What is Notes Payable?
Notes Payable is a written agreement (a promissory note) 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. However, when the amounts are not due within one year, notes payable are classified as long-term liabilities.
An example of different accounts on a balance sheet:
Notice how notes payable can be short-term and/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, have no interest, and are a short-term liability (usually paid within a month).
Notes payable is a written agreement (a promissory note) 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 specific 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
Notes Payable vs Notes Receivable
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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