Journal Entry for Commercial Paper

Commercial paper is an unsecured short-term debt instrument issued by a corporation. Commercial paper is a promissory note with a maturity of 270 days or less.

Commercial paper can be a great way for businesses to fulfill the short-term capital without having to take on additional long-term debt or dilute their equity. It also offers investors a relatively safe investment with relatively high liquidity.

Commercial paper is often used by finance subsidiaries of US companies to finance the accounts receivable, inventory, and other short-term assets owned by the company. The commercial paper is the secured debt as they are not backed by any collateral. The commercial paper is not subject to claims by creditors since no security was given. Commercial paper is usually sold at a discount from face value with the rate of the discount dependent upon the creditworthiness of the issuer. If an issuer fails to pay back, in most cases it is required to file for bankruptcy and liquidate its assets.

The issuers have to record the commercial paper as the liability on the balance sheet. Due to the short life, it should be recorded as short-term debt.

The issuer has to pay the interest to the investor base on the agreed rate. It will be recorded as an interest expense on the income statement. This expense has to record based on accrued basic which is not related to the cash payment.

Journal Entry for Commercial Paper

When the company issues commercial paper to the market, it will be able to raise the cash to support the operation. They have the obligation to pay back the principal and interest to the holders.

The journal entry is debiting cash and credit short-term debt security.

The cash will increase based on the amount receive from the investors. It will increase the short-term debit security as well.

At the end of the month, the issuer has to record the interest expense base on the agreed rate. The journal entry is debiting interest expense and credit cash paid.

On the maturity date, the company has to pay back the amount of cash received from investors. The journal entry is debiting short-term debit security and credit cash.

Example

Company ABC has issued 1,000 commercial paper to the private investors for $ 1,000 each. The company is able to raise $ 1 million. The interest expense is 6% per annum, and they require to pay back at the end of the 6th month. Please prepare the journal entry for commercial paper transactions.

The company issues commercial paper and receives cash from private investors. The journal entry is debiting cash $ 1,000,000 and credit short-term debt security $ 1,000,000.

At the end of the month, company has to record interest expenses and make payments to the investors.

Interest expense /month = ($ 1,000,000 * 6%)/12 = $ 5,000

The journal entry is debiting interest expense $ 5,000 and credit cash $ 5,000.

The company has to record the interest expense for the period of six months which is the coverage period of commercial paper.

On the maturity date, ABC has to pay back the principal to the investors. The journal entry is debiting short-term debt security $ 1,000,000 and credit cash $ 1,000,000.