Chapter 16 Lecture Notes

In this chapter you will learn how to record notes payable and notes
receivable, how to determine whether an instrument meets the requirements
of negotiability, and how businesses use promissory notes, drafts or trade
acceptances to pay a large amount over a period of time.

Notes may be described in terms of months or days. When calculating

interest the formula is Principle x Rate x Time, so for a two month (or 60
day) $1000 note with 10% interest you would either calculate this as 1000
x .10 x 2/12 (two months out of twelve) or 1000 x .10 x 60/360. Notice that
a 360 day (bank’s year) is used for simplicities sake when calculating based
on days. Also note that when calculating the maturity date of a note you do
not include the issue date itself.

Recording the note payable involves a debit to the asset account and a credit
to the notes payable account; when payment is made on the note you will
debit notes payable for the amount of the note, debit interest expense for
the amount of the interest and cash for the total of the note plus the
interest. If interest is deducted in advance from the note (so you receive
the face amount of the note less the interest charge) it is called
discounting. In this case you would debit cash for the amount of the note
minus the amount of the interest, debit interest expense for the total
interest, and credit notes payable for the face value of the note. When the
note is paid you will debit notes payable for the face value and credit cash
for the full amount – there is no need to make an entry for interest because
it has already been recorded.

Notes receivable can be interest or non-interest bearing and can be issued

either at the point of sale or to replace an overdue accounts receivable. If a
note receivable is not collected at maturity, however, and arrangements have
not been made for renewal, then it is considered “dishonored” and an entry
must be made to transfer the balance out of notes receivable and back to
accounts receivable: debit accounts receivable/account name for the value
of the note and interest, credit notes receivable for the face value of the
note, and credit interest income for the amount of interest. A company can
discount (sell) a notes receivable if they have an immediate need for cash
because a note receivable is an asset; however, remember that notes-
receivable discounted represents a contingent liability. A detailed
description of how to calculate and apply discounts can be found on pages
592-595.

Important internal controls for notes payable, notes receivable, and drafts
are:

 Limit the number of people who can sign notes for the firm.
 Record all notes payable immediately.
 Identify a specific person or department to be responsible for prompt
payment of interest and principal for notes payable.
 When paid, mark the note payable “Canceled” or “Paid” and file the
note.
 Handle drafts as carefully as checks.
 Authorize certain persons only to accept notes.
 Record all notes receivable in the accounting records.
 Store notes receivable securely in a safe or fireproof vault to which
access is limited.
 Verify and compare the actual notes receivable to the notes
receivable register.
 Near the maturity date, inform the issuer of the approaching due
date and the amount owed.
 If payment is not received on the due date, contact the issuer
immediately.
 Review all past-due notes promptly and take necessary steps, including
legal action, to ensure payment.