Discounting Notes Receivable

At Finance Strategists, we partner with financial experts to ensure the accuracy of our financial content. The discount is amortized over each of the next 3 years to Interest Expense. Borrowers should be careful to understand the full economics of any agreement, and lenders should understand the laws that define fair practices. Lenders who overcharge interest or violate laws can find themselves legally losing the right to collect amounts loaned.

• The discount period is the length of time between a note’s sale and its due date.
• “Discount on Notes Payable” is a concept similar to “Discount on Bonds Payable,” except it relates to promissory notes instead of bonds.
• In some cases, the issuer of notes payable simply issues the securities at a discount.
• The organization borrows money from the owner of the firm, and the borrower agrees to repay the amount borrowed plus interest at a specified date in the future.
• The concepts related to these notes can easily be applied to other forms of notes payable.

When a company borrows money by issuing a promissory note, the lender may require the company to pay a lower amount than the face value of the note upfront. The difference between the face value and the cash received is recorded as a “Discount on Notes Payable” on the company’s balance sheet. This discount is amortized over the life of the note and recognized as interest expense in the income statement. Just as accounts receivable can be factored, notes can be converted into cash by selling them to a financial institution at a discount. Notes are usually sold (discounted) with recourse, which means the company discounting the note agrees to pay the financial institution if the maker dishonors the note. When notes receivable are sold with recourse, the company has a contingent liability that must be disclosed ni the notes accompanying the financial statements.

Discount on Notes Receivable FAQs

These notes are called zero interest, but they do carry an implicit interest rate figured into the face value of the note. As we’ve seen, short-term interest rates are quoted as simple rates per annum. Therefore, the (simple annual) quoted rates are multiplied by 3/12 to work out the actual interest for a three-month-long period. Now, assuming the same facts as in Example 2, suppose that the note is assigned originally on 30 June 20×1. Current liabilities are one of two-part of liabilities, and hence, Notes payable are liabilities.

• In addition, these debt instruments are considered safe investments due to the fact that they are backed by the full faith and credit of the U.S. government.
• The company obtains a loan of $100,000 against a note with a face value of $102,250.
• When a company borrows money this way, they have received cash that is less than the face value of the notes payable.
• As the discount is amortized, it increases the interest expense recorded by the company, effectively raising the cost of borrowing to the market rate.
• However, notes payable on a balance sheet can be found in either current liabilities or long-term liabilities, depending on whether the balance is due within one year.

It would be inappropriate to record this transaction by debiting the Equipment account and crediting Notes Payable for $18,735 (i.e., the total amount of the cash out-flows). The agreement calls for Ng to make 3 equal annual payments of $6,245 at the end of the next 3 years, for a total payment of $18,935. This situation may occur when a seller, in order to make a detail appear more favorable, increases the list or cash price of an item but offers the buyer interest-free repayment terms. A problem does arise, however, when an obligation has no stated interest or the interest rate is substantially below the current rate for similar notes.

Classification of notes payable

Notes payable can be classified as either a short-term liability, if due within a year, or a long-term liability, if the due date is longer than one year from the date the note was issued. For accounting purposes, discounts on notes payable are treated as an interest expense. The dollar amount of the discount is entered on the issuer’s books over the life of the note.

Suppose a bond issuer gets $950 each for bonds with a par value of $1,000. A discount on notes payable is expressed as a negative, because it represents an expense for the issuer. The company obtains a loan of $100,000 against a note with a face value of $102,250.

Journal Entry to Record Equipment Purchased and Issuance of Notes Payable

The preceding illustration should not be used as a model for constructing a legal document; it is merely an abbreviated form to focus on the accounting issues. In the preceding note, Oliva has agreed to pay to BancZone $10,000 plus interest of $400 on June 30, 20X8. The interest represents 8% of $10,000 for half of a year (January 1 through June 30). The first journal is to record the principal amount of the note payable. The face of the note payable or promissory note should show the following information.

What is the Difference Between Notes Payable vs. Short Term Debt?

Similar to accounts payable, notes payable is an external source of financing (i.e. cash inflow until the date of repayment). When a customer uses a promissory note to buy merchandise, the store records this on the balance sheet by debiting notes receivable and crediting sales. This is done by giving a discount on notes receivable to a bank or other lender prior to their maturity date. Let’s assume a company borrows $10,000 by issuing a promissory note with a face value of $10,000 but receives only $9,800 in cash due to a $200 discount on the note.

This note represents the principal amount of money that a lender lends to the borrower and on which the interest is to be accrued using the stated rate of interest. The organization borrows money from the owner of the firm, and the borrower agrees to repay the amount borrowed plus interest at a specified date in the future. Generally, there are no special problems to solve when accounting for these notes. As interest accrues, it is periodically recorded and eventually paid. For example, notes may be issued to purchase equipment or other assets or to borrow money from the bank for working capital purposes. Finally, at the end of the 3 month term the notes payable have to be paid together with the accrued interest, and the following journal completes the transaction.

Notes payable can be referred to a short-term liability (lt;1 year) or a long-term liability (1+ year) depending on the loan’s due date. Divide the annual interest expense by 12 to calculate the amount of interest to record in a monthly adjusting entry. For example, if a $36,000 long-term note payable has a 10 percent interest rate, multiply 10 percent, or 0.1, by $36,000 to get $3,600 in annual interest.

Most institutional fixed-income buyers will compare the yield-to-maturity (YTM) of various zero-coupon debt offerings with standard coupon bonds in order to find yield pickup in discount bonds. The bank subtracts the discount from the note’s maturity value and pays the company $4,921.92 for the note. A financial professional will offer guidance based on the information provided and offer a no-obligation call to better understand your situation. The articles and research support materials available on this site are educational and are not intended to be investment or tax advice. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly.

Footnotes are also widely used as a supplement to the balance sheet disclosure to inform readers of other facts about receivables. “Discount on Notes Receivable” is an accounting concept that pertains to promissory notes a company receives from its customers. This discount is essentially the opposite of a “Discount on Notes Payable,” and it occurs when a customer pays back a promissory note for less than its face value. Suppose XYZ Company issues a 1-year, $20,000 promissory https://accounting-services.net/notes-payable-discount-amortization-using/ note to a lender, but because the interest rate stated on the note is lower than the market rate, the lender only provides XYZ with $19,000 in cash. There are other instances when notes payable or a promissory note can be issued, depending on the type of business you have. The company records this transaction by debiting cash for $5,047.95, debiting interest expense for $26.02, crediting notes receivable for $5,000.00, and crediting interest revenue for $73.97.