LO8–2 Account for notes payable and interest expense.

What is a note payable and how is it created?

Borrowing cash and signing a note promising repayment plus interest.

Why do companies often use short‑term debt?

Short‑term loans usually have lower interest rates because default risk is lower.

Formula for calculating interest on a note

Interest = Face Value × Annual interest rate × (Months ÷ 12).

Total interest on Southwest’s six‑month note

$3,000.

Why is interest split between 2027 and 2028?

Interest must be recorded in the period it is incurred, not when paid.

Journal entry when Southwest borrows $100,000 on Sept 1, 2027

Debit: Cash 100,000

Credit: Notes Payable 100,000

Adjusting entry for interest on Dec 31, 2027 (4 months)

Debit: Interest Expense 2,000

Credit: Interest Payable 2,000

Why is 2027 interest = $2,000?

100,000 × 6% × 4/12 = 2,000 (Sept–Dec)

Journal entry when note is paid on March 1, 2028

Debit: Notes Payable 100,000

Debit: Interest Payable 2,000

Debit: Interest Expense 1,000

Credit: Cash 103,000

Why is 2028 interest = $1,000?

100,000 × 6% × 2/12 = 1,000 (Jan–Feb)

What is a note receivable?

A written promise for the lender to receive repayment plus interest.

What is interest receivable?

Interest earned but not yet collected.

Bank of America entry when lending $100,000 on Sept 1, 2027

Debit: Notes Receivable 100,000

Credit: Cash 100,000

Bank adjusting entry for interest on Dec 31, 2027

Debit: Interest Receivable 2,000

Credit: Interest Revenue 2,000

Bank entry when note is collected on March 1, 2028

Debit: Cash 103,000

Credit: Notes Receivable 100,000

Credit: Interest Receivable 2,000

Credit: Interest Revenue 1,000

What is a line of credit?

A prearranged borrowing limit allowing a company to borrow as needed.

A note payable is recorded each time the company borrows money under the line of credit. However, there is no financial statement effect up front when the line of credit is first negotiated because no money has yet been borrowed and no interest cost has been incurred.

When is interest charged on a line of credit?

Only when money is actually borrowed.

What journal entry is made when a line of credit is first arranged?

None — no cash borrowed yet.

What is another name for a line of credit?

Revolving credit arrangement.

What is commercial paper?

Short‑term borrowing from another company instead of a bank.

Why is commercial paper cheaper?

Companies charge lower interest rates than banks.

Typical maturity of commercial paper

30–270 days.

How is commercial paper recorded?

Same as notes payable.

• Debit cash

• Credit commercial paper payable

Interest being built up

• Debit interest expense

• Credit interest payable

When commercial paper matures and is paid

• Debit commercial paper payable

• Debit interest payable

• Debit interest expense

• Credit cash

What are accounts payable?

Amounts owed to suppliers for goods/services purchased on credit.

Why are accounts payable attractive?

Suppliers usually do not charge interest — free financing.

How are most accounts payable classified?

Current liabilities.

Journal entry when inventory is purchased on account

Debit: Inventory

Credit: Accounts Payable

Journal entry when accounts payable is paid

Debit: Accounts Payable

Credit: Cash