Page 392 - Accounting Principles (A Business Perspective)

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2009
Dec. 1 Cash (+A) 9,775
Discount on Notes Payable (-L) 225
Notes Payable (+L) 10,000
Issued a 90-day note to bank.
Needham credits Notes Payable for the face value of the note. Discount on notes payable is a contra account
used to reduce Notes Payable from face value to the net amount of the debt. The balance in the Discount on Notes
Payable account appears on the balance sheet as a deduction from the balance in the Notes Payable account.
Over time, the discount becomes interest expense. If Needham paid the note before the end of the fiscal year, it

would charge the entire USD 225 discount to Interest Expense and credit Discount on Notes Payable. However, if
Needham's fiscal year ended on December 31, an adjusting entry would be required as follows:
2009
Dec. 3 Interest Expense (-SE) 75
1 Discount on Notes Payable (+L) 75
To record accrued interest on note payable at
year-end.
This entry records the interest expense incurred by Needham for the 30 days the note has been outstanding. The

expense can be calculated as USD 10,000 X 0.09 X 30/360, or 30/90 X USD 225. Notice that for entries involving
discounted notes payable, no separate Interest Payable account is needed. The Notes Payable account already
contains the total liability that will be paid at maturity, USD 10,000. From the date the proceeds are given to the
borrower to the maturity date, the liability grows by reducing the balance in the Discount on Notes Payable contra
account. Thus, the current liability section of the 2009 December 31, balance sheet would show:
Current Liabilities:
Notes payable $ 10,000
Less: Discount on notes payable 150 $ 9,850
When the note is paid at maturity, the entry is:
2010
Mar. 1 Notes Payable (-L) 10,000
Interest Expense (-SE) 150
Cash (-A) 10,000
Discount on Notes Payable (+L) 150
To record note payment and interest expense.
The T-accounts for Discount on Notes Payable and for Interest Expense appear as follows:
Discount on Notes Payable Interest Expense
2009 2009 2009 2009
Dec. 1 225 Dec. 31 75 Dec. 31 75 Dec. 31 To close 75
Dec. Balance 150 2010 2010
31
Mar. 1 150 Mar. 1 150
In Exhibit 79, we compare the journal entries for interest-bearing notes and non-interest-bearing notes used by
Needham Company.

Accounting Principles: A Business Perspective 393 A Global Text