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Short Term Notes Payable

Short Term Notes Payable

Author: Evan McLaughlin
Description:

In this lesson, the student will learn about short term notes payable.

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Tutorial

"Short Term Notes Payable"

Source: Instrumental “Drops of H2O ( The Filtered Water Treatment )" by J.Lang (feat. Airtone),” Creative Commons, http://ccmixter.org/files/djlang59/37792

Video Transcription

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Hey everyone, and welcome to our video today on short-term notes payable. So what is today's video about? Well, today we're going to talk about short-term notes payable. We're going to start by reviewing our current liabilities, discussing short-term notes payable, and then we're going to finish up today by doing some interest payable calculations.

But let's start with a quick review of current liabilities. What are our current liabilities? They show the company's obligation to pay debts to others within one year or the operating cycle, whichever is shorter. So this is our short-term debt obligations.

What types are there? Well, there's accounts payable, sales tax payable, unearned revenue, and contingent and uncertain liabilities are some of the current liabilities that we'll see. But today we're going to discuss another current liability called short-term notes payable.

So let's talk about that. Short-term notes payable, what are they? They're written agreements to pay a defined sum of money at a specific future date. So we have an agreement to pay a defined sum of money at a specified future date. That's a key piece there, specified at a future date.

And because they're short-term notes payable, they're going to be due within less than a year. So that specified future date is going to be within less than a year. And short-term notes payable are also interest bearing, so there's going to be a stated interest rate for our short-term notes payable.

Now, what do we use short-term notes payable for? Well, one example would be for purchasing equipment. So it's a way to finance that purchase if the company doesn't have the cash on hand immediately.

So now let's look at some examples of establishing notes payable. Our first example, we have ABC Company that borrows $50,000 from National Bank on January 1, 2012. Now ABC Company signs a 5%, six-month note.

So the key terms there are they sign, so we have an agreement. There's our specified amount, $50,000. We have a stated interest rate. And it's due in less than a year.

So what does the journal entry look like to establish this note payable? We're going to have a debit to cash, because the company is receiving cash. And then we're going to credit our short-term notes payable. So we're going to credit that current liability account for $50,000.

Let's look at a second example. So now we have XYZ Company. And they borrow $100,000 from Local Bank on January 1, 2012. XYZ Company signs a 6%, eight-month note.

So again we see "signs," so there's a written agreement to pay a specified sum. We have a stated interest rate and at a specified future date. So it's due in eight months.

So what's the journal entry to establish that note? Well, we would debit our cash again for $100,000, because the company is receiving those funds. And then we would credit that short-term notes payable current liability account for $100,000. So those are a couple examples of establishing our note payable. So that's short-term notes payable.

Now let's turn our attention to interest payable. So what is the calculation for determining interest payable? Well, the calculation reads I equals P times R times T.

What does all that mean? What does that stand for? I stands for interest, so the interest equals the principal, so the amount of the loan, multiplied by the rate. So that's going to be our stated rate that's in that written agreement. And time is the length of time that that note is outstanding.

So now the easiest way to illustrate interest payable, this I equals P times R times T, is to look at some examples. So let's use those same two examples that we just looked at. But now we're going to calculate interest payable.

So if we have ABC Company that borrowed $50,000 from National Bank and they signed a 5%, six-month note, what is the interest payable? Well, we start with our formula I equals PRT. So I equals principal, which is $50,000, multiplied by the rate, which is 5%, and then multiplied by 6 divided by 12.

So because it's a six-month note and those interest rates are based on an entire year, we would multiply it by the number of months of the note divided by the number of months in the year. So that's why we use that 6 divided by 12. So that would give us interest for this example of $1,250.

Now let's look at that second example that we did earlier. XYZ Company borrowed $100,000 from Local Bank on January 1, 2012. XYZ Company signed a 6%, eight-month note.

So what is the interest payable? We're going to go through that same process that we did above. We have our formula I equals principal times rate times time. I equals $100,000, which is our principal in this case, multiplied by our rate, which is 6%, and then multiplied by 8 divided by 12, again because it's a fraction of a year. That gives us total interest of $4,000 in this example.

So that's our total interest payable. So that's our interest payable. That's how we would calculate interest payable.

So let's summarize what we talked about today. In a nutshell, we talked about short-term notes payable. We did a review of current liabilities, talked about those short-term notes payable. And then we walked through some calculations of interest payable and looking at that formula I equals P times R times T.

I hope everybody enjoyed this video. And I hope to see you next time.