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Liabilities arise from an event that can cause an outflow of economic benefits in the future. For most companies, these include loans, leases, short-term borrowings, trade payables, etc. Another common item that companies may report in this category is notes payable. It is a type of liability that usually appears under current liabilities on the balance sheet.
What are Notes Payable?
A note payable represents a promissory note where one party promises another party a specific amount of money. It is a written agreement to bind the borrower to repay the specified amount at a given date. Usually, a note payable also includes interest on the borrowed amount. For most companies, notes payable are short-term. However, they can also be long-term.
A note payable allows companies and other entities to borrow money for various purposes. The notes payable act as the written agreement between both parties, similar to a contract. In accounting, a note payable represents a liability when a company receives a specific sum from a lender. This liability can appear under the current and non-current sections in the balance sheet based on its repayment date.
How to account for Notes Payable?
The accounting for a note payable is straightforward. However, it falls under various steps. When a company receives a loan, it signs a promissory note to repay that amount at a later date. At this stage, the borrower records that sum as a note payable. The agreement between both parties serves as the supporting document to record the transaction.
At the end of each financial period, the borrower must evaluate the note payable based on its repayment date. If that date falls within the next 12 months, the borrower must report it as a current liability. In contrast, if it lasts beyond that period, it will be a non-current liability. During these periods, the borrower must also record any interest accruing and paid on the note payable.
Lastly, the borrower must repay the amount borrowed through the note payable. At this stage, the company must record the repayment to the lender. The borrower must also remove any balances relating to the note payable from the accounts. If the note payable has an unpaid interest, the company must also repay that amount and record it.
What are the journal entries for Notes Payable?
When a company receives a loan through notes payable, it must record it using the following journal entry.
| Dr | Cash or bank |
| Cr | Note payable |
Sometimes, companies may also create a note payable for expenses. In that case, the journal entry will be as follows.
| Dr | Expense |
| Cr | Note payable |
During the period, if the note payable accrues interest, the company must record it as follows.
| Dr | Interest expense |
| Cr | Note payable |
When the company repays the note payable, it must record the repayment using the following journal entry.
| Dr | Note payable |
| Cr | Cash or bank |
Example
A company, Red Co., receives a cash loan of $10,000 from a lender. The company issues a note payable in exchange. Red Co. records this transaction using the following journal entry.
| Dr | Cash | $10,000 |
| Cr | Note payable | $10,000 |
One year later, Red Co. repays the lender the borrowed amount. For that transaction, the journal entry will be as below.
| Dr | Note payable | $10,000 |
| Cr | Cash | $10,000 |
Conclusion
A note payable is a written contract between a borrower and lender for a loan. This note is a promise from the borrower to repay the lender for a specific amount. Usually, it also involves the terms associated with the agreement, including the repayment date and interest terms. The accounting for notes payable consists of several stages, as mentioned above.
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