Promissory Note

Promissory Note Negotiable Instrument Payment Promise Financial Document Debt Instrument Payment Obligation Maker Payee Financial Agreements
A promissory note is a negotiable instrument that contains a written promise to pay a specified sum of money to a named person, their order, or the bearer at a predetermined future date. It must be unconditional, signed by the maker, and delivered to the payee or bearer.
On this page

Definition: Promissory Note

A promissory note is a financial document and negotiable instrument that includes an explicit, written promise by one party (the maker) to pay a certain amount of money to another party (the payee), or to their order, or to the bearer of the note, at a specified time in the future. For a promissory note to be valid, it must meet several criteria:

  • The promise to pay must be unconditional.
  • It must be signed by the maker.
  • The document must be delivered to the payee or bearer.

Promissory notes are widely used in the USA but are not in common use in the UK. Reissuance of a promissory note is not possible unless the promise is made by a banker and the note is payable to the bearer, which effectively makes it a banknote.

Examples

  1. Personal Loan Agreement: A borrower signs a promissory note to borrow $10,000 from a lender, promising to repay the amount in monthly installments over the next five years at a 5% annual interest rate.

  2. Corporate Finance: A company issues a promissory note for borrowing funds to finance expanding its operations, promising to pay back the principal along with interest to the lender after two years.

Frequently Asked Questions

What is the primary purpose of a promissory note?

The main purpose of a promissory note is to formally document the commitment of the maker to repay a specified sum of money to the payee or bearer at a future date.

Is a promissory note legally binding?

Yes, a promissory note is a legally binding document, provided it contains all the necessary elements and is signed by both parties involved.

Can a promissory note be negotiated?

Yes, since a promissory note is a negotiable instrument, it can be transferred to another party via endorsement, making the new holder the payee.

What happens if a promissory note is not paid?

If the maker of the note fails to fulfill its payment obligations, the payee can take legal action to recover the owed amount based on the terms outlined in the promissory note.

How does a promissory note differ from an IOU?

A promissory note is a more formal financial document than an IOU. It includes terms related to payment date, interest rate, and signatures, making it legally enforceable. An IOU is generally a simple acknowledgment of debt without detailed terms or legal enforceability.

  1. Negotiable Instrument: A written document guaranteeing the payment of a specific amount of money, either on demand or at a set time, which is transferable by endorsement or delivery.
  2. Maker: The party who signs and promises to pay the amount specified in a promissory note.
  3. Payee: The party to whom the payment is promised in a promissory note.
  4. Endorsement: The act of signing the back of a negotiable instrument, making it payable to someone other than the stated payee.
  5. Banknote: A type of promissory note issued by a bank, payable to the bearer on demand without conditions.

Online References

  1. Investopedia: Promissory Note
  2. US Small Business Administration: Understanding Promissory Notes
  3. The Balance: Promissory Note Legal Overview

Suggested Books for Further Studies

  1. “The Law of Promissory Notes: Cases, Materials, and Problems” by Steven L. Emanuel
  2. “Fundamentals of Negotiable Instruments” by Franklin D. Summers
  3. “Debt Instruments: A Guide to the world’s debt capital markets” by Moorad Choudhry

Accounting Basics: “Promissory Note” Fundamentals Quiz

### What is a promissory note primarily used for? - [x] Documenting a promise to pay a specific sum of money. - [ ] Creating a lease agreement. - [ ] Transferring property ownership. - [ ] Verifying an employee's salary. > **Explanation:** A promissory note is used to document a promise to pay a certain sum of money to a specified party at a future date, making it a formal debt instrument. ### Who must sign a promissory note to make it valid? - [ ] Only the payee. - [x] The maker. - [ ] A witness. - [ ] Both the maker and the payee. > **Explanation:** The maker, who is the party promising to pay, must sign the promissory note for it to be valid. The payee's signature is not mandatory for validity. ### Can a promissory note be reissued? - [ ] Yes, always. - [ ] No, never. - [x] Only if it is made by a banker and payable to the bearer. - [ ] Only with consent from the payee. > **Explanation:** A promissory note cannot be reissued unless it is a banknote, which is a promissory note made by a banker and payable to the bearer. ### What is a critical requirement for a promissory note? - [ ] A specified future payment date. - [ ] It must earn interest. - [x] It must include an unconditional promise to pay. - [ ] It must be in the form of a digital document. > **Explanation:** A promissory note must contain an unconditional promise to pay a specified sum of money to the payee or bearer at a future date. ### Is a promissory note legally enforceable? - [x] Yes, if it meets all necessary legal requirements. - [ ] No, it is only a simple acknowledgment. - [ ] Only if a lawyer drafts it. - [ ] Only if both parties are corporations. > **Explanation:** A promissory note is legally enforceable if it includes all required elements such as an unconditional promise to pay, signature of the maker, and delivery to the payee. ### Who can endorse a negotiable promissory note? - [ ] Only the initial maker. - [ ] Only the payee. - [x] Any current holder. - [ ] Only a recognized financial institution. > **Explanation:** Any current holder of a negotiable promissory note can endorse it to transfer the right to another party. ### What differentiates a promissory note from an IOU? - [ ] A promissory note cannot be transferred. - [ ] An IOU is legally binding. - [x] A promissory note includes detailed payment terms. - [ ] An IOU is more formal. > **Explanation:** A promissory note is more formal and includes detailed terms such as payment dates and interest rates, unlike an IOU, which is generally a simple acknowledgment of debt. ### What must accompany the promissory note to ensure delivery? - [ ] A witness signature. - [x] Physical transfer to the payee. - [ ] A notary public seal. - [ ] Bank verification. > **Explanation:** The promissory note must be physically delivered to the payee to ensure the promise to pay is recognized. ### How often are promissory notes used in the UK compared to the USA? - [x] Less frequently in the UK. - [ ] More frequently in the UK. - [ ] Equally in both countries. - [ ] Only in the UK. > **Explanation:** Promissory notes are widely used in the USA but are not in common use in the UK. ### What does the term "maker" refer to in a promissory note? - [ ] The person who receives payment. - [ ] The intermediary in the transaction. - [ ] The issuing bank. - [x] The person promising to pay. > **Explanation:** The "maker" in a promissory note is the person who signs and promises to pay the amount specified to the payee or bearer.

Thank you for your dedication to understanding fundamental accounting terms and for engaging in our informative quiz about promissory notes. Continue striving for excellence in your financial education!

Tuesday, August 6, 2024
Promotion
Proletariat
Note Receivable January 1, 1
Accommodation Paper January 1, 1
Check January 1, 1
Debt January 1, 1
Debt Instrument January 1, 1
Maker January 1, 1

Accounting Terms Lexicon

Discover comprehensive accounting definitions and practical insights. Empowering students and professionals with clear and concise explanations for a better understanding of financial terms.