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Long-term Note Payable:Interest Expense

Brian Krogol
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Alright. So we're gonna continue with that similar example except now we're gonna turn it into a long term note. All right. So let's see how that interest expense gets dealt with in a long term note. And what happens in long term notes since we owe the money for so long, usually five years, 10 years, 20 years. Well, the bank doesn't want to wait that long to collect some of the cash. They're gonna periodically want some of that interest. They're gonna say, okay, it's been maybe every six months. They'll say, okay, pay us we Whatever interest you owe us. You don't have to pay back any principle yet, but pay us that interest that you owe us or after 12 months or you know, they're gonna tell you when you have to pay the interest. And it's usually gonna be every six months or 12 months in these problems. So, with these long term notes, interest is paid to the bank periodically here. Right? You don't wait till the very end to pay it back. So you're still could make those adjusting entries when we have the financial statement date. But then you're gonna be paying it off as time goes on. All right? So let's see this example here on october 1st year one. The goods company signed $100,000.12 percent 10 year note. So notice. Now it's a 10 year note right before we are dealing with. I think it was an eight month note in the previous video. But now we're talking about a long term note, right? 10 years and it's maturing on october 1st year 11. Okay, so that's when we're gonna on october 1st year 11. We have to pay back the 100,000. Cool Notice what it says here interest is payable annually on October one. So every year on October one. Whatever interest we oh well we're gonna pay it to the bank in cash, prepare the adjusting entry on december 31st, Year one. And the journal entry on october 1st, year two for the payment of interest. Okay So the adjusting entry on december 31st Year one, it's gonna be very similar to what we did previously, right? Because we signed this note on october 1st year one, some months have passed and we have to accrue the interest in year one for the time that has passed uh in year one that we borrowed the money. So let's go ahead and calculate that interest again. So this is gonna be the December 31. So 1231 interest calculation. And this is for the interest payable right? We're gonna be accruing some interest that we haven't paid yet. So let's see what that is. There's $100,000 note just like before 12% 0.12. And we're accruing for the same proportion of the year, right? We still took it out on october 1st. So it's been out all of october november and december right? We're reaching december 31st of year one. So it's still three months out of the total 12 months in a year. And we found that to be 3000 in interest. Right? So that's the amount of interest incurred during year one from october through december. So let's go ahead and make that entry again just like we did before we had interest expense. Right? And this is so that we match in year one the time right? The time that we've borrowed it in year one. So interest expense for the 3000 and we haven't paid it in cash yet right? It's only payable on october 1st. So we're not gonna pay until october 1st year two, we're not gonna pay this interest that we're accruing so we're gonna increase the payable right? We have our liability for this interest that we're accruing in year one. Cool so that's just like we did before but now this this is a long term note october 1st Year two rolls around, we don't have to pay back the principal, none of this 100,000 is being paid back. But the bank said hey you gotta pay me whatever interest you owe me. Okay so if we think about it, how long has it been since we borrowed the note from october 1st year one to october 1st year two when we finally have to pay interest the first time it's been one year right? We have to pay one full year's worth of interest. So when we pay the bank the cash that we're gonna pay the bank, it's one full year's worth of interest. So let's go ahead and calculate that the cash this is on 10 10 1 year to write the cash we're going to pay to the bank. Well, that's gonna be the total interest for a year. It's gonna be the 100,000 that we owe times the 12% interest. But the time factor this time. Well, the time factor is just one, right? Because it's one full year, we're not doing a proportion of the year we owe them for a full year. And that comes out to be 12,000 in cash. That's gonna be going to the bank, right? So this 12,000 in cash, what does it represent first? It represents this 3000, right? There's the 3000 from last year that we owed. But there's also the time that has passed this year, Right? How about in year two there was january february March april may june july august september nine months, right? We had nine months that have passed in Year two that we owed interest. And that should make sense. So, let's go ahead and look at that. The interest expense in year two, That's gonna be the same thing where we've got the 100,000 times to 12%, times 9/12, right, nine months have passed in year two. And that's gonna come out to 9000, right? 100,000 times 90000.12 times 9, 12, That's 9000 in interest expense for year two. Okay, So that's where all of these numbers come from. Let me get out of the way here. We've got the 12,000 total cash we're paying to the bank, And 9000, 9000 of that 12,000 is for interest that we've incurred this year.