Page 391 - Accounting Principles (A Business Perspective)

9. Receivables and payables

from the bank the principal borrowed; when the note matures, the company pays the bank the principal plus the
interest.
Accounting for an interest-bearing note is simple. For example, assume the company's accounting year ends on

December 31. Needham Company issued a USD 10,000, 90-day, 9 per cent note on 2009 December 1. The
following entries would record the loan, the accrual of interest on 2009 December 31 and its payment on 2010
March 1:
2009 1 Cash (+A) 10,000
Dec. Notes Payable (+L) 10,000
To record 90-day bank loan.
31 Interest Expense (-SE) 75
Interest Payable (+L) 75
To record accrued interest on a note payable at
30
year-end ($10,000 X 0.09 X /360).
2010 1 Notes Payable (-L) 10,000
60
Mar. Interest Expense ($10,000 X 0.09 X /360) (-SE) 150
Interest Payable (-L) 75
Cash (-A) 10,225
To record principal and interest paid on bank
loan.
Non interest-bearing notes (discounting notes payable) A company may also issue a non interest-
bearing note to receive short-term financing from a bank. A non interest-bearing note does not have a stated
interest rate applied to the face value of the note. Instead, the note is drawn for a maturity amount less a bank
discount; the borrower receives the proceeds. A bank discount is the difference between the maturity value of the
note and the cash proceeds given to the borrower. The cash proceeds are equal to the maturity amount of a note
less the bank discount. This entire process is called discounting a note payable. The purpose of this process is to
introduce interest into what appears to be a non interest-bearing note. The meaning of discounting here is to
deduct interest in advance.

Because interest is related to time, the bank discount is not interest on the date the loan is made; however, it
becomes interest expense to the company and interest revenue to the bank as time passes. To illustrate, assume that
on 2009 December 1, Needham Company presented its USD 10,000, 90-day, non interest-bearing note to the bank,
which discounted the note at 9 per cent. The discount is USD 225 (USD 10,000 X 0.09 X 90/360), and the proceeds
to Needham are USD 9,775. The entry required on the date of the note's issue is:

392