Journal entry for issuing note payable

Introduction

In business, we may issue the note payable to the supplier to purchase the merchandise goods or to borrow money from another party. In this case, we need to make the journal entry for issuing the note payable in order to account for the liability that exists at the time of the issuance of the promissory note.

Note payable is the liability that occurs when we issue a promissory note to another party and this promissory note usually has the interest attached. Likewise, we usually need to also make the journal entry for the interest on note payable at the period adjusting entry or at the time of making the interest payment.

The interest on note payable represents the interest expense that will occur through the passage of time. In this case, we usually need to record the accrued interest at the period-end adjusting entry if the note is a long-term one or the note maturity crosses the accounting period.

Journal entry for issuing note payable

As mentioned, we may issue the note payable to borrow cash from another party or to purchase merchandise goods from our suppliers. In this case, we will have different journal entries for different cases.

Issuing note payable to borrow cash

We can make the journal entry for issuing the note payable to borrow the cash by debiting the cash account and crediting the notes payable account.

This journal entry of issuing the note payable will increase both total assets and total liabilities on the balance sheet.

Issuing note payable to purchase merchandise goods

Sometimes, we may issue the note payable to our supplier in order to exchange for the merchandise goods that we purchase. In other words, we may use the promissory note to purchase the merchandise goods from our supplier in steading of using cash.

In this case, we can make the journal entry for issuing the note payable to exchange for merchandise goods by debiting the merchandise inventory account and crediting the note payable account if we use the perpetual inventory system.

On the other hand, if we use the periodic inventory system, we will debit the purchases account instead.

In this journal entry, the purchases account is a temporary account that will be cleared at the end of the accounting period when we need to calculate the cost of goods sold.

Interest on note payable

As note payable usually comes with the interest attached, we usually need to also to make the journal entry for interest on note payable too.

Accrued interest on note payable

As mentioned, we may also need to make the journal entry for the accrued interest on the note payable if the note payable is a long-term note payable or it crosses the accounting period. This is to avoid the understatement of liabilities on the balance sheet as well as the understatement of the expenses on the income statement.

In this case, we can make the journal entry for the accrued interest on note payable by debiting the interest expense account and crediting the interest payable account.

Later, when we make the interest payment for the accrued interest on the note payable that we have recorded, we can make the journal entry as below:

Paying the accrued interest:

This journal entry is made to eliminate the interest payable that we have recorded above.

Alternatively, we don’t need to record the accrued interest on the note payable for the short-term note payable that will end during the accounting period. In this case, we only need to record the interest expense on the note payable when we make the interest payment.

Likewise, we can make the journal entry for paying the interest on the note payable as below instead:

Paying interest without accrual:

Lastly, at the end of the note’s maturity, we can make the journal entry for paying the note payable when we honor the promissory note as below:

Paying principal of the notes payable:

Issuing note payable example

For example, on January 1, we have issued a note payable of $10,000 to one of our suppliers in order to exchange for merchandise goods that we have received on the same day.

This note payable is a 6-month note payable with a 10% interest per annum or $500 ($10,000 x 10% x 6 / 12) that we promise to pay at the end of note maturity together with the principal of $10,000. And we use the perpetual inventory system in our company to manage to flow of the inventory in and out.

In this case, we can make the journal entry for issuing the $10,000 note payable by debiting this $10,000 amount to the merchandise inventory account and crediting the same amount to the notes payable account.

Issuing note payable:

This journal entry of issuing of $10,000 note payable will increase both total assets and total liabilities on the balance sheet by $10,000 as of January 1.

Later, when we make the payment on the note payable, including both principal and interest, at the end of the note maturity, we can make the journal entry for payment of note payable as below:

Paying principal and interest of note payable: