What is Notes Payable?
Notes Payable are written agreements (promissory notes) in which one party agrees to pay the other party a certain amount of cash. Alternatively put, a note payable is a loan between two parties.
The following information is contained in a note payable:
- The amount to be paid
- The interest rate applied to the loan
- The maturity date
- Name of the maker of the note (payer)
- Name of the payee
- The signature of the person who issued the note with the date signed.
Notes Payable on a Balance Sheet
Notes payable appear as liabilities on a balance sheet. Additionally, they are classified as current liabilities when the amounts are due within a year. When a note’s maturity is more than one year in the future, it is classified with long-term liabilities.
An example of different accounts on a balance sheet:
Notice how notes payable can be short-term or long-term in nature.
John borrows $100,000 from Michelle on January 1, 2017. John signs the note and agrees to pay Michelle $100,000 six months later (January 1 through June 30). Additionally, John also agrees to pay Michelle a 15% interest rate every 2 months.
The journal entries would be as follows:
The Difference Between Accounts Payable and Notes Payable
The concept of accounts payable and notes payable are often mixed up. A definition of both of these terms along with their respective attributes are detailed below:
Accounts payable is an obligation that a business owes to creditors for buying goods or services. Accounts payable do not involve a promissory note, usually do not carry interest, and are a short-term liability (usually paid within a month).
These are written agreements in which the borrower obtains a specific amount of money from the lender and promises to pay back the amount owed, with interest, over or within a specified time period. It is a formal and written agreement, typically bears interest, and can be a short-term or long-term liability, depending on the note’s maturity time frame.
Creating an Enforceable Promissory Note
To create an enforceable promissory note, the following elements must be included:
- The loan amount
- The repayment dates
- The interest rate
- Default terms
- The names of both the lender and the borrower
- Mailing address where each payment is mailed to
- The borrower should print, sign, and date the promissory note
Both the items of Notes Payable and Notes Receivable can be found on the Balance Sheet of a business. While Notes Payable is a liability, Notes Receivable is an asset. Notes Receivable record the value of promissory notes that a business should receive, and for that reason, they are recorded as an asset. NP is a liability which records the value of promissory notes that a business will have to pay. This is analogous to accounts receivable vs. accounts payable.
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