© 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater Notes Receivable and Notes Payable Chapter 14

Learning Objective 1 Determining interest calculations and maturity dates on notes © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater LO-1

Promissory Note Interest - cost of using money for a period of time Formal written promise by a borrower to pay a certain sum at a fixed future date Note payable – amounts the company owes to others Note receivable – amounts owed to a company by others © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater LO-1

Promissory Note Principal - amount being borrowed Term - Amount of time money is being borrowed Payee - company or person to whom the note is payable Annual interest rate - rate being charged to borrower Maturity date - due date of promissory note Maker - the one promising to pay the note plus interest when it comes due © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater LO-1

Refer to Problem 14B-2 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater LO-1 Term Annual Interest Rate Maturity Date Payee Maker Principal

Calculate Interest Interest = Principal x Rate x Time Calculate interest for exact number of days based on 360-day year Interest = $40,000 x 11% x (90/360) = $1,100 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater LO-1

Determine Maturity Date Days in term on note90 Number of days remaining in June (30 days – 2)28 Days left on note after June62 Days in July31 August31 Due date: August 31 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater LO-1

Maturity Date by Number of Months If note is expressed in months, count the months from the date of issue, regardless of number of days in each month. A note issued on January 31 for 3 months, has a maturity date of April 30. © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater LO-1

Learning Objective 2 Journalizing entries to record renewal of a note, dishonoring of a note, eventual receipt of payment, and note given in exchange for Equipment purchased © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater LO-2

Time Extension of a Note At the end of a credit period, a borrower may ask for an extension. A time frame and interest rate are agreed upon between buyer and seller. Accounts Receivable and Accounts Payable both decrease. Notes Receivable and Notes Payable both increase. © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater LO-2

Dishonored Note A note that was not paid at maturity by the maker Also known as defaulting © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater LO-2

Time Extension of a Note © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater LO-2 The initial sale of merchandise on books of buyer and seller

Time Extension of a Note © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater LO-2 A shift in assets for seller and a shift in liabilities for buyer

Renewing & Dishonoring Notes We will use Problem 14B-1 to illustrate the journal entries. © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater LO-2

Time Extension with a Note © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater LO-2

Time Extension with a Note © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater LO-2

Note Due and Paid at Maturity © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater Interest= Principal x Rate x Time = $6,000 x.09 x (90/360) = $135 Maturity Value = Principal + Interest = $6, = $6,135 LO-2

Note Due and Paid at Maturity © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater LO-2

Note Due and Paid at Maturity © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater LO-2

Dishonored Note Assume Connors Co. dishonors the note, rather than paying on November 8. © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater LO-2

Note Due and Paid at Maturity © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater LO-2

Dishonored Note Connors Co. pays the note on November 16. © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater LO-2

Note Due and Paid at Maturity © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater LO-2

Note Given in Exchange for Equipment Purchased Seller ◦ Debit Notes Receivable ◦ Credit Sales Buyer ◦ Debit Equipment ◦ Credit Notes Payable © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater LO-2

Learning Objective 3 Discounting an interest-bearing note receivable and recording a discounted note that has been dishonored © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater LO-3

Problem 14B-2 We will complete Problem 14B-2. Apples Co. received a $40,000, 90 day, 11% note from Fletcher Co. dated June 2. Apples discounted note at 12% discount rate. We will calculate: Maturity value, # of days bank holds note until maturity Bank discount Proceeds © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater LO-3

Discounting a Note The process of transferring the note to a bank before the maturity date The company receives the maturity value less bank charges for holding note from date of discounting to maturity date © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater LO-3

Discounting a Note The time period the bank holds the note is the discount period. The amount the bank charges the company is the bank discount. The actual money a company receives is called the proceeds. © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater LO-3

14B-2 Discounting a Note Step 1: Find the maturity value of the note. Interest = Principal x Rate x Time $40,000 x 11% x (90/360) = $1,100 Maturity Value = Principal + Interest $40, ,100 = $41,100 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater LO-3

14B-2 Discounting a Note Step 2: Calculate the discount period. (Discount period – number of days from the date of discounting until the maturity date) 90 daysNote -44 daysExpired before discounting 46 daysThat bank holds note © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater LO-3

14B-2 Discounting a Note Step 3: Calculate the bank discount (what the bank charges Apples Co. for holding the note until maturity) Maturity Value X Bank Discount Rate X(No. of days bank holds note/ 360 days) Bank Discount © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater LO-3

14B-2 Discounting a Note Step 3: Calculate the bank discount (what the bank charges Apples Co. for holding the note until maturity) $41,100 x 12% x (46/360) = $ © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater LO-3

14B-2 Discounting a Note Step 4: Calculate the proceeds (what Apples receives from the bank) Proceeds = Maturity Value – Bank Discount = $41, = $40, © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater LO-3

Journalize Discounting a Note © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater LO-3

Journalize Discounting a Note If proceeds are less than the face of the note, recognize Interest Expense for the difference between the proceeds and the face. Sometimes companies have to discount notes very early into their maturity due to financial hardships. © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater LO-3

Journalize Discounting a Note What if Apples Company would have discounted the note after only 3 days? First we go back to Step 2 90 daysNote - 3 daysExpired before discounting 87 daysThat bank holds note © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater LO-3

Journalize Discounting a Note Next, we go to Step 3 Calculate the bank discount $41,100 x.12 x (87/360) = $1, Bank Discount © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

Journalize Discounting a Note Finally, we go to Step 4 Calculate the proceeds (Maturity value – bank discount) $41,100 – 1, = $39, © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

When a Discounted Note is Dishonored The company who endorses the note is liable to the bank for the maturity value of the note until the note is paid – Contingent Liability © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater LO-3

Discounting a Note We will use 14B-3 to illustrate these concepts. © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater LO-3

Problem 14B-3 Discounting One’s Own Note Problem 14B-3 Discounting One’s Own Note Joye discounted its own $25,000, 90-day note at National Bank at 10%. Bank Discount = Maturity value x Rate x (Discount Period/360) $25,000 x 10% x (90/360)= $625 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater LO-3

Proceeds = Maturity Value – Discount = $25, = $24,375 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater Problem 14B-3 Discounting One’s Own Note Problem 14B-3 Discounting One’s Own Note

Problem 14B-3 Discount on Notes Payable Problem 14B-3 Discount on Notes Payable Amount of interest deducted in advance by the lender Reduces Notes Payable to actual Cash value © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater Partial Balance Sheet Current liabilities: Notes Payable$25,000 Discount on Notes Payable625 $24,375 LO-3

Learning Objective 4 Handling adjustments for Interest Expense and Interest Income © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater LO-4

Interest: The Need for Adjustments On December 3, 20X4, Rochester Company received a $6,000, 60-day, 11% note from Larry Company in payment of account past due. © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater LO-4

Interest: The Need for Adjustments © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater LO-4 Accounts Payable Notes Payable Larry Co.

Interest: The Need for Adjustments © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater Adjusting entry is required to record interest incurred or earned to date. LO-4 Dec. 3, Jan. 31,

Interest: The Need for Adjustments Step 1: Calculate interest on the note: $6,000 x.11 x 60/360 = $ Step 2: Calculate the number of days the note has already run before the end of the current period Dec. 31- Dec. 3 = 28 days © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater LO-4

Interest: The Need for Adjustments Step 3: Calculate interest incurred (earned) for this period. 28/60 x $110 = $51.33 Step 4: Prepare the adjusting journal entries. © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater LO-4

Interest: the Need for Adjustments Interest: the Need for Adjustments © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater LO-4 Larry Co.

On Due Date On Due Date © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater LO-4

Adjusting Entries From previous example: Joye discounted its own $25,000, 90-day note at National Bank at 10% on December 1, 20X4. © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater LO-4

Adjusting Entries As of December 31, 30 days or 1/3 of the term of the note has passed. © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater LO-4

On Due Date © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater LO-4

© 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater End of Chapter 14