Notes payables are written promises between two parties. A note payable is created when one party receives a loan from another party. The note is for a specified amount of money, due on a specified date and has a stated interest rate. Notes that are due within one year are considered short-term, while notes that are due longer than that are considered long-term. Notes payables are recorded on a company’s books as a liability. Each month that a company has a notes payable, an adjusting entry is required to record accrued interest expenses.
Understand the details of the note. Assume a company borrowed $10,000 on June 1 and that it must be paid back in one year, plus interest that is at the rate of eight percent. Each month a portion of the interest accrues and must be recorded as an adjusting entry to keep the books up to date. The entry recorded when the note was received is posted by debiting the Cash account for $10,000 and crediting the Notes Payable account for $10,000.
Calculate the monthly interest. Using a simplified version to calculate interest, a simple equation is used, which is I = PRT. I represents the interest amount, P is the principal, R is the interest rate and T is the amount of time. When interest is calculated per month, the time amount for one month must be divided by 12 (months). This equation listed represents the interest for the entire time of the note, which in this case is one year. To calculate the interest for this example, the equation reads: I = ($10,000) (0.08) (1/12). The answer is that the interest amount per month is $66.67.
Record the adjusting entry each month. This is recorded by debiting Interest Expense for $66.67 and Interest Payable for $66.67. This adjusting entry is recorded at the end of each month until the note is due.
Record the payment of the note. When June 1 of the following year comes, the note is paid off as well as all of the accrued interest payable. By then the amount of interest payable is $733.37 (11 months times $66.67). The last month of interest is recorded when the note is paid. The entry made is a debit to Interest Expense for $66.67, a debit to Interest Payable for $733.37, a debit to Notes Receivable for $10,000 and a credit to cash for the total payment of $10,800.04.