Video Transcript: Short Term Financing Through Notes Payable

Hello and welcome back now we're going to discuss the short term financing  through notes payables. A company sometimes needs short term financing. This situation may occur when the company's cash receipts are delayed because of  lenient credit terms grant to customers or the company's cash to finance the  build up of seasonal inventories, such as before Christmas, to secure short term financing, companies issue interest bearing or non interest bearing notes to  receive short term financing, a company may issue an interest bearing note to a  bank. An interest bearing note specifies the interest rate charged on the  principal borrowed the company receives 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 $10,000.90 day 9% note on December 1, 2009 the following entries  would record the loan, the accrual of interest on December 31 2009 and it's  payment on March 1 2010 so 2009 you issued the note payable. You received  $10,000 cash, and you still have to pay it back. So it's recorded as a note  payable of 10,000 and you just simply to record a 90 day banknote. The interest  that's due on the 31st is an expense of $75 and is a payable of $75 as well. And  you your your description is to just record accrued interest on a note payable,  and you're going to tell the terms of that note, which is the 10,000 times the 9%  for 30 days or 90 days, I'm sorry, and then on March, 1 2010 you're going to  record the Interest paid at that point which notes payable, you're actually paying  off the note on March 1. So you're going to debit notes payable for the full  amount of $10,000 and the interest expense of $150 plus the interest payable,  you're going to close it out of $75 and then you paid your cash of $1,225 to the  bank to to repay back the note. And then you're just going to simply record.  What you did is to record the principal interest paid on the bank note. 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 plus 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, so you acquired a $10,000 note. However, the discount the amount the bank's going to charge you for the $10,000 is the  $225 so you received, you didn't receive the full amount of 10 so you have to  record the full amount that you received in cash of $9,775 and what is the  difference? The difference is the discount. So record the difference as a discount on notes payable. And of course, you still have to pay the loan back of 10,000 

so the 10,000 gets booked to notes payable Needham credits notes payable for  the face value of the note, and discounts on notes payables 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 and the notes payable account, over time, the  discount becomes interest expense. The Needham paid the note before the end  of the fiscal year, it would charge the entire $225 discount to interest expense  and credit discount on notes payable. However, if Needham's fiscal year ended  December 31 an adjusting entry would be required, and that adjusting entry year the $75 to interest expense and the discount on the note, and it's the accrued  interest for the year end of $75 the entry, of course, the interest expense  incurred by Needham for the 30 days the note has been outstanding. The  expense can be calculated by multiplying 10, nine, 9% by 10,000 by the 90 days notice that the 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, which is the $10,000 from the date that  the proceeds are given to the borrower to maturity date. The liability grows by  reducing the balance and the discount on notes payable contra account. Thus  the current liability section of 2009 of December 31 the balance sheet with show. So you have on your balance sheet, you have notes payable. You actually have  to pay back the full 10,000 however, the note is only worth $9,850 because  that's the only amount of money that you received. So you that is your net  realized value on the net payable, on the note payable, excuse me, when the  note is paid at maturity, the interest is going to be as follows, so you posted the  full amount of the note to accounts payable as a credit. So once you pay it, you  have to get rid of that note payable balance by debiting $10,000 to note payable, the full amount of interest you must realize, which is the $150 and the cash  amount that you paid was 10,000 and the $150 which was a discount at first,  becomes The interest expense. The individual T accounts would look as follows, your discounts on notes payable, you have the full amount of 225 you're  realizing 75 by the end of the year, which will leave $150 balance. And then for  the interest expense, this $75 that was realized here becomes an expense once it's realized, and you're going to close it out on December 31 and then the  balance that's left is $150 which will be paid off in March when the note matures.