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College Accounting

College Accounting. Heintz & Parry 20 th Edition. 17. Accounting for Notes and Interest. 1. Describe a promissory note. PROMISSORY NOTE. A written promise to pay a specific sum at a definite future date Also called a “note”

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College Accounting

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  1. College Accounting Heintz & Parry20th Edition

  2. 17 Accounting for Notes and Interest

  3. 1 • Describe a promissory note.

  4. PROMISSORY NOTE • A written promise to pay a specific sum at a definite future date • Also called a “note” • Often used when credit is extended for 60 days or more, or when large amounts of money are involved

  5. PROMISSORY NOTE PRINCIPAL $ 2,500.00

  6. PROMISSORY NOTE Date of the note $ 2,500.00 June 9, 20 - -

  7. PROMISSORY NOTE Term of the note $ 2,500.00 June 9, 20 - - Ninety Days AFTER DATE I PROMISE TO PAY TO

  8. PROMISSORY NOTE $ 2,500.00 June 9, 20 - - Ninety Days AFTER DATE I PROMISE TO PAY TO PAYEE Central Bank THE ORDER OF

  9. PROMISSORY NOTE $ 2,500.00 June 9, 20 - - Ninety Days AFTER DATE I PROMISE TO PAY TO Central Bank THE ORDER OF Two Thousand Five Hundred and 00/100 Central Bank PAYABLE AT WITH INTEREST AT 9% per Annum from Date INTEREST RATE Notes may be interest bearing or non-interest bearing.

  10. PROMISSORY NOTE $ 2,500.00 June 9, 20 - - Ninety Days AFTER DATE I PROMISE TO PAY TO Central Bank THE ORDER OF Two Thousand Five Hundred and 00/100 Central Bank PAYABLE AT MATURITY DATE WITH INTEREST AT 9% per Annum from Date 2307 Sept. 7, 20-- No. Due

  11. PROMISSORY NOTE $ 2,500.00 June 9, 20 - - Ninety Days AFTER DATE I PROMISE TO PAY TO Central Bank THE ORDER OF Two Thousand Five Hundred and 00/100 Central Bank PAYABLE AT MAKER OF NOTE WITH INTEREST AT 9% per Annum from Date Sarah Morney 2307 Sept. 7, 20-- No. Due

  12. 2 • Calculate interest on and determine the due date of promissory notes.

  13. TERM OF THE NOTE • The months or days from the date of issue to the date of maturity • Used to calculate TIME: • The term of the note stated as a fraction of a year • Note: It is common to use 360 days as a year When the term of note is expressed as months, TIME is calculated in months.

  14. TERM OF THE NOTE • The months or days from the date of issue to the date of maturity • Used to calculate TIME: • The term of the note stated as a fraction of a year • Note: It is common to use 360 days as a year When the term of the note is expressed as days, the TIME is calculated using the exact number of days.

  15. COMPUTING THE DUE DATE EXAMPLE: The note signed by Sarah Mornay is dated June 9, 20-- and is due in 90 days. Days in June 30 STEP #1 Start with the month the note was issued.

  16. COMPUTING THE DUE DATE EXAMPLE: The note signed by Sarah Mornay is dated June 9, 20-- and is due in 90 days. Days in June 30 9 Deduct date of note (June 9) 21 Days remaining in June Subtract the date the note was issued (do not count the date of issuance).

  17. COMPUTING THE DUE DATE EXAMPLE: The note signed by Sarah Mornay is dated June 9, 20-- and is due in 90 days. Days in June 30 Deduct date of note (June 9) 9 Days remaining in June 21 Add: Days in July 31 31 Days in August STEP #2 Add to the result of step #1 the number of days in as many months as possible without exceeding the time of the note.

  18. COMPUTING THE DUE DATE EXAMPLE: The note signed by Sarah Mornay is dated June 9, 20-- and is due in 90 days. Days in June 30 9 Deduct date of note (June 9) 21 Days remaining in June Add: Days in July 31 31 Days in August By the end of August, 83 days of the note have past.

  19. COMPUTING THE DUE DATE EXAMPLE: The note signed by Sarah Mornay is dated June 9, 20-- and is due in 90 days. Days in June 30 9 Deduct date of note (June 9) 21 Days remaining in June Add: Days in July 31 31 Days in August STEP #3 Subtract the result of step #2 from the time of the note (90 – 83).

  20. COMPUTING THE DUE DATE EXAMPLE: The note signed by Sarah Mornay is dated June 9, 20-- and is due in 90 days. Days in June 30 9 Deduct date of note (June 9) Days remaining in June 21 Add: Days in July 31 31 Days in August The result is the date of the month the note is due.

  21. COMPUTING THE DUE DATE EXAMPLE: The note signed by Sarah Mornay is dated June 9, 20-- and is due in 90 days. Days in June 30 9 Deduct date of note (June 9) Days remaining in June 21 Add: Days in July 31 31 Days in August Maturity date, September 7 7 The 90th day (Sept. 7th) is called the maturity date.

  22. COMPUTING THE DUE DATE EXAMPLE: The note signed by Sarah Mornay is dated June 9, 20-- and is due in 90 days. Days in June 30 9 Deduct date of note (June 9) Days remaining in June 21 Add: Days in July 31 31 Days in August Maturity date, September 7 7 Total time in days 90

  23. CALCULATING INTEREST EXAMPLE: The note signed by Sarah Mornay has a principal of $2,500, an annual interest rate of 9%, and is due in 90 days. FORMULA:   TIME PRINCIPAL RATE 90/360  9% $2,500.00  $56.25 interest

  24. CALCULATING INTEREST EXAMPLE: A $2,000, 8% note due in 3 months FORMULA:   PRINCIPAL RATE TIME  3/12 $2,000.00  8% $40 interest

  25. 3 • Account for notes receivable transactions and accrued interest.

  26. NOTES RECEIVABLE TRANSACTIONS • Seven types: • Note received from a customer in exchange for assets sold • Note received from a customer to extend time for payment of an account • Note collected at maturity • Note renewed at maturity • Note discounted before maturity • Note dishonored • Collection of dishonored note

  27. NOTE RECEIVED IN EXCHANGE FOR ASSETS EXAMPLE: On June 1, Linesch Hardware Co. sells an industrial mower to Williams Manufacturing for $8,500 in exchange for a 180-day, 9% note signed by Williams.

  28. GENERAL JOURNAL DATE DESCRIPTION DEBIT PR CREDIT 20-- 1 June 1 Notes Receivable 8,500 2 Sales 8,500 3 Received note for 4 merchandise sale 5 This is simply a sale in which the buyer signs a note (a promise to pay). Note that the seller will receive interest as well as principal. 6 7 8 9 10 11

  29. GENERAL JOURNAL DATE DESCRIPTION DEBIT PR CREDIT 20-- 1 Nov. 28 Cash 8,882.50 2 Notes Receivable 8,500.00 3 Interest Revenue 382.50 4 Received principal and interest 5 Assume 180 days later, Williams Manufacturing pays the maturity value of the note (principal plus interest). 6 7 8 9 10 11

  30. NOTE RECEIVED TO EXTEND TIME FOR PAYMENT EXAMPLE: Accounts receivable customer, Michael Putter, owes $2,000 to Linesch Hardware Co. To settle this account, Putter signs a 90-day, 10% note dated June 8. Why would we want to accept this note?

  31. NOTE RECEIVED TO EXTEND TIME FOR PAYMENT EXAMPLE: Accounts receivable customer, Michael Putter, owes $2,000 to Linesch Hardware Co. To settle this account, Putter signs a 90-day, 10% note dated June 8. Two reasons to accept this note: • The note is a formal, written promise to pay • Can be converted to cash at a bank if necessary • The note is likely to bear interest

  32. GENERAL JOURNAL DATE DESCRIPTION DEBIT PR CREDIT 20-- 1 June 8 Notes Receivable 2,000 2 Accts. Receivable/M. Putter 2,000 3 Received note to settle 4 account 5 6 Mr. Putter’s balance is removed from Accounts Receivable and placed into Notes Receivable. 7 8 9 10 11

  33. NOTE RECEIVED TO EXTEND TIME FOR PAYMENT EXAMPLE: What if accounts receivable customer, Michael Putter, gives a check for $250 and a note for $1,750 instead? Let’s look at the journal entry!

  34. GENERAL JOURNAL DATE DESCRIPTION DEBIT PR CREDIT 20-- 1 June 8 Cash 250 2 Notes Receivable 1,750 3 Accts. Receivable/M. Putter 2,000 4 Received cash and note 5 to settle account 6 7 8 9 10 11

  35. NOTE COLLECTED AT MATURITY • When a note receivable matures, it may be collected: • By the payee • By the bank named in the note • By a bank where it was left for collection

  36. NOTE COLLECTED AT MATURITY EXAMPLE: On September 6 (the due date), Putter pays the principal and interest on the note. Principal of note $2,000 Interest 50 $2,000 × 10% × 90/360

  37. NOTE COLLECTED AT MATURITY EXAMPLE: On September 6 (the due date), Putter pays the principal and interest on the note. Principal of note $2,000 Interest 50 Maturity value $2,050

  38. GENERAL JOURNAL DATE DESCRIPTION DEBIT PR CREDIT 20-- 1 2,050 Sept. 6 Cash 2 Notes Receivable 2,000 3 Interest Revenue 50 4 Received payment of note 5 with interest 6 7 8 9 10 11

  39. NOTE COLLECTED AT MATURITY EXAMPLE: What if the note had been left at Planet Bank for collection instead? Planet Bank would collect the maturity value from Putter, subtract out a service charge, and deposit the remainder in Linesch’s account.

  40. GENERAL JOURNAL DATE DESCRIPTION DEBIT PR CREDIT 20-- 1 2,040 Sept. Cash 6 2 Collection Expense 10 3 Notes Receivable 2,000 4 Interest Revenue 50 5 Received payment of note 6 with interest less collection 7 fee 8 9 10 11

  41. NOTE RENEWED AT MATURITY EXAMPLE: What if Mr. Putter had been able to pay the interest due on the note and asked to renew the note? Linesch Hardware Co. would collect the interest, and accept a new note to replace the original note.

  42. GENERAL JOURNAL DATE DESCRIPTION DEBIT PR CREDIT 20-- 1 50 Sept. 6 Cash 2 Notes Receivable (new note) 2,000 3 Notes Receivable (old note) 2,000 4 50 Interest Revenue 5 Received new note plus 6 interest on old note 7 8 9 10 11

  43. NOTE RENEWED AT MATURITY EXAMPLE: What if Mr. Putter had been able to pay the interest due on the note, pay $500 on the principal, and asked to renew the balance of the note? Linesch Hardware Co. would collect the interest and partial payment, and accept a new note to replace the original note.

  44. GENERAL JOURNAL DATE DESCRIPTION DEBIT PR CREDIT 20-- 1 550 Sept. 6 Cash 2 Notes Receivable (new note) 1,500 3 Notes Receivable (old note) 2,000 4 Interest Revenue 50 5 Received new note plus 6 partial payment and interest 7 on old note 8 9 10 11

  45. NOTE DISCOUNTED BEFORE MATURITY • If a business needs cash before the due date of a note, it can endorse the note and transfer it to a bank • The bank charges an interest fee called a “bank discount” • For the time between the date of discounting and the due date of the note • The difference between the maturity value and the bank discount is called the “proceeds”

  46. NOTE DISCOUNTED BEFORE MATURITY EXAMPLE: Assume the $2,000, 10%, 90-day note from Putter dated June 8 is discounted at the bank on July 8 at a rate of 12%. Calculating the discount and proceeds is a four- step process.

  47. NOTE DISCOUNTED BEFORE MATURITY EXAMPLE: Assume the $2,000, 10%, 90-day note from Putter dated June 8 is discounted at the bank on July 8 at a rate of 12%. Step #1 Compute the maturity value of the note. Face Interest Maturity Value = + = $2,000 $50 $2,050 +

  48. NOTE DISCOUNTED BEFORE MATURITY EXAMPLE: Assume the $2,000, 10%, 90-day note from Putter dated June 8 is discounted at the bank on July 8 at a rate of 12%. Step #2 Compute the number of days in the discount period—from the discount date to the due date. Days in July 31 Less: Discount date 8 The discount date is not counted in the discount period.

  49. NOTE DISCOUNTED BEFORE MATURITY EXAMPLE: Assume the $2,000, 10%, 90-day note from Putter dated June 8 is discounted at the bank on July 8 at a rate of 12%. Step #2 Compute the number of days in the discount period—from the discount date to the due date. Days in July 31 Less: Discount date 8 Remaining days in July 23 Plus days in August 31 Plus due date (Sept.) 6 Days in discount period 60

  50. NOTE DISCOUNTED BEFORE MATURITY EXAMPLE: Assume the $2,000, 10%, 90-day note from Putter dated June 8 is discounted at the bank on July 8 at a rate of 12%. Step #3 Compute the discount amount. Maturity Value Discount Period Discount Amount Discount Rate   =   = $41 $2,050 12% 60/360

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