Chapter 16 - Notes Payable and Notes Receivable

Question 1

ACCOUNTING FOR NOTES PAYABLE

promissory notes

Answer 1

• is a written promise to pay a certain amount of money at a specific future time
• is a negotiable instrument

Question 2

ACCOUNTING FOR NOTES PAYABLE

interest

Answer 2

• is the fee charged for the use of money
• is calculated used the formula :
  Interest = Principal x Rate x Time or I = PRT
• the time period is indicated in frictions of a year - 360 days

Question 3

ACCOUNTING FOR NOTES PAYABLE

banker’s year

Answer 3

• a 360-day period used to calculate interest on a note

Question 4

ACCOUNTING FOR NOTES PAYABLE

principal

Answer 4

• the amount shown on the face of the note

Question 5

ACCOUNTING FOR NOTES PAYABLE

face value

Answer 5

• an amount of money indicated to be paid, exclusive of interest or discounts

Question 6

ACCOUNTING FOR NOTES PAYABLE

maturity value

Answer 6

• the total amount (principal plus interest) payable when a note comes due

Question 7

ACCOUNTING FOR NOTES PAYABLE

note payable

Answer 7

• a liability representing a written promise by the maker of the note (the debtor) to pay another party (the creditor) a specified amount at a specified future date

Question 8

ACCOUNTING FOR NOTES PAYABLE

discounting

Answer 8

• deducting the interest from the principal on a note payable or receivable in advance

Question 9

ACCOUNTING FOR NOTES PAYABLE

Notes Payable

Answer 9

• at the end of each accounting period, a schedule of notes payable is prepared from the information in the notes payable register
• the schedule of notes payable must agree with the Notes Payable account in the general ledger
• For each note payable, the notes payable register shows the following information :
  
  • the issue date
  • the payee
  • where the note is payable
  • the term of the note
  • the maturity date
  • the face amount
  • the Interest rate, if any
  • the interest amount, if any
• Notes due within one year are classified as current liabilities
• Notes due in more than one year are classified as long-term liabilities l

Question 10

ACCOUNTING FOR NOTES PAYABLE

negotiable instrument

Answer 10

• a financial document containing a promise or order to pay that meets all requirements of the Uniform Commercial Code in order to be transferable to another party
• The UCC requirements specify that to be negotiable an instrument must :
  
  • be in writing and must be signed by the maker or drawer
  • contain an unconditional promise or order to pay a definite amount of money
  • be payable either on demand or at a future time that is fixed or that can be determined
  • be payable to order of a specific person or to the bearer
  • clearly name or identify the drawer if addressed to a drawee
• checks are negotiable instruments
• another important negotiable instrument is the promissory note
• promissory notes may be either notes payable or notes receivable

Question 11

ACCOUNTING FOR NOTES RECEIVABLE

notes receivable

Answer 11

• an asset representing a written promise by another party (the debtor) to pay the note holder (the creditor) a specified amount at a specified future date
• at maturity date, the holder will receive cash for the note receivable; if the holder wants cash before the maturity date, the note can be discounted (sold) at the bank; the bank pays the holder the maturity value (principal plus any interest) minus the discount charge.

Question 12

ACCOUNTING FOR NOTES RECEIVABLE

Annual Percentage Rate (APR)

Answer 12

• Some lenders charge lower interest rates but add high fees; others do the reverse
• The APR allows you to compare them on equal terms
• It combines the fees and interest charges to give you the true annual interest rate.

Question 13

ACCOUNTING FOR NOTES RECEIVABLE

Calculating the Discount and the Proceeds

Answer 13

• Step 1 : Determine the maturity value of the note.
• Step 2 : Calculate the number of days in he discount period
  
  • The discount period is the number of days from the discount date to the maturity date
• Step 3 : Compute the discount charged by the bank.
  
  • The discount formula is similar to the interest formula
  • The time is the number of days in the discount period
  • Discount = Maturity Value (MV) x Discount Rate x Discount Period
• Step 4 : Calculate the proceeds, the amount received from the bank
  
  • This is the maturity value minus the discount

Question 14

ACCOUNTING FOR NOTES RECEIVABLE

contingent liability

Answer 14

• an item that can become a liability if certain things happen
• a common way to show contingent liabilities is to present the net notes receivable on the balance sheet and to include a footnote with the information about the discounted notes receivable

Question 15

ACCOUNTING FOR NOTES RECEIVABLE

Calculating the Discount and the Proceeds

Answer 15

• Step 1 : Determine the Maturity Value of the note
  
  • Maturity value is the principal plus the interest
• Step 2 : Calculate the number of days in the discount period
• Step 3 : Compute the discount charged by the bank
• Step 4 : Calculate the proceeds
  
  • Maturity Value minus the discount

Question 16

ACCOUNTING FOR NOTES RECEIVABLE

Reporting Notes Receivable and Interest Income

Answer 16

• Notes receivable appear on the balance sheet as assets
  
  • Notes that mature within one year are classified as current assets
  • Notes that mature in more than one year are classified as long-term assets
• The contra asset account Notes Receivable - Discounted appears as a deduction from Notes Receivable
• Interest income is classified as nonoperating income
• It is listed in the Other Income and Expenses section of the income statement and is added to income from operations
• The discount charged for discounting notes is shown as interest expense in the Other Income and Expenses section and is deducted from Income from Operations

Question 17

ACCOUNTING FOR NOTES RECEIVABLE

draft

Answer 17

• a written order that requires one party (a person or business) to pay a stated sum of money to another party
• includes checks, bank drafts, and commercial drafts

Question 18

ACCOUNTING FOR NOTES RECEIVABLE

bank draft

Answer 18

• a check written by a bank that orders another bank to pay the stated amount to a specific party
• a bank draft is more readily accepted than a personal or business check
• bank drafts are used to pay debts to suppliers with whom credit has not been established

Question 19

ACCOUNTING FOR NOTES RECEIVABLE

cashier’s check

Answer 19

• a draft on the issuing bank’s own funds
• cashier’s checks are sometimes used to pay bills
• for the creditor, a cashier’s check offers more protection than a business or personal check.

Question 20

ACCOUNTING FOR NOTES RECEIVABLE

Negotiable Instruments

Answer 20

• Because notes payable and notes receivable are negotiable instruments, they fall under the rules and regulations of the Uniform Commercial Code. Management needs to understand the rights, responsibilities, and obligations of the business for negotiable instruments.
• Management should carefully control and limit borrowing to minimize the interest charged for the use of funds.
• In a well-run business, managers ensure the prompt payment of debts to minimize interest expense and to maintain the company’s credit rating.
• Management authorizes specific individuals to approve the use of debt.
• When cash is needed for current operations, managers need to know that notes receivable can be discounted.
• Good managers ensure that past due accounts receivable are converted into notes receivable because notes provide more legal protection and are more likely to be collected.
• Because notes and drafts are negotiable, management ensures the internal control procedures are in place.

Question 21

ACCOUNTING FOR NOTES RECEIVABLE

commercial draft

Answer 21

• a note issued by one party that orders another party to pay a specified sum on a specified date
• commercial drafts are used for special shipment and collection situations
• commercial drafts may be either sight drafts or time drafts

Question 22

ACCOUNTING FOR NOTES RECEIVABLE

sight draft

Answer 22

• a commercial draft that is payable on presentation
• when a sight draft is issued, no journal entry is made
• when a sight draft is honored, the transaction is recorded as a cash receipt
• sight drafts are used to collect past-due accounts receivable
• sight drafts are also used to obtain cash in delivery when shipments are made to customers with poor credit or to new customers with no credit established

Question 23

ACCOUNTING FOR NOTES RECEIVABLE

Bill of lading

Answer 23

• a business document that lists goods accreted for transportation
• the bill of lading is sent to a bank near the customer
• the customer pays the draft in order to get the bill of lading
• the customer needs the bill of lading in order to obtain the goods
• the collecting bank sends the money, less a collection fee, to the business issuing the draft
• when the funds arrive, the business records the transaction as a cash sale and debits an expense account for the collection fee

Question 24

ACCOUNTING FOR NOTES RECEIVABLE

time draft

Answer 24

• is a commercial draft that is payable during a period of time.
• the time period may be a specific date, or a specific number of days either after the date of the draft or after the acceptance of the draft
• no journal entry is made when a time draft is issued
• if the business honors (pays) the draft, the word “Accepted” is written on the draft and it is signed and dated.
• the business records it as a note receivable

Question 25

ACCOUNTING FOR NOTES RECEIVABLE | trade acceptance

Answer 25

- a form of commercial time draft used in transactions involving the sale of goods - the original transaction is recorded as a sale on credit - when the draft is accepted, it is accounted for as a promissory note - merchants have fewer credit losses on trade acceptances an on accounts receivable - trade acceptances can be discounted

Question 26

ACCOUNTING FOR NOTES RECEIVABLE | Internal Controls for Notes Payable, Notes Receivable, and Drafts

Answer 26

- Limit the number of people who can sign notes for the firm. - Record all notes payable immediately. - Identify a specific person or department to be responsible for prompt payment of interest and principal for notes payable. - When paid, mark the note payable "Canceled" or "Paid" and file the note. - Handle drafts as carefully as checks. - Authorize certain persons only to accept notes. - Record all notes receivable in the accounting records. - Store notes receivable securely in a safe or fireproof vault to which access is limited. - Verify and compare the actual notes receivable to the notes receivable registrar. - Near the maturity date, inform the issuer of the approaching due date and the amount owed. - If payment is not received on the due date, contact the issuer immediately. - Review all past-due notes promptly and take necessary steps, including legal action, to ensure payment.