Promissory notes are commonly issued for goods purchased on account or when a bank extends a short-term loan. Notes issued by banks can be interest-bearing or non-interest bearing. Non-interest bearing notes deduct the interest from the face value (or maturity value) of the note from the amount loaned to the borrower. An interest bearing note requires payment of both the principal and interest accrued at maturity. An adjusting entry is necessary whenever interest is paid a day other than the end of the financial periods.
ABC company bougth ten tonnes of steel from XYZ company on credit on May 1 for $10,000 with term 2/10 Net30. On May 30, ABC issues and sends a 90 day 10% promissory note to XYZ company. On
August 31, ABC pays the $10,000 note and an interest of $250 (10,000 x 10% x 90/360).
The entries at ABC company are
May 1 Raw materials inventory 10,000
Accounts payable 10,000
May 30 Accounts payable 10,000
Notes payable 10,000
Aug 31 Notes payable 10,000
Interest expense 250
Cash 10,250
The entries at XYZ company are
May 1 Accounts receivable 10,000
Sales 10,000
Cost of goods sold 7,000
Cost of goods sold 7,000
May 30 Notes receivable 10,000
Accounts receivable 10,000
Aug 31 Cash 10,250
Notes receivable 10,000
Interest revenue 250
Note that ABC could have issues a non-interest bearing 90 day promissory note of $10,250 on May 30 for its liability of $10,000. The implied interest in such non-interest bearing note is
known as discount rate.
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