UNIT 4: THE ACCOUNTING CYCLE

NOTES PAYABLE & NOTES RECEIVABLE

Chapter 16 of ebook
4.6 Journalizing promissory notes transactions

Negotiable instruments
A financial document containing a promise or order to pay, that meets all the legal requirements to be transferable to
another party

THE NEGOTIABLE INSTRUMENTS LAW

ACT NO. 2031 of the Philippines
February 03, 1911

An instrument to be negotiable must conform to the following requirements:

(a) It must be in writing and signed by the maker or drawer;
(b) Must contain an unconditional promise or order to pay a sum certain in money;
(c) Must be payable on demand, or at a fixed or determinable future time;
(d) Must be payable to order or to bearer; and
(e) Where the instrument is addressed to a drawee, he must be named or otherwise indicated therein with reasonable
certainty.

Notes Payable
A liability that represents a written promise by the debtor to pay the creditor a specified amount at a specified future date,
usually requiring an additional payment of explicit interest

Notes Receivable
An asset that represents a written promise by the debtor to pay the creditor a specified amount at a specified future date,
usually requiring an additional receipt of explicit interest

Classification of accounts
Account Classification NB
Notes Payable -Current liabilities if due within one year Cr
-Non-current liabilities if due in more than one year
Interest Expense Non-operating expense Dr
Listed in the Other Expenses section of the Statement of P&L
Notes Receivable -Current asset if due within one year Dr
-Non-current asset if due in more than one year
Interest Income Non-operating income Cr
Listed in the Other Income section of the Statement of P&L
Notes Receivable – Contingent liability Cr
Discounted Shown as a deduction from Notes Receivable to get Net Notes Receivable

Interest
Fee charged for use of money
I = prt
Interest = Principal x Rate x Time

where,
p = face value of the note
r = an annual rate, by default
t = days or Months
360 12
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 NOTES RECEIVABLE NOTES PAYABLE
Receipt of note Issuance of note
Notes Receivable xxx Face Value Debit account xxx
Credit account xxx Notes Payable xxx Face Value

Collection of note Payment of note

Cash xxx Maturity value Notes Payable xxx Face value
Interest Income xxx prt Interest Expense xxx prt
Notes Receivable xxx Face value Cash xxx Maturity value

If note is dishonored by maker, If note is dishonored,

Accounts Receivable xxx Maturity value Notes Payable xxx Face value
Interest Income xxx prt Interest expense xxx prt
Notes Receivable xxx Face value Accounts Payable xxx Maturity value

Internal Control of Notes Payable and Notes Receivables

 Limit the number of people who can sign notes for the firm.
 Record all notes payable immediately.
 Review all past due notes promptly and take necessary steps, including legal action to ensure payment.

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Discounting
Deducting the interest from the principal on a note in advance

NOTES PAYABLE
Discounting of note payable
Cash xxx Face value - i
Interest expense xxx prt
Notes Payable xxx Face value

Payment of discounted note

Notes Payable xxx Face value
Cash xxx

If note is dishonored,
Notes Payable xxx Face value
Accounts Payable xxx

NOTES RECEIVABLE
Receipt of note
Notes Receivable xxx Face Value
Credit account xxx

Discounting of note receivable

Cash xxx MV - IE If NR is non-interest bearing, then
Interest expense xxx MV x i* of bank Cash Proceeds = Face Value - IE
where IE = Face Value x i charged by
Notes Receivable - Discounted xxx Face value bank
Interest Income prtxxx
*where t in prt = discount period, the remaining period Alternatively, only the net of
the interest may be shown:
Payment of discounted note by maker IE > II = Interest Expense [dr]
Notes Receivable - Discounted xxx Face value IE < II = Interest Income [cr]
Notes Receivable xxx Face value

If note is dishonored by maker,

Notes Receivable - Discounted xxx Face value
Accounts Receivable [maker] xxx MV + SC
Notes Receivable xxx Face value
Cash [bank] xxx MV + SC
MV = Maturity Value
Discount period = Term – Used period

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REFERENCES
 Price, J., Haddock, M., & Farina, M., (2021). College Accounting, 16th edition. McGraw-Hill Education.
 ACT NO. 2031 of the Philippines

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