Accounting

for
Promissory
Notes
 Course Learning
Outcome #4
Analyze and apply
appropriate
procedures and
accounting treatment
for transactions of a
sole proprietorship
business engaged in
merchandising
operations.

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 Topic Learning
Outcome #13

Analyze promissory note

transactions and demonstrate
the appropriate accounting
treatment for notes receivable
and notes payable.
➢ Account for notes receivable
➢ Account for Notes Payable

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 • Analyze and account for notes receivable
Learning • Compute for interest income

Objectives •
•
Record honored and dishonored notes
Account for discounting of Notes Receivable

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 HOW ARE NOTES RECEIVABLE
ACCOUNTED FOR?

• Promissory note—A written promise to pay a specified amount

of money at a particular future date, usually with interest.
• Maker of the note (debtor)—The entity that signs the note and
promises to pay the required amount.
– The maker of the note is the debtor.
• Payee of the note (creditor)—The entity to whom the maker
promises future payment; the payee of the note is the
creditor.
– The creditor is the company that loans the money.

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 HOW ARE NOTES RECEIVABLE
ACCOUNTED FOR?

• Principal—The amount loaned by the payee and borrowed by

the maker of the note.
• Interest—The revenue to the payee for loaning money.
– Interest is an expense to the debtor and revenue to the
creditor.
• Interest period—The period of time during which interest is
computed.
– It extends from the original date of the note to the
maturity date.
– Also called the note term.

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 HOW ARE NOTES RECEIVABLE
ACCOUNTED FOR?

• Interest rate—The percentage rate of interest specified by the

note.
– Interest rates are almost always stated for a period of one
year.
• Maturity date—The date when final payment of the note is
due.
– Also called the due date.
• Maturity value—The sum of the principal plus interest due at
maturity.
– Maturity value is the total amount that will be paid back.

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 Computing
Interest on a
Note

The formula for computing the

interest is as follows:

In the formula, time represents

the portion of a year that
interest has accrued on the
note.
• It may be expressed as a
fraction of a year in months
(number of months/12)
• Or a fraction of a year in
days (number of days/360)

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 Calculating Interest and Maturity Value

We received a P25,000, 10%, 90-day note dated Aug.6, 2020.

Interest Calculation

Principal x Rate x Time = Interest

P25,000 x 10% x 90 /360 = P625

Maturity Value Calculation

Principal + Interest = Maturity Value

P25,000 + P625 = P25,625

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 Accounting for Notes Receivable
Date Description Debit Credit

Aug. 6 Notes Receivable 25,000

Accts. Receivable - B Co. 25,000

Received a P25,000,90-day, 10% note.

Nov. 4 Cash 25,625

Notes Receivable 25,000
Interest Revenue 625

Collected amount due on note dated Aug 6.

Principal + Interest = Maturity Value
P25,000 + (P25,000 x 10% x 90 / 360) = P25,6250

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 Understanding the 360-Day Year

1. Assume a P100,000 note dated June 1 for 90 days

at an interest rate of 12 percent. The textbook
calculation is as follows:
P100,000 x (12 / 100) x (90 /360) = P3,000.00
2. A more precise calculation is as follows:
P100,000 x (12 / 100) x (90 /365) = P2,958.90
3. When large sums are involved, the 360-day method
(known as ordinary interest or banker’s rule)
yields significantly more interest to the lender. It is
used by banks and commercial organizations.
4. The second method (known as exact interest) is
used by the government.

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 Identifying Maturity Date

• Some notes specify the maturity date.

• Other notes state the period of the
note in days or months.
– When the period is given in
months, the note’s maturity date
falls on the same day of the month
as the date the note was issued.
– When the period is given in days,
the maturity date is determined by
counting the actual days from the
date of issue.
• Count the maturity date
• Omit the issue date

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 Identifying Maturity Date

A 90-day note dated August 7, 2020, matures on

November 5, 2020, as shown here:

Month No. of Days Cumulative Total

Aug 2020 31 days - 7 24
Sep 2020 30 54
Oct 2020 31 85
Nov 2020 5 90

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Department
 Identifying Maturity Date

❑ A 3-month note dated March 11, 2020 matures

on June 11, 2020.
❑ A one-year note dated November 5, 2020
matures on November 5, 2021

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 Recording Dishonored
Notes Receivable

• When a maker dishonors a note,

the dishonored note and the
unpaid interest are transferred to
Accounts Receivable.
• Later, the Accounts Receivable
can be written off under the
direct write-off method or the
allowance method.

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Recording Dishonored Notes Receivable

Suppose Cebu Jewelers has a six-month, 10% note

receivable for P120,000 from Mark Co that was signed
on March 3, 2020, and Co defaults. Cebu Jewelers will
record the default on September 3, 2020, as follows:

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 Discounting of Notes Receivable

Notes can be converted into cash by selling them to a financial institution at a

discount.

Notes are usually sold (discounted) with recourse, which means the company
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discounting the note agrees to pay the financial institution if the maker
dishonors the note.
When notes receivable are sold with recourse, the company has a contingent
liability that must be disclosed ni the notes accompanying the financial
statements.
A contingent liability is an obligation to pay an amount in the future, if and
when an uncertain event occurs.

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 Discounting of Notes
Receivable
The discount rate is the annual percentage rate that the
financial institution charges for buying a note and
collecting the debt

The discount period is the length of time between a

note's sale and its due date.

The discount, which is the fee that the financial

institution charges, is found by multiplying the note's
maturity value by the discount rate and the discount
period.
Discount = MV of PN x Discount Rate x Discount Period

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• Say, Arlene Co. received a
90-day, 6% note for
P100,000 from Dan’s Store
in settlement of an account
on October 1, 2020. The
Discounting
journal entry to record the
receipt of the note follows: of Notes
Receivable

Date Particulars DR CR
Oct 1 Notes Receivable 100,000
Accounts Receivable 100,000
Dan’s 90-day, 6% note.

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 Discounting of Notes
Receivable

• On Nov. 1, 2020, Arlene Co.

discounted the Dan’s note at BPI
at 6%. How much is the cash
proceeds from discounting?

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 Discounting of
Notes Receivable
Step 1:: MV = P100,000 + (P100,000 x .06 x 90/360)

MV = P100,000 + P1,500 = P101,500

Step 2: Discount Period = 60 days (90-30)

Step 3: Discount = P101,500 x .06 x 60/360

Discount = P1,015

Step 4: Net Proceeds = P101,500 – P1,015

Net Proceeds = P100,485

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 Discounting of
Notes Receivable
Step 5: CA = P100,000 + (P100,000 x .06 x 30/360)

CA = P100,000 + P500 = P100,500

Step 6: Gain /Loss on Discounting=P100,485-P100,500

Loss on Discounting=P15

Interest Income net of Loss on Discounting= P500-P15

Interest Income net of Loss on Discounting=P485

Step 7: Journal entries

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 Discounting • The journal entry to record the
of Notes discounting of the note follows:

Receivable

Date Particulars DR CR

Nov. 1 Cash 100,485

Notes Receivable 100,000

Discounted

Interest Income 485

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 Discounting • If Dan’s Store honors its note, the
journal entry in the books of Arlene
of Notes follows:
Receivable

Date Particulars DR CR

Dec. 30 Notes Receivable 100,000

Discounted

Notes Receivable 100,000

Cancelled the note and the

contingent liability.

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 Discounting • If Dan’s Store dishonors its note,
then Arlene has to pay the bank. The
of Notes journal entries in the books of Arlene
follow:
Receivable

Date Particulars DR CR
Dec 30 Accounts Receivable 101,500
Cash 101,500
Paid the bank for the
dishonored note of Dan’s
Store

Notes Receivable Discounted 100,000

Notes Receivable 100,000
To cancel the contingent
Liability and PN of Dan’s
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 Learning
Objective
Account for Notes
Payable

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 Short-term Notes Payable

• A short-term note payable represents a written

promise by a business to pay a debt, usually
involving interest, within one year or less.
• On May 1, ACD Trading purchases display cabinets with
a 10%, 90-day note payable, for P80,000.

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 Short-term Notes Payable

On July 30, when the note is due, ACD pays

the note plus interest.

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 Short-term Notes
Payable

• Businesses occasionally borrow

cash from banks.
• A bank requires a business to sign
a promissory note stating that the
business will pay the principal plus
interest at a specified maturity
date.

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 Short-term Notes Payable

On November 1, 2020, ACD Trading borrows P100,000

from BPI at 6% for five months. On November 1, the
accounting clerk records the following entry:

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 Short-term Notes Payable

At year-end, the matching principle requires the

business to accrue interest expense for November and
December as follows:

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 Current Portion of
Long-term
Notes Payable
Long-term notes payable are
typically reported in the long-
term liability section of the
balance sheet.

When a long-term debt is paid in

installments, the business reports
the current portion of notes
payable as a current liability.

The remainder is classified as long

term.

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 Current Portion of Long-term
Notes Payable

• Consider a P200,000 note payable that is paid

in P50,000 installments over four years. The
portion that must be paid within one year,
P50,000, is current. The remaining P150,000 is
classified as long term. No journal entry is
needed to reclassify the current portion. It is,
instead, only classified as current or long term
for reporting purposes on the balance sheet.
Notice that the reclassification does not change
the total amount of debt. It only reclassifies
P50,000 of the total debt from long term to
current.

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 Discounting of Notes Payable

• Assume that On November 1, 2019, ACD

Trading discounted its own P100,000 note
at 6% for five months at BPI. On Nov 1,
the accounting clerk records the following
entry:
Date Particulars Debit Credit
Nov-01 Cash 97,500
Prepaid Interest 2,500
Notes Payable 100,000
Discounted our 5-month, 6% note.

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 Short-term Notes Payable

At year-end, the matching principle requires the

business to accrue interest expense for November and
December as follows:

Date Particulars Debit Credit

Dec-31 Interest Expense 1,000
Prepaid Interest 1,000
I = P100,000 x 6% x2/12.

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 Short-term Notes Payable

ACD honored its note on maturity date.

Date Particulars Debit Credit

4/1/20 Notes Payable 100,000

Cash 100,000

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