Notes Payable

Alright so let's see some of the journal entries related to notes payable, how we acquire them, deal with the interest and finally pay them back. So I think it'd be really cool after you guys watch this lesson to go back and review the notes receivable lesson and you'll see how similar notes payable are. Two notes receivable. Right? Because when you think about it, one person's notes receivable is the other person's note payable. So some kind of old adage like that. So it's not in here to notes payable. So it's similar to a P. Right? Because it's a liability, it's money that we owe except it's supported by a formal written contract. Right? With a P. It might be just we got an invoice that we have to pay. Well here we've signed an actual note, write a note payable. We've signed a contract. That's the note. And the difference here with a P. Is that these notes? Well they're gonna have a maturity date. So there's gonna be a specific date in the contract, a maturity date and it has to be paid back and they earn interest. Okay so accounts payable. Think about it when we receive an invoice from a supplier it's not like they tell us we're gonna have to pay interest. No they just give us a few maybe a few weeks to pay and then we just pay it back. No interest included there. So the note payable interest is a big part of this. So we've got two terms here first we've got the principal right? The principle that's the actual amount of money borrowed um that that we actually borrowed. So the principal of the loan if we borrowed $100,000. Well the principle is $100,000 and then we pay interest on the borrowing, right? There's gonna be an interest rate and that's the cost of borrowing, right? That's why the bank will lend us money is because they're gonna earn interest. So we have a formula here uh for calculating interest and what we have is the face value of the note. So that's the principle right there, it's gonna be stated, this is gonna be given to you, we borrowed $100,000 whatever it might be, there's gonna be an interest rate and this interest rate is always gonna be an annual rate that they give you, even if it's a note that's five years long or six months long, nine months, they always tell you the full years interest. Even if you're not gonna pay that much or if you're gonna pay it for several years, you're gonna have an annual interest rate. And then we're gonna multiply it by a time factor. This time factor is usually a proportion of a year proportion of the year that we're calculating the interest, right? Because if let's say we took a loan out on september 1st and we're preparing december 31st financial statements, Well we only have, we don't have a full year there, right, we only want to calculate interest for that portion of the year. So we'll see some examples about that. But let's go ahead and start with acquiring the note. Let's see what the journal entry looks like when we acquire a note from the bank. So we actually sign sign a contract to borrow some money and we get the money on october 1st year one. The goods company signed a $100,000.12 percent eight month note payable. Maturing on May 1st year too. So there's a lot of information there. But that's all valuable here. They tell us the interest rate 12%. Right? And that's annual annual interest rate. They tell us the term. Right? This is the term of the loan. It's gonna be eight months total. Right. But it's not eight months this year. It's eight months between today, october 1st and May 1st when we're finally going to pay it back next year. So right here we have the maturity date, right? That's gonna be the maturity date May 1st. And what about the $100,000 over here? The $100,000. Well, that's the principle of the loan. Right? That's the principle, the face amount that we borrowed. So the journal entry when we first acquired the note payable? It's pretty easy. Right. What did we receive? We received cash from the bank. Right? They gave us cash and we signed this note. So we're gonna debit cash. And that's gonna be for the face amount. The 100,000. In principle that we took out 100,000. That is our debit. What's gonna be our credit? We've got this liability. We signed the note, we owe this money. It's a note payable. Right? So we're gonna credit notes payable And now we have this liability on our books for the 100,000 that we borrowed. Right? So now we got this cash, our cash went up by 100,000. And our liabilities for the note payable. Np. Np for note payable that also went up by 100,000. Right so we stay balanced here. Everything makes sense in there. Cool. So this is pretty simple um Pretty much a very simple journal entry. When we acquire a note payable it gets a little more interesting when we start dealing with the interest. So let's go ahead and do that in the next video.

Alright, so let's deal with the interest expense here. So when we deal with interest with a notes payable, Well, it's a little bit different when we have a short term note or a long term note. Generally the contract is gonna have very specific details about how the interest is going to be paid. But in general we're going to see is a short term note, something that's under a year while you're usually don't make interest payments throughout the term, you usually just pay all the interest at the end. So if you borrow something for say six months, well you're not gonna pay interest every month. You usually hold on to it and then at the end of the six months you pay back the loan and you give them the interest as well. So let's start here with a short term note. And what we'll see is that the total amount of interest is usually paid at maturity paid at maturity. Okay. So you're not going to be making interest payments as you go. But what we are going to be doing is we're gonna be making adjusting entries to accrue for interest, right? Because as time passes we have to take the expense right? Because we borrowed the money and we're getting the advantage of borrowing the money. Well, we need to take the expense when we're getting that advantage of having the money right? So that interest expense has to be accrued when we're using it. So let's go ahead and see this in an example, building on our previous one on october 1st year one, the goods company signed a $100,000.12 percent eight month note payable maturing on May 1st year to prepare the adjusting entry to accrue interest on december 31st year one. Alright so we borrowed this money on october 1st and we made that entry above where we created the liability. Now some time has passed. Right? October has gone by november december and we're preparing our financial statements. Well since sometimes gone by we've gotten some of the benefit right that interest has started accruing and we need to take the interest expense because we've been we've borrowed the money. Well we've got to take the expense for the time that we've borrowed it already. Okay so let's use our interest calculation to find out how much interest we have to accrue. So remember when we do our interest to calculate the interest, what are we gonna take first? We need our principal amount. Right? The 100,000. And we're gonna multiply that by our annual interest rate that's given to us the 12%. So let's turn that into a decimal 12% is 0.1 to write 0.12 for 12%. And now we have to multiply that by our time factor. So how much time have we actually had the note out. Right? It's not gonna be a full 12% that we owe an interest. Right? Because it hasn't been a whole year. We've only had it for all of October right. That's the way you always want to count on your fingers. This is like part of accounting. It's so funny. October we had it out November and December. Right? And now we're at December 31 and we're preparing the financial statements. So we've had it for three months October November December that we've had the loan. So that's three months out of the 12 months in a year. Right? That's how much interest we've accrued at this point. How much we owe? So interest. It's going to be this formula 100,000 times 0.12 times the three out of the 12 months that we've we've had the money borrowed. So that's the proportion of the year that we've borrowed the money. Let's go ahead and see how much that is. 100,000 times 0.12. So 12,000 would be the total amount we would owe in one year, but it hasn't been a whole year. So times three divided by 12, it comes out to 3000. Alright. 3000 is the amount of interest incurred so far. Right. We didn't incur a whole year's worth of interest. It's only been three months. So we have three months worth of interest there at 3000. So what is this? 3000 do how are we going to use this in our journal entry? Well, we've incurred the expense. Right? We've borrowed this money and time has passed. So we owe this interest, we need to take interest expense. Our debit is going to be the interest expense, right? Our expenses go up with a debit. So this makes makes sense here. So interest expense. And that's gonna be for the 3000 right? 3000 because $3,000 worth of interest has been incurred so far. What about our credit in this entry? It's not cash. Right. We haven't paid it out yet. We need to accrue a liability for this interest and that's gonna be interest payable. Right? So now we have this new liability separate from the note payable. So, we have the note payable that's holding the principal amount of what we owe. And now we have the interest payable that holds the interest that we owe. So, there's the 3000 that we owe up through December 31. Right? And we're making this entry on 1231 Year one. Alright, so we haven't paid back anything yet. We still borrowed all the money. We now owe them a little more money because time has passed. But we haven't paid them anything back in cash. All right. So, what do we see here? The interest expense that goes into equity, right, because that's gonna flow through net income and lower our retained earnings. So I'm gonna put the interest expense in here And that's 3000 decreased. Right? The expenses are gonna decrease our net income and the interest payable. I'm gonna just put I payable And that's gonna be 3000 as well, right? And that's an increase here, right? So we stay balanced here, right? Because our our liabilities let me get out of the way. Our liabilities went up by 3000, our equity went down by 3000. So we stay balanced on this equation. Cool. Alright, let's go ahead and pause here, and then we'll continue and we'll see interest from a long term notes perspective. Alright, let's check that out.

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.

All right. So let's continue here and see how we deal with a short term note on maturity date when we pay back the principal. Alright. So remember with the short term note we're crewing all the interest and paying it back. Finally, when we pay back the principle we pay back all the interest. So let's go ahead and do our example here on october 1st year one, the goods company signed $100,000.12 percent eight month note payable, maturing on june 1st year too, prepare the entry to repay the note payable and all accrued interest on june 1st year two. So notice we haven't made any interest payments up to this point where we're paying all the accrued interest as well as the principal on june 1st year too. So if you remember previously we had accrued interest in year one. Right? We had our interest payable account. I'm gonna put I payable for interest payable. And we had accrued $3000 of interest as a liability right? Because three months had passed in year one october november december. Well those three months we accrued the interest for the interest expense in year one. The rest of it is gonna be in year two. Right? So three months we're in year one. Well five months are in year two, so that's gonna be january february, March april may right? Five months and then we pay it back on june 1st. Right? So I'm just reminding you here that we already have this 3000 credit from the previous year as a liability. So let's go ahead and find out our interest expense in year two. Right? And this is year to interest expense. And that's going to equal the same formula. Right? We got 100,000 times the 0.1 to the 12% interest. 0.12. But now, how many months happened in year two? The five months, right january through May. So we're gonna do 5 12 right, 5, 12 of that annual interest. And that's gonna come out to $5000. Right? So we have 5000 and interest expense in year two. Okay? So that that should make sense, right? Because there were eight total months and as you can see it's 1000 and interest every month we have those three months in year 15 months in year two, there's the 8000 total interest. Well, we're gonna go ahead and pay all of that back here on june 1st year two when we repay the loan. So let's go ahead and make our journal entry. Right? Because we need to get rid of all the liabilities. Right? We have the note payable liability that we're paying back. We need to get rid of the interest payable because we're gonna finally pay for it and we've got to take our interest expense for this year. Okay? So let's go ahead and see what all of that's gonna be. First. We're paying back the note payable. Let's get that off of our books. Note payable. That's coming off of our books. And that was in the value of 100,000. Right? We had previously had this liability for 100,000. Well that was a credit balance so we're going to debit it to get it off of our books reduce this liability down to zero. We no longer owe this money. We're paying it back. All right. How about the interest payable? Well we're paying that back to write interest payable. We're gonna put I. N. T. Payable And that's the 3000 from last year. Right we're finally paying that back. So that's off of our books with a debit. What else we've got the interest expense from this year? Right we've incurred some interest expense this year and we're paying it back this year. So we gotta take that expense right now. And that's what we just calculated that 5000 we're gonna take that expense right now and this is everything we're paying back. Right this makes sense. We're paying back the note, the principal value of the note and all the interest that we owe which is last year's 3000 this year's 5000. So we're paying it all back and that's gonna be the cash right? The cash is going to be our credit here and that's gonna be from the total of everything we're paying back all of those. And that comes out to 108,000 right 100,000 plus 3000 plus 5000. There's all the cash. So we're literally going to the bank and here here's 100 and 8000. Thanks for letting us borrow that money. Cool. So that's how we deal with the short term note. We gotta get rid of all of the liabilities, all the payables associated with it, and we gotta make sure we accrue any additional interest expense during the current period. Cool. Alright, so let's go ahead and do the same thing with a long term note in the next video.

Alright. So you're gonna see this is very similar to paying back a short term note because we still have to pay back any accrued interest which we're usually gonna have some interest accrued in that final year leading up to the final maturity date and principal repayment. So let's go ahead and dive into the problem here because we're here we're still going to repay the principal and repay any interest that hasn't been paid yet On october 1st year one the goods company signed $100,000.12 percent 10 year note. Maturing on october 1st year 11 interest is payable annually on october 1st prepare the entry to repay the note payable. So now we're paying the whole principal and all accrued interest on october 1st year 11. So now we're talking about that final year right? So every year has passed and we've been making interest payments right? We've been making those entries like we did above for the the interest payable interest expense and paying cash right? And now it's finally the final year and we're gonna do those same entries for the interest but we're also going to repay the principal of the loan. So just like before we're going to have our interest um Interest payable like we did with the short term note, we would have still accrued if you think about it in year at the end of year 10 October and November and December of year 10 after our previous interest payment right? We made an interest payment on October 1st year 10 we had made an interest payment and now one more year is passing where we're accruing interest. So we would have made that adjusting entry to accrue for those $3,000 of interest. And then we would have to in year 11 take the remaining interest expense. So just like we did above the interest expense in year 11. So I'm just showing you here right, we have this this liability already for 3000 on our books from year 10 And that's October through December of year 10. Well now we're talking about the interest expense for year 11 and that's gonna be just like above those nine months, january february March april may june july august september nine months of interest in year 11. Before we pay everything back on october 1st year 11. Okay. So we've got the 100,000 that we borrowed times the 12% 0.12 times nine twelve's right for the nine months in year 11. And that's gonna equal 9000. Right? We Owe 9000 and interest expense from year 11. So this is gonna be it right. We've got to get rid of the interest payable that we still, oh we gotta get rid of the interest. We gotta pay the interest expense that we incurred this year. And we got to repay the note payable the principal the 100,000. Cool. Let's go ahead and make this journal entry first. We gotta get rid of the note payable because we're gonna pay them back the principal amount. So we're gonna put that with a debit, right? We're going to debit note payable to get that off of our books. We had that liability previously and we are paying it back. Cool. So now the note payable is off of our books with a debit. The interest payable. This 3000 from from the end of year 10. What? We got to pay that back now as well? What? So we gotta get rid of that liability with a debit as well interest payable. And that's gonna be the 3000 related to the end of year 10. And then we've got interest expense For those nine months that have happened in year 11, right? That we just calculated. So that's everything we have to pay back. Right? We have to pay back the note payable. The principle we have to pay back any accrued interest, which is this full year's worth of interest right here, 3000 from last year, october through december 9000 from this year, january through september leading up to october 1st. Cool. So we're gonna pay all of that back with cash. We're going to credit cash for the total amount of everything we're paying 112,000. That comes out to 112,000 that we pay back. Cool. And that makes sense. Right? We've got the 100,000 which was the the principal amount. And then the 12,000 which is a year's worth of interest 100,000 times 12%. Well, that's a year's worth of interest. And that's how much since the last interest payment. Cool. Alright. So that's how we deal with notes payable. Let's go ahead and move on to the next topic.