Unit 6: Accounting for Promissory Note

ACTBAS1 Term 2, AY 2011-2012

Overview

A promissory note is a written promise made by a maker promising to pay the payee a certain amount of money at a fixed determinable future time which may or may not include interest.

T.I.P. #1
The elements of a promissory note are: Maker Payee Principal Interest Interest Rate Maturity Date Maturity Value

Lets answer first Exercise 6-14 on page 66 of your workbook. Next, lets answer Exercise 6-16 on page 68 of your workbook.

Elements of Promissory Note

The maker is the person or business that signs the note and promises to pay the amount required by the agreement. The maker is the debtor. The payee is the person or business to whom the maker promises future payment. The payee is the creditor The principal is the amount loaned out by the payee and borrowed by the maker of the note

Elements of Promissory Note (cont.)

The interest is the revenue to the payee for loaning out principal and the expense to the maker for borrowing the principal. The interest rate is the percentage rate that is multiplied to the principal amount and the term of the note in computing for the interest The maturity date is the date on which final payment of the note is due The maturity value is the sum of principal and interest due at the maturity date of note

T.I.P. #2
The payee regards all promissory notes it holds that are due in less than a year as Notes Receivable in the current assets section of the balance sheet. The maker regards them as Notes Payable in the current liabilities section of the balance sheet

T.I.P. #3
A promissory note may either be a non-interest or an interestbearing note. A non-interest bearing note is a promissory note, which does not provide any payment for interest so that the amount to be paid at maturity is equal to the face value of the note.

T.I.P. #4
Interest is computed using the following formula:

Interest = Principal x Rate x Time

Lets answer first Exercise 6-18 on page 69 of your workbook.

Discounting a Note Receivable

Endorsing a note receivable before maturity is called discounting a note receivable because the payee of the note receives less than its maturity value. This lower amount decreases the amount of interest income the payee earns on the note. Giving up some of this interest is the price the payee is willing to pay for the convenience of receiving cash early.

T.I.P. #5
When a note is discounted at the bank before maturity, the bank advances the money equal to its value on the date of discounting computed on the bank rate of discount. The endorsement to the bank may either be: with recourse without recourse

Endorsement (Discounting with Recourse)

The holder of the note (usually the payee) endorses the note and delivers it to the bank The bank in turn pays the amount equal to the net cash proceeds (i.e., maturity value less the discount charged by the bank) to the endorser (usually the payee of the note) The bank expects to collect the maturity value of the note on the maturity date but also has recourse against the endorser or seller of the note If the maker fails to pay on maturity date, the endorser is liable to the bank for payment

T.I.P. #6
Discount is the amount of interest deducted by the bank in advance. Discount = Maturity Value x Discount Rate x Discount Period

Steps in Computing for Net Cash Proceeds

1.

2.
3. 4.

Compute for the maturity value. Determine the discount period. Compute for the discount. Compute for the net cash proceeds.

Pro-forma Entries

Pro-forma entry to record the discounting of customers note:

Cash xxx Interest Expense xxx Notes Receivable Discounted xxx Interest Income xxx

Pro-forma Entries (cont.)

Pro-forma entry when maker honored the note: xxx

Notes Receivable Discounted Notes Receivable xxx

Pro-forma Entries (cont.)

Pro-forma entry when maker dishonored the note:

Accounts Receivable xxx Notes Receivable Discounted xxx Cash xxx Notes Receivable xxx

Lets answer first Exercise 6-19 on page 70 of your workbook.

T.I.P. #7
Notes Receivable Discounted is the contingent liability of the endorser on the customers notes that have been discounted.

Discounting of Own Note

Usually, payment of interest is made on the maturity date of the note Sometimes, the creditor would collect the interest on the note being issued by the maker on the same day the loan was granted. Paying interest in advance for the note issued is called discounting ones own note

Discounting of Own Note (cont.)

Pro-forma entry to record the discounting of own note: xxx xxx xxx

Cash Discount on notes payable Notes payable