Promissory Note Accounting
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Transcript of Promissory Note Accounting
ACCOUNTING FOR
PROMISSORY
NOTES
PROMISSORY NOTE
• A negotiable instrument
• An unconditional promise to pay a sum certain in
money at a determinable future time, made by a
maker, to a payee.
• May either be:
• Interest-bearing
• Non-Interest bearing
PROMISSORY NOTE
Manila, Philippines
P150,000.00
July 1, 20x3
PROMISSORY NOTE
FOR VALUE RECEIVED, I promise to pay Allen Molina the
amount of One Hundred Fifty Thousand Pesos (P150,000.00) on
August 30, 20x3 plus interest at the annual rate of 12%
(Signed) Hannah Marie Sy
COMPONENTS OF A
PROMISSORY NOTE
• MAKER
• The party who made the promissory note and
eventually signs on it
• The party who makes a promise to pay the agreed
amount at a specified future date
• The debtor in the transaction
COMPONENTS OF A
PROMISSORY NOTE
• PAYEE
• The person or business to whom the promise of future
payment was made.
• The recipient of the promissory note
• The creditor in the transaction
COMPONENTS OF A
PROMISSORY NOTE
• PRINCIPAL AMOUNT/ PRINCIPAL
• The amount loaned or borrowed by the maker of the
promissory note
COMPONENTS OF A
PROMISSORY NOTE
• INTEREST
• The opportunity cost involved in the lending
transaction
• Represents a revenue on the part of the payee, for
money lent
• Represents a cost or expense on the part of the maker
for money borrowed.
COMPONENTS OF A
PROMISSORY NOTE
• INTEREST PERIOD
• The period of time during which the interest on the
note is to be computed
• Extends from the date of the note until the maturity
date
COMPONENTS OF A
PROMISSORY NOTE
• INTEREST RATE
• The percentage rate multiplied to the principal and the
term of the note in order to arrive at the interest earned
or incurred for the period.
COMPONENTS OF A
PROMISSORY NOTE
• MATURITY DATE
• The date on which final payment on the promissory
note is due.
COMPONENTS OF A
PROMISSORY NOTE
• MATURITY VALUE
• The sum of the PRINCIPAL and INTEREST due at
the maturity date of the promissory note
• The amount that the payee expects to receive, and the
maker expects to pay
COMPONENTS OF A
PROMISSORY NOTE
• PLACE OF ISSUE
• The location, specifically the city or town in which the
maker issued the promissory note
SOURCES OF A PROMISSORY
NOTE
• The entity renders services or sells goods to a client, in
return the client issued a promissory note in settlement of
the account.
• The client has an outstanding account that is going to be
due, however, he does not have sufficient cash to pay. In
return, he offers to issue a promissory note
• A loan is extended to a borrower who issues a promissory
note
ILLUSTRATION
PROMISSORY NOTE ARISING FROM SERVICES
RENDERED TO CLIENTS
Notes Receivable XXXXXX
Service Income XXXXX
To record the receipt of promissory
note for services rendered.
ILLUSTRATION
PROMISSORY NOTE ISSUED BY A CLIENT TO
EXTEND HIS ACCOUNT
Notes Receivable XXXXXX
Accounts Receivable XXXXX
To record the receipt of promissory
note as settlement of a previous account.
ILLUSTRATION
PROMISSORY NOTE RECEIVED IN
CONSIDERATION OF A LOAN GRANTED
Notes Receivable XXXXXX
Cash XXXXX
To record the receipt of promissory
note for money lent.
INTEREST ON PROMISSORY
NOTES
• A promissory note may either be
• Interest-Bearing- a promissory note which provides for the
separate payment of interest together with the principal at
maturity date.
• Non-Interest Bearing- a promissory note that does not
require a separate payment for interest at maturity date
INTEREST- represents an opportunity cost
INTEREST ON PROMISSORY
NOTES
• SIMPLE INTEREST COMPUTATION FORMULA:
• I = PRT
• Interest = Principal X Rate X Time
INTEREST COMPUTATION
ON PROMISSORY NOTES
• The PRINCIPAL AMOUNT is the amount stated on the
face of the promissory note
• The rate, if silent, is assumed to be ANNUAL.
• The most critical factor in interest computation,
COMPUTING FOR THE TIME/ PERIOD IN
WHICH INTEREST WAS EARNED
INTEREST COMPUTATION
ON PROMISSORY NOTES
• HOW TO PROPERLY COUNT THE DAYS EARNED IN A PROMISSORY NOTE?
• Let us use the earlier example, in which the promissory note was issued July 1, 20x3 and due August 30, 20x3
Number of Days in July 31 Date of the Note (1) Number of remaining days in July 30
Number of Days needed in August 30
Total Number of Days from July 1 60
INTEREST COMPUTATION
ON PROMISSORY NOTES
• HOW TO PROPERLY COUNT THE DAYS EARNED IN A PROMISSORY NOTE?
• Assume a promissory note was issued September 15, 20x3 and due December 31, 20x3
Number of Days in Sept 30 Date of the Note (15) Number of remaining days in Sept 15
Number of Days needed in October 31
Number of Days needed in Nov 30
Number of Days needed in Dec 31
Total Number of Days from Sept 1 107
INTEREST COMPUTATION
ON PROMISSORY NOTES
• Continuing the earlier illustration on which a
promissory note with P150,000 principal was received
and an interest of 12% annually was stipulated:
• Interest = Principal X Rate X Time
= P150,000 X 0.12 X 60/360
INTEREST = P3,000
INTEREST COMPUTATION
ON PROMISSORY NOTES
• Continuing the earlier illustration on which a
promissory note with P150,000 principal was received
and an interest of 12% annually was stipulated:
• Principal P150,000
Interest 3,000
Maturity Value P153,000
INTEREST COMPUTATION
ON PROMISSORY NOTES
• The entry to record the collection of the promissory
note at maturity date:
Cash 153,000
Notes Receivable 150,000
Interest Income 3,000
To record the collection of the note at
maturity date
DISCOUNTING
CUSTOMER’S NOTE
DISCOUNTING NOTES
RECEIVABLE
• Endorsing or selling the promissory note before its
maturity date
• The purpose is to generate quick cash to finance some
needs of the entity
• When payee discounts a promissory note, the payee
receives lesser proceeds compared to that of the
maturity value
DISCOUNTING NOTES
RECEIVABLE
• When the payee endorses or discounts the promissory
note to a bank prior to maturity, the bank advances to
the payee a sum of money computed at the date of
discounting and at the discount rate of the bank
• May either be:
• With recourse
• Without recourse
DISCOUNTING CUSTOMER’S
NOTE WITH RECOURSE
• The bank holds a recourse or a right against the seller of the note or the payee
• In effect, the seller of the note guarantees that at maturity date, the maker will pay the sum to the bank, thus a need to recognize a contingent liability exists.
• There are two possibilities when a customer’s note has been discounted with recourse
• Maker honors the note
• Maker dishonors the note
DISCOUNTING CUSTOMER’S
NOTE WITH RECOURSE
Example:
Maria De Leon received a 60-day 12% P15,000
promissory note from Alvin Ban on July 1, 2013. On
August 4, 2013 Maria De Leon endorses the note to BPI
for discounting.
Two possible scenarios at MATURITY DATE:
Alvin Ban honors the promissory note
Alvin Ban dishonors the promissory note
The main issue in discounting a customer’s note would be
the COMPUTATION OF PROCEEDS TO BE
RECEIVED at the date of discounting.
In computing the proceeds, THREE DATES must be
remembered:
1. Date of the note
2. Date of discounting
3. Maturity date of the note
DISCOUNTING CUSTOMER’S
NOTE WITH RECOURSE
ILLUSTRATION: DISCOUNTING
OF CUSTOMER’S NOTE
• Illustration:
On July 1 2013, Allen Molina received a 60-day 12%
P150,000 promissory note from Hannah Marie Sy. On
July 27, 2013 Allen discounted the promissory note with
PNB. At that time the discount rate was 14%
ILLUSTRATION: DISCOUNTING
OF CUSTOMER’S NOTE
• 1. Determine the MATURITY VALUE of the note
Principal P XXXXX
Interest XXXXX
Maturity Value P XXXXX
• Applying the illustration:
Principal P 150,000
Interest(150,000*0.12*60/360) 3,000
Maturity Value P153,000
ILLUSTRATION: DISCOUNTING
OF CUSTOMER’S NOTE
• 2. Determine the DISCOUNT PERIOD
No. of Days in July 31
Date of Discounting (27)
No. of Days remaining in July 4
Days in August before Maturity 30
DISCOUNT PERIOD 34
60 DAYS
Date of
Note:
July 1,
20x3
Date of
Discounting:
July 27,
20x3
Maturity
Date:
August
30, 20x3
26
Days
34
Days
DISCOUNT PERIOD
ILLUSTRATION: DISCOUNTING
OF CUSTOMER’S NOTE
3. Compute for the DISCOUNT.
DISCOUNT FORMULA:
DISCOUNT = MATURITY VALUE X DISCOUNT RATE X
DISCOUNT PERIOD
ILLUSTRATION: DISCOUNTING
OF CUSTOMER’S NOTE
Applying the illustration:
Maturity Value: P153,000
Discount Rate: 14%
Discount Period: 34 Days
DISCOUNT:
= P153,000 X 0.14 x 34/360
= P2,023
ILLUSTRATION: DISCOUNTING
OF CUSTOMER’S NOTE
ILLUSTRATION: DISCOUNTING
OF CUSTOMER’S NOTE
• 4. Determine the NET PROCEEDS FROM
DISCOUNTING
Formula:
Maturity Value PXXXXX
Discount (XXXXX)
Net Proceeds PXXXXX
ILLUSTRATION: DISCOUNTING
OF CUSTOMER’S NOTE
• 4. Determine the NET PROCEEDS FROM
DISCOUNTING
Formula:
Maturity Value P153,000
Discount (2,023)
Net Proceeds P150,977
JOURNAL ENTRIES
JOURNAL ENTRIES
ASSUMPTION 1: HANNAH MARIE SY HONORED
THE NOTE
JOURNAL ENTRIES
ASSUMPTION 2: HANNAH MARIE SY
DISHONORED THE NOTE AND THE BANK
CHARGED A PROTEST FEE OF P1,000
PRESENTATION OF THE NOTES RECEIVABLE
DISCOUNTED ON THE FINANCIAL
STATEMENTS
• Generally, it is presented as a CONTINGENT
LIABILITY ON THE CURRENT LIABILITY side of
the STATEMENT OF FINANCIAL POSITION
Current Liabilities:
Notes Receivable Discounted P XXXXX
DISCOUNTING
OWN NOTE
DISCOUNTING OWN NOTE
• A transaction wherein the maker issues a promissory
note to borrow a sum of money
• A liability in the form of a Note Payable is being
incurred
• The concept of discounting implies, that the INTEREST
IS DEDUCTED IN ADVANCE, thus the PROCEEDS
from discounting were already reduced by the interest
PRO-FORMA ENTRIES
• To record the discounting of own-note:
Cash xxxxx
Discount on Notes Payable xxxxx
Notes Payable xxxxx
*Discount on Notes Payable: computed using the interest
formula I = PRT
*Cash- proceeds from discounting
Principal Pxxxxx
Discount (xxxxx)
Cash Proceeds Pxxxxx
ILLUSTRATION:
• On September 1, 2013 James Morth discounted its own
30-day 12% P10,000 note with Mary Dela Cruz
Cash 9,900
Discount on Notes Payable 100
Notes Payable 10,000
To record the discounting of promissory note
FINANCIAL STATEMENTS
PRESENTATION
• *Discount on Notes Payable is presented as a Contra-
Liability account, as a deduction to Notes Payable
Notes Payable P xxxxx
Discount on Notes Payable (xxxxx)
Amortized Cost Pxxxxx
AMORTIZATION OF DISCOUNT
ON NOTES PAYABLE
• Amortization- refers to the reduction of an amount over
a period of time
• Usually prepared at the END of the accounting period
• Pro-Forma Entry to Record Amortization of Discount
Interest Expense xxxxx
Discount on Notes Payable xxxxx