ACTBAS1 Unit VI Accounting for Promissory Note

7/31/2019 ACTBAS1 Unit VI Accounting for Promissory Note

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Unit 6: Accounting forPromissory Note

ACTBAS1Term 2, AY 2011-2012


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Overview

A promissory note is a writtenpromise made by a maker promisingto pay the payee a certain amount of

money at a fixed determinable futuretime which may or may not includeinterest.


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T.I.P. #1The elements of a promissory note

are:

Maker

PayeePrincipalInterest

Interest RateMaturity DateMaturity Value


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Lets answer first Exercise 6-14 on page 66 of yourworkbook. Next, lets answer Exercise 6-16 on page

68 of your workbook.


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Elements of Promissory Note

The maker is the person or businessthat signs the note and promises topay the amount required by the

agreement. The maker is the debtor. The payee is the person or business

to whom the maker promises futurepayment. The payee is the creditor

The principal is the amount loanedout by the payee and borrowed by themaker of the note


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Elements of Promissory Note(cont.) The interest is the revenue to the payee

for loaning out principal and the expenseto the maker for borrowing the principal.

The interest rate is the percentage rate

that is multiplied to the principal amountand the term of the note in computing forthe interest

The maturity date is the date on which

final payment of the note is due The maturity value is the sum of

principal and interest due at the maturitydate of note


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T.I.P. #2

The payee regards all promissorynotes it holds that are due in lessthan a year as Notes

Receivable in the current assetssection of the balance sheet.The maker regards them as

Notes Payable in the currentliabilities section of the balancesheet


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T.I.P. #3

A promissory note may either be anon-interest or an interest-bearing note.

A non-interest bearing note is apromissory note, which does notprovide any payment for interestso that the amount to be paid atmaturity is equal to the facevalue of the note.


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T.I.P. #4

Interest is computed using thefollowing formula:

Interest = Principal x Rate xTime


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Lets answer first Exercise 6-18 on page 69 of your

workbook.


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Discounting a NoteReceivable Endorsing a note receivable before

maturity is called discounting a notereceivable because the payee of the

note receives less than its maturityvalue.

This lower amount decreases the

amount of interest income the payeeearns on the note. Giving up some ofthis interest is the price the payee is

willing to pay for the convenience ofreceivin cash earl .


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T.I.P. #5

When a note is discounted at the bank beforematurity, the bank advances the moneyequal to its value on the date of discountingcomputed on the bank rate of discount.

The endorsement to the bank may either be:

with recourse

without recourse


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Endorsement(Discounting with Recourse) The holder of the note (usually the payee)

endorses the note and delivers it to the bank

The bank in turn pays the amount equal tothe net cash proceeds (i.e., maturity value

less the discount charged by the bank) to theendorser (usually the payee of the note)

The bank expects to collect the maturityvalue of the note on the maturity date but

also has recourse against the endorser orseller of the note

If the maker fails to pay on maturity date, theendorser is liable to the bank for payment


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T.I.P. #6

Discount is the amount ofinterest deducted by the bankin advance.

Discount = Maturity Value x

Discount Rate x DiscountPeriod


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Steps in Computing for Net CashProceeds1. Compute for the maturity value.

2. Determine the discount period.

3. Compute for the discount.

4. Compute for the net cash proceeds.


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Pro-forma Entries

Pro-forma entry to record thediscounting of customers note:

Cash xxx

Interest Expense xxx

Notes Receivable Discounted

xxx

Interest Income xxx


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Pro-forma Entries (cont.)

Pro-forma entry when maker honoredthe note:

Notes Receivable Discounted xxx

Notes Receivablexxx


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Pro-forma Entries (cont.)

Pro-forma entry when makerdishonored the note:

Accounts Receivable xxx

Notes Receivable Discounted xxx

Cash xxx

Notes Receivablexxx


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Lets answer first Exercise 6-19 on page 70 of your

workbook.


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T.I.P. #7

Notes Receivable Discountedis the contingent liability of the

endorser on the customersnotes that have beendiscounted.


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Discounting of Own Note

Usually, payment of interest is madeon the maturity date of the note

Sometimes, the creditor would collect

the interest on the note being issuedby the maker on the same day theloan was granted. Paying interest in

advance for the note issued is calleddiscounting ones own note


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Discounting of Own Note (cont.)

Pro-forma entry to record thediscounting of own note:

Cash xxx

Discount on notes payable xxx

Notes payable xxx

ACTBAS1 Unit VI Accounting for Promissory Note

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