Page 386 - Accounting Principles (A Business Perspective)

9. Receivables and payables

Notes receivable and notes payable

A note (also called a promissory note) is an unconditional written promise by a borrower (maker) to pay a
definite sum of money to the lender (payee) on demand or on a specific date. On the balance sheet of the lender
(payee), a note is a receivable; on the balance sheet of the borrower (maker), a note is a payable. Since the note is
usually negotiable, the payee may transfer it to another party, who then receives payment from the maker. Look at
the promissory note in Exhibit 78.
A customer may give a note to a business for an amount due on an account receivable or for the sale of a large

item such as a refrigerator. Also, a business may give a note to a supplier in exchange for merchandise to sell or to a
bank or an individual for a loan. Thus, a company may have notes receivable or notes payable arising from
transactions with customers, suppliers, banks, or individuals.
Companies usually do not establish a subsidiary ledger for notes. Instead, they maintain a file of the actual notes
receivable and copies of notes payable.
Most promissory notes have an explicit interest charge. Interest is the fee charged for use of money over a
period. To the maker of the note, or borrower, interest is an expense; to the payee of the note, or lender, interest is a
revenue. A borrower incurs interest expense; a lender earns interest revenue. For convenience, bankers sometimes
calculate interest on a 360-day year; we calculate it on that basis in this text. (Some companies use a 365-day year.)

Exhibit 78: Promissory note

The basic formula for computing interest is:
Interest=Principal×Rate×Time , or I=P×R×T
Principal is the face value of the note. The rate is the stated interest rate on the note; interest rates are
generally stated on an annual basis. Time, which is the amount of time the note is to run, can be either days or
months.
To show how to calculate interest, assume a company borrowed USD 20,000 from a bank. The note has a

principal (face value) of USD 20,000, an annual interest rate of 10 per cent, and a life of 90 days. The interest
calculation is:
90
Interest=USD20,000×0.10×
360
Interest = USD 500

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