In accounting, the recording of any single business transaction involves at least two accounts representing both a debit and credit. In other words, according to the University of Minnesota, the double-entry recording requires that the full transaction value be recorded on the debit side of one or more accounts and also on the credit side of one or more accounts.
The general rule of thumb is that the total amount of debit should always match, or offset, the total amount of credit in any journal entry. Notes payable as a liability account is often offset by an increase or decrease in an asset account depending on the change in notes payable.
What Is Notes Payable?
Notes payable is a type of borrowing in the form of a promissory note in which the borrower promises to pay back the principal amount plus interest (at a specified interest rate) to the lender at a future due date. The written promises tend to be more specific than accounts payable, which is usually more short term and informal.
Thus, notes payable is a liability account listed on financial statements, specifically the balance sheet, explains the Harvard Business School. It is also defined as a credit account.
It's also important to know the difference between short-term notes payable vs long-term notes payable. When the amount of money is due to the creditor within a year, the short-term notes are classified under current liabilities. However, when the due date is more than a year, the long-term notes will be noncurrent and categorized as a long-term liability.
An increase in the amount of notes payable from a new issuance is recorded as a credit entry to the account, and a decrease in the amount of notes payable from repayments of a due balance is recorded as a debit entry to the account.
How Issuance Entry Works
Since the issuance of notes payable requires recording a credit entry to the notes payable account, the offset entry to the notes payable as issued will be a debit entry, most likely to an asset account.
If the issuance of notes payable is directly used to provide a capital source for an asset business owners want or need, the offset entry to the notes payable will be a debit entry to increase either the cash account or the account of the asset straightly financed by the notes payable.
However, if the issuance of notes payable is to pay down the balance of another liability, the offset entry to the notes payable account will be a debit entry to that liability account in the balance sheet.
How Repayment Entry Works
Since the repaying of notes payable requires recording a debit entry to the notes payable account, the offset entry to the notes payable being repaid will be a credit entry to an asset account or an equity account.
When cash is used to pay down the notes payable, the offset entry to the notes payable will be a credit entry to decrease the cash account. When the due notes payable is restructured and converted to equity, the offset entry to the notes payable will be a credit entry to increase either the preferred or common stock account.
How Interest Entry Works
A transaction of notes payable also involves making different entries on related interest accounts. Interest on notes payable accrues at the end of an accounting period during the term of the notes payable.
To record the accrued interest, interest expense is debited, and interest payable is credited, notes the College of San Mateo. At the due date of the notes payable, interest payable is debited for the interest, and cash is credited to pay for the interest expense.
Also, additional cash is credited to pay for any outstanding interest payable from previous accrual, and the outstanding interest payable is debited and removed.
This article was written by PocketSense staff. If you have any questions, please reach out to us on our contact us page.