Notes Payable (N/P) as a Current Liability - dummies

Notes Payable (N/P) as a Current Liability

By Maire Loughran

Transactions originally booking as accounts payable (A/P) could eventually be reclassified as a short-term note payable. This situation may happen if the company can’t pay the vendor and the vendor wants to formalize this open account via a note payable, which is a formal document showing an amount owed and a mutually acceptable interest rate and payback period.

Notes payable showing up as current liabilities will be paid back within 12 months.

Vendors can issue notes that are interest or zero-interest bearing. If the note is interest bearing, the journal entries are easy-peasy.

For example, on November 1, 2013, Big Time Bank loans Green Inc. $50,000 for five months at 6 percent interest. Green Inc. records this short-term note by debiting cash and crediting short-term notes payable for $50,000.

When preparing the financial statements as of November 30, 2013, Green Inc. makes an adjusting journal entry to record one month of interest in the amount of $250 ([$50,000 x .06] x 1/12).

You use 1/12 because you’re figuring interest for one month and there are 12 months in the year. Debit interest expense and credit interest payable for $250.

If the note is zero-interest bearing, the present value tables have to come into play. Without going into all the oohs and aahs of working it out with the present value tables (it isn’t a tested objective for the current liability section of your intermediate accounting class), for this chapter, just assume that, using the appropriate present value factor, the discount on the note payable is $1,250.

To get this transaction on the books, debit cash for $50,000 and discount on notes payable for $1,250. The total amount of the short-term note payable is $51,250 ($50,000 + $1,250).

The discount on a zero-interest note payable shows the cost to the debtor of borrowing the money.