000 – $18,403).
The following figure shows how to journalize this transaction.
The next figure gives you the lowdown on the amortization table used to prepare the journal entry.
To record the borrower’s interest payment at the end of each year, journalize the first year by crediting discounts on notes payable for $272 and debiting interest expense for $1,472. The credit goes to cash for $1,200. For the second year, you credit discounts on notes payable for $294, debit interest expenses for $1,494, and credit cash for $1,200 — and so on for the remaining three years.