Notes Payable

Definition of Notes Payable

When a company issues promissory notes, it maintains the records of the amount of promissory notes issued in a ledger account. Such account is termed as Notes Payable. Under these, the lender lends the money at an agreed interest to a borrower who promises to pay back the amount within a stipulated time or on a pre-decided date.

Difference between Notes Payable and Accounts Payable

Notes payable is different from accounts payable. In accounts payable, there is no need to issue promissory notes or to pay interest on the amount borrowed. Whereas in the case of notes payable, the borrower is required to pay interest on the principle amount borrowed apart from the need to issue promissory notes.

Classification of Notes Payable

They can be classified as short-term and long-term:

  • Short-term notes payable are those promissory notes which are due for payment within 12 months from the date of issue. On balance sheet, these are represented as short term liability.
  • Long-term notes payables are promissory notes which are due for payment after 12 months from the date of issue. They are classified as long-term liability in the balance sheet.

Notes Payable Example  

X Ltd. borrows 5,00,000 at an interest rate of 10% from DZB Bank under notes payable. The borrowed amount will be paid to the bank on a specified date. The accounting entries in the books of X Ltd. on receiving of cash shall be:

Particulars                                                                   Debit                            Credit

Cash                                                                              5,00,000

Notes Payable                                                                                                     5,00,000

When the interest to be paid on the borrowed amount accrues, the following entry shall be passed in the books of X Ltd.:

Particulars                                                                   Debit                            Credit

Interest expense                                                           50,000

Interest payable                                                                                                  50,000

Upon payment of interest, X Ltd. shall record the entry as:

Particulars                                                                   Debit                            Credit

Interest payable                                                              50,000

Cash                                                                                                                          50,000

When X Ltd. pays the amount borrowed from DBZ bank, the following entry shall be passed:

Particulars                                                                   Debit                            Credit

Notes payable                                                               5,00,000

Cash                                                                                                                    5,00,000

Conclusion

Notes Payable is a ledger account prepared by an accountant for recording transactions that involve borrowing of money. This is the most effective way of recording the transactions relating to amount borrowed and on which interest is to be paid. The future planning of the business depends on the information provided in notes payable account.

References:

Last updated on : July 12th, 2017
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