When you take out a loan, it’s important to manage your payments carefully. Any business loan payments and outstanding amounts should be marked on the balance sheet as part of the notes payable account. Here’s a closer look at what the notes payable account is, and what function it serves in business accounting.
Introduction to notes payable
Notes payable is a liability account written up as part of a company’s general ledger. It’s where borrowers record their written promises to repay lenders. By contrast, the lender would record this same written promise in their notes receivable account.
Any written note included in the notes payable account should include basic information about the debt, including factors like:
These are marked down in a formal promissory note. Whether or not the note is classified as a current or long-term liability will depend on its due date. Notes due within the next 12 months are considered to be current or short-term liabilities, while notes due after one year are long-term or non-current liabilities.
Notes payable vs. interest payable
If a company uses the accrual method of accounting, notes payable will need to be supplemented with an interest payable account. This is because a promissory note requires the borrower to pay interest, creating an additional interest expense. In the interest payable account, a company records any interest incurred during the accounting period that has not yet been paid.
Notes payable vs. accounts payable
Because it creates a record of debts or liabilities, notes payable might sound quite similar to accounts payable. However, there are a few key differences between these two accounts.
The major difference when looking at notes payable vs accounts payable is that accounts payable doesn’t include a formal written promise, or promissory note. It serves as a more informal record of any outstanding purchases that need to be paid off. Accounts payable is also a liability account, used to record any purchases on credit from the business’s suppliers.
Another difference between accounts payable and notes payable relates to how they’re recorded on the balance sheet:
When recording details of a loan as notes payable, you’ll need to use the following accounts on the balance sheet:
As you repay the loan, you’ll record notes payable as a debit journal entry, while crediting the cash account. This is recorded on the balance sheet as a liability. But you must also work out the interest percentage after making a payment, recording this figure in the interest expense and interest payable accounts.
By contrast, recording liabilities in accounts payable doesn’t always take interest into account, nor does it involve formal promissory notes. Instead, you simply enter each individual item on the liability side of the balance sheet.
With accounts payable, the amount paid for each item might change due to frequency of use. For example, accounts payable could include charges for things like utilities and legal services, rather than bank loans.
Notes payable example
Whenever a business borrows money from any lender, it must be reported in the notes payable account. The lender will ask the borrower to sign a formal loan agreement. To illustrate how this works, imagine the following notes payable example.
A start-up business owner named John borrows $10,000 from his credit union to help open a restaurant. John would need to sign a formal loan agreement stating that he will make repayments of $500 per month, as well as $250 interest until the full amount is repaid. This agreement would first be recorded in two accounts:
Cash would receive a credit of $10,000
Notes payable would receive a debit of $10,000
In addition to these entries, the interest must be recorded with an additional $250 debit to the interest payable account and adjusting entry in cash.
This shows that when recording any loan agreement on the balance sheet, it must be reflected not only in cash, but notes payable and interest payable. This helps maintain balance until the loan is paid off.
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