Definition
The financial accounting term discounts on notes payable is used to describe a contra liability account that holds future interest charges that are included on the face value of a promissory note.
Explanation
A promissory note is an unconditional promise to repay a pre-defined sum of money at a future point in time or on demand. The maker of the note (borrower) is charged interest for the use of that money.
A note payable is a liability which can sometimes include the interest payable on the face of the note; meaning the face value of the note will include future interest charges.
When a company borrows money this way, they have received cash that is less than the face value of the notes payable. The contra liability account, discounts on notes payable, is used to account for the difference between the cash received and the money owed on the note.
Over time, interest will accrue to the note, thereby lowering the balance of the discounts on accounts payable and increasing the balance of notes payable.
Example
Company A borrows $100,000 from a bank; agreeing to repay $105,000 in 12 months. Initially, Company A's balance sheet would include:
Notes Payable | $105,000 |
Less: Discounts on Notes Payable | $5,000 |
Net Notes Payable | $100,000 |
After six months, $2,500 in interest charges would have accrued to Notes Payable through the contra liability account as shown below:
Notes Payable | $105,000 |
Less: Discounts on Notes Payable | $2,500 |
Net Notes Payable | $102,600 |
Related Terms
A contra account is a balance sheet account that is used to offset a related asset, liability, or equity account. Contra accounts are used to ensure the proper valuation of these items is reflected on the balance sheet.
Moneyzine EditorJanuary 12th, 2024- The financial accounting term notes payable refers to the obligations of a company that are in the form of a promissory note, which is a written promise to pay a fixed sum of money to the lender. Notes payable appear on the balance sheet as current liabilities.Moneyzine EditorSeptember 20th, 2023
The financial accounting term discounts on notes receivable is used to describe a contra asset account that holds unearned interest that was included in notes receivable.Moneyzine EditorJanuary 16th, 2024- The term recognition of notes receivable is used to describe the process of acknowledging the existence of a notes receivable on the balance sheet of a company. Accounting practices dictate that companies record notes receivable using the present value of all future cash flows.Moneyzine EditorSeptember 21st, 2023
The term long-term notes payable refers to an agreement a company enters into with another party, which includes a formal written promise to pay pre-determined amounts on specific dates. To be categorized as a long-term note payable, the maturity of the note must be longer than one year or operating cycle. Both long-term and current notes payable appear in the liabilities section of a company's balance sheet.Moneyzine EditorJanuary 24th, 2024
