Note, Note Payable

Definition

A note or note payable is a written document that acknowledges a debt and contains a promise by one party (the maker) to pay a specific sum of money to another party (the payee) at a designated future date. This financial instrument specifies the principal amount, the interest rate (if any), the date when the payment is due (maturity date), and other terms and conditions of the repayment.

Examples

Business Loan: A company borrows $100,000 from a bank, agreeing to pay it back over five years with interest. This agreement is documented in a note payable.
Promissory Note: An individual takes out a private loan from a friend and provides a promissory note indicating the amount owed, the repayment schedule, and the interest rate.
Vendor Financing: A small business purchases inventory on credit from a supplier who issues a note payable specifying the payment terms.

Frequently Asked Questions (FAQ)

What is the difference between a note payable and a promissory note?

A note payable is a broader term that refers to any written agreement to pay a debt, while a promissory note is specifically a type of note payable that strictly outlines the promise to pay a certain amount at a stipulated time.

Can a note payable have an indefinite maturity date?

No, a note payable must have a maturity date that is either definite or becomes definite over time. The agreement should specify when the debt is due to provide clarity for both parties.

Is interest always applied to notes payable?

Not necessarily. While many notes payables have an interest component, some may be interest-free, particularly in certain informal or intrapersonal agreements.

What happens if a note payable is not paid by the maturity date?

If a note payable is not paid by the maturity date, the debt is considered in default. The payee may then pursue legal action to recover the owed sum, and the maker may face additional penalties or increased interest rates.

How are notes payable recorded in accounting?

Notes payable are recorded as liabilities on the balance sheet of the entity that owes the money. The principal amount is classified under long-term or short-term liabilities based on the maturity date, and any interest expense appears on the income statement.

Promissory Note: A specific type of note payable that explicitly promises to pay a specified sum at a determined date or on demand.
Debenture: A medium to long-term debt instrument not secured by physical assets or collateral.
Bond: A debt security issued by entities such as corporations or governments typically for a fixed term at a specified interest rate.
Maturity Date: The date on which the principal amount of a note, bond, or another debt instrument becomes due and payable.
Interest Rate: The percentage of the principal charged by the lender to the borrower for the use of assets.

Online References

Investopedia: Note Payable
Wikipedia: Promissory Note
Accounting Tools: Notes Payable
Corporate Finance Institute: Notes Payable

Suggested Books for Further Studies

“Accounting Made Simple: Accounting Explained in 100 Pages or Less” by Mike Piper
“Principles of Accounting” by Donald E. Kieso, Jerry J. Weygandt, and Paul D. Kimmel
“Intermediate Accounting” by J. David Spiceland, James Sepe, and Mark Nelson
“Financial Accounting” by Walter T. Harrison Jr., Charles T. Horngren, and C. William (Bill) Thomas
“Corporate Finance” by Jonathan Berk and Peter DeMarzo

Fundamentals of Note Payable: Accounting Basics Quiz

### What is a note payable? - [ ] It is a written promise to receive money. - [x] It is a written promise to pay a specific sum of money at a future date. - [ ] It is a demand for immediate payment. - [ ] It is a receipt of goods or services. > **Explanation:** A note payable is a written promise to pay a specific sum of money to another party by a designated future date. ### Is interest always charged on a note payable? - [ ] Yes, always. - [x] No, it depends on the terms of the agreement. - [ ] Yes, but at a fixed rate. - [ ] No, never. > **Explanation:** Not all notes payables accrue interest; it depends on the contractual terms agreed upon by the involved parties. ### What happens if a note payable is not paid by the maturity date? - [ ] The debt is forgiven. - [x] The debt is considered in default. - [ ] The maturity date is extended automatically. - [ ] The interest rate is reduced. > **Explanation:** If a note payable is not paid by the maturity date, the debt is considered in default, which may lead to legal action and potential penalties. ### How is a note payable categorized on a balance sheet? - [x] As a liability - [ ] As an asset - [ ] As revenue - [ ] As equity > **Explanation:** A note payable is categorized as a liability on the balance sheet because it represents a debt that the company is obliged to pay. ### What does the maturity date indicate in a note payable? - [ ] When the note was issued - [ ] The interest rate applied - [x] When the principal amount is due - [ ] The creditworthiness of the borrower > **Explanation:** The maturity date indicates when the principal amount of the note payable becomes due and must be repaid to the payee. ### Which of the following documents is a type of note payable? - [ ] Invoice - [ ] Receipt - [x] Promissory note - [ ] Memorandum of understanding > **Explanation:** A promissory note is a type of note payable that explicitly promises to pay a specified sum at a determined date or on demand. ### How would a company record the issuance of a note payable in its accounting books? - [ ] As an equity transaction - [x] As a liability entry - [ ] As a revenue transaction - [ ] As a capital investment > **Explanation:** The issuance of a note payable is recorded as a liability in the company's accounting books because it represents a debt obligation. ### What might affect whether a note payable is considered a short-term or long-term liability? - [x] The note's maturity date - [ ] The principal amount - [ ] The interest rate - [ ] The financial condition of the borrower > **Explanation:** The maturity date of the note payable determines whether it is classified as a short-term (due within one year) or long-term liability (due after one year). ### Which entity typically has the designation of payee in a note payable arrangement? - [x] The party receiving the payment - [ ] The party making the payment - [ ] The financial institution holding the note - [ ] The government body overseeing the transaction > **Explanation:** In a note payable arrangement, the payee is the party receiving the payment, who is owed the specified amount of money described in the note. ### Can conditions other than monetary terms be included in a note payable? - [ ] No, only monetary terms are allowed. - [x] Yes, other conditions may apply depending on the agreement. - [ ] Yes, but only legally non-binding ones. - [ ] No, other conditions render the note invalid. > **Explanation:** Yes, a note payable can include other conditions as agreed upon by the parties involved, such as collateral agreements or performance requirements.

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