Journal entry for interest-bearing note payable

Introduction

Sometimes, we may issue an interest-bearing note to purchase the goods from our supplies or to borrow money from the creditor. In this case, we can make the journal entry for interest-bearing note payable in order to record our liability as well as to recognize the increase of the asset.

Interest-bearing note payable is the type of promissory note that we issue to the holder of the note with the interest attached. And we will need to recognize this interest as the interest expense on the income statement.

The interest expense is a type of expense that occurs through the passage of time. Hence, we may need to make the journal entry for the accrued interest on the note payable at the period-end adjusting entry even though we have made not the payment yet.

Of course, if the interest-bearing note payable is a type of short-term note which ends during the accounting period, we can record the interest expense when we make the interest payment.

In either case, there won’t be any interest to be recorded at the time of issuing the interest-bearing note. We just need to record the face value of the interest-bearing note payable in the journal entry at the time of issuing the promissory note to recognize our liability on the balance sheet.

Journal entry for interest-bearing note payable

At the time of issuing the note

We can make the journal entry for interest-bearing note payable by debiting the asset account and crediting the notes payable account on the day that we issue the note.

The asset account in this journal entry can be the cash account if we issue the promissory note to borrow money or it can be the merchandise goods if we issue the note to purchase the goods. Likewise, the journal entry for interest-bearing notes payable in this case will increase both total assets and total liabilities on the balance sheet.

Accrued interest on note payable

As mentioned, we may need to record the accrued interest on the note payable at the period end adjusting entry before the payment is made.

In this case, we can make the journal entry for the accrued interest on the notes payable by debiting the interest expense account and crediting the interest payable account at the period-end adjusting entry.

This journal entry is necessary as the interest occurs through the passage of time. Likewise, at the period-end adjusting entry, we need to recognize the accrued interest expense that has already occurred. At the same time, we need to record the liability which is the interest payable that we owe to the holder of the note.

Interest payment on note payable

Later, when we make the interest payment on the note payable, we can make another journal entry with the debit of the interest payable account and the credit of the cash account.

This journal entry is made to eliminate the interest payable that we have recorded above as well as to account for the cash outflow for the interest payment on the note payable.

Payment of notes payable

At the end of note maturity, we need to make the payment to the holder of the note in order to honor the promissory note that we have issued.

In this case, we can make the journal entry for the payment of notes payable by debiting the notes payable account and crediting the cash account.

The payment of the notes payable journal entry will decrease both total assets and total liabilities on the balance sheet.

Interest-bearing note payable example

For example, we run a merchandising business that uses the perpetual inventory system and our accounting period ends on December 31.

On July 1, 2021, we issue a 6-month promissory note to one of our suppliers in exchange for the $10,000 merchandise goods. In the note, we promise to pay the $10,000 which is the face value of the note with the interest of 10% per annum on January 1, 2022.

In this case, we can make the journal entry for issuing the $10,000 interest-bearing note on July 1, 2021, by debiting the merchandise inventory with this $10,000 together with the credit of the same amount to the notes payable account as below:

July 1, 2021:

In this journal entry of issuing the $10,000 promissory note, both total assets and total liabilities on the balance sheet increase by the same amount of $10,000 as of July 1, 2021.

Then, at the period-end adjusting entry of December 31, 2021, we can make the journal entry for the accrued interest on note payable with the $500 ($10,000 x 10% x 6 / 12) as below:

December 31, 2021:

This journal entry of accrued interest on note payable will increase total expenses on the income statement and total liabilities on the balance sheet by the same amount of $500 as of December 31, 2021.

Later, on January 1, 2022, when we make the payment to honor the promissory note that we have issued, we can make the journal entry as below:

Interest payment on notes payable:

Payment of notes payable:

Of course, we can combine these two journal entries into one journal entry instead as below:

January 1, 2022:

Interest payment without making accrual

As mentioned, we don’t need to record the accrued interest before the payment is made if the interest-bearing notes payable are short-term notes payable that its maturity ends during the accounting period.

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

Difference from the above journal entry, there is no accrued interest recorded here as we directly debit the interest expense account when we make the interest payment.

For example, on January 1, we issue a promissory note to borrow $1,000 cash from one of our friends. On this note, we promise to pay back the $1,000 amount with the interest of $50 on Jun 31 which is at the end of the second quarter of our accounting period.

In this case, we can make the journal entry for this $1,000 interest-bearing note payable on January 1 and June 31 as below:

Issuing the note on January 1:

Payment of the note with interest on June 31: