Note Payable Example Journal Entry

A business will issue a note payable if for example, it wants to obtain a loan from a lender or to extend
its payment terms on an overdue account with a supplier. In the first instance the note payable is issued
in return for cash, in the second they are issued in return for cancelling an accounts payable balance.
Issued for Cash
In notes payable accounting there are a number of journal entries needed to record the note payable
itself, accrued interest, and finally the repayment.
Suppose for example, a business issues a note payable for 15,000 due in 3 months at 8% simple interest
in order to obtain a loan, then the total interest due at the end of the 3 months is 15,000 x 8% x 3 / 12 =
300.
The first journal is to record the principal amount of the note payable.
Account Debit Credit
Cash 15,000
Notes payable 15,000
Total 15,000 15,000
Note Payable – Issued for new borrowing
The debit is to cash as the note payable was issued in respect of new borrowings.
Issued to Extend Payment Terms
Had the note payable been issued in respect of an overdue supplier account in order to extend the terms
of payment, then this would have converted an accounts payable to a note payable, and the debit would
be to accounts payable as follows:
Account Debit Credit
Accounts payable 15,000
Note payable 15,000
Total 15,000 15,000
Note Payable – Issued to replace accounts payable
In this case the note payable is issued to replace an amount due to a supplier currently shown as
accounts payable, so no cash is involved.
As the note payable charges interest, each month interest of 300 / 3 = 100 needs to be accrued. At the
end of the 3 month term the total interest of 300 would have been accrued.
Account Debit Credit
Interest expense 300
Interest payable 300
Total 300 300
Note Payable – Accrue the interest
Finally, at the end of the 3-month term the notes payable have to be paid together with the accrued
interest, and the following journal completes the transaction.
Account Debit Credit
Note payable 15,000
Interest payable 300
Cash 15,300
Total 15,300 15,300
Note Payable – Payment at the end of the term
Discount on Note Payable
In the above example, the principal amount of the note payable was 15,000, and interest at 8% was
payable in addition for the term of the notes. Sometimes notes payable are issued for a fixed amount
with interest already included in the amount. In this case the business will actually receive cash lower
than the face value of the note payable.
Note Payable Discount Example
Suppose for example, a business issued a note payable for 14,600 payable in 1 year and received cash of
13,744. The 14,600 is the total amount to be repaid and interest assumed to be included in this amount
is 14,600 – 13,744 = 826.
The cash amount in fact represents the present value of the notes payable and the interest included is
referred to as the discount on notes payable.
In this situation the present value of the notes payable is calculated using the present value formula PV =
FV / (1 + i%)n. Where FV = future value, in this case 14,600, i% = the interest rate, say 6% and n = the
term in years, in this case 1 year.
PV = FV / (1 + i%)n
PV = 14,600 / 1.06 = 13,774
Furthermore, the note payable would be recorded as follows:
Account Debit Credit
Cash 13,774
Discount on note payable 826
Notes payable 14,600
Total 14,600 14,600
Note Payable – Discount on note payable
It is important to realize that the discount on a note payable account is a balance sheet contra liability
account, as it is netted off against the note payable account to show the net liability.
Subsequently each month a portion of the discount on the note payable is charged as an interest
expense. In this case the amount is 826 / 12 = 69 per month.
Account Debit Credit
Interest expense 69
Discount on notes payable 69
Total 69 69
Note Payable – Discount charged as expense
Finally at the end of the term, all the discount is included as an expense in the income statement, the
balance on the discount on notes payable account is zero, and the balance on the notes payable account
is paid.
Account Debit Credit
Notes payable 14,600
Cash 14,600
Total 14,600 14,600
Note Payable – Payment at the end of the term

Interest Expense = Effective Interest * Present Value

Interest Payable = Nominal/Stated Interest * Face Amount
Amortization of Discount= Interest Expense – Interest Payable
Methods of Amortizing the Discount
1. Effective Interest method (Default)
2. Straight-line Method
PS: There is no premium in notes payable. Premium is present only on Bonds Payable.

What Is Debt Restructuring?

Debt restructuring is a process that involves negotiating with creditors to reduce your interest rate, extend
your repayment term or cut your loan balance. It can help make your debt situation more manageable
through smaller monthly payments, lower interest rates or reducing how much you owe.
Modification of terms Substantially modified
• [(CA old - PV new)/ CA old] ≥ 10%
Accounted for as debt extinguishment. Not substantially modified
• [(CA old - PV new)/ CA old] < 10%
Not accounted for as debt extinguishment

EXAMPLE
Due to adverse economic circumstances and poor management, Compostela Corp. has negotiated a
restructuring of its P5,000,000 note payable to Valley Bank. Valley Bank has agreed to reduce the face
value of the note from P5,000,000 to P4,000,000, reduce the interest rate from 15% to 10%, and extend
the due date three years from the date of restructuring. The restructuring will occur on Dec. 31, 2023,
the last day of Compostela’s annual reporting period. The unpaid interest on the restructured loan at this
time is P750,000 which is forgiven. The tax rate is 30%. (Round off present value factors to four decimal
places)
14. How much is the on gain on extinguishment of debt for the year 2023?
a. P2,206,720 c. P1,544,704
b. P1,750,000 d. P 0
15. How much is the interest expense in 2024?
a. P600,000 c. P400,000
b. P531,492 d. P354,328
CA of Old debt
Principal 5,000,000
Unpaid Accrued Interest 750,000
Carrying Amount 5,750,000

PV of New debt
Principal (4M*PV of 1, n=3@15%) 2,630,000
Interest (4M*10%*PV of OA of 1, n=30@15%) 913,280
PV 3,543,280

Difference 2,206,720
Percentage (2,206,720/5,750,000)= .38
Thus, greater than 10%, accounted for as a debt extinguishment.
JE:
Notes Payable 5,000,000
Interest Payable 750,000
Discount on Notes Payable 456,720
Notes Payable 4,000,000
Gain on Debt Extinguishment 2,206,720

Interest Expense = 3,543,280*15%= 531,492