![]() The following entry occurs when Sierra initially takes out the loan.Ĭash increases (debit) as does Short-Term Notes Payable (credit) for the principal amount of the loan, which is $150,000. Sierra borrows $150,000 from the bank on October 1, with payment due within three months (December 31), at a 12% annual interest rate. ![]() Sierra does not have enough cash on hand currently to pay for the machine, but the company does not need long-term financing. ![]() Sierra Sports requires a new apparel printing machine after experiencing an increase in custom uniform orders. (credit: “Business Paperwork Deal” by “rawpixel”/Pixabay, CC0) A short-term note can be created from a loan. The other short-term note scenario is created by a loan.īank Loan. Cash decreases (credit) for $12,200, which is the principal plus the interest due. Interest Expense is found from our earlier equation, where Interest = Principal × Annual interest rate × Part of year ($12,000 × 10% × ), which is $200. Interest Expense increases (debit) for two months of interest accumulation. Since Sierra paid the full amount due, Short-Term Notes Payable decreases (debit) for the principal amount of the debt. When Sierra pays cash for the full amount due, including interest, on October 31, the following entry occurs. The conversion entry from an account payable to a Short-Term Note Payable in Sierra’s journal is shown.Īccounts Payable decreases (debit) and Short-Term Notes Payable increases (credit) for the original amount owed of $12,000. Interest is now included as part of the payment terms at an annual rate of 10%. On August 31, the supplier renegotiates terms with Sierra and converts the accounts payable into a written note, requiring full payment in two months, beginning September 1. Let’s assume that Sierra Sports was unable to make the payment due within 30 days. Credit terms were 2/10, n/30, invoice date August 1. Sierra Sports purchased $12,000 of soccer equipment from a supplier on credit. To illustrate, let’s revisit Sierra Sports’ purchase of soccer equipment on August 1. (attribution: Copyright Rice University, OpenStax, under CC BY-NC-SA 4.0 license) Accounts Payable may be converted into a short-term notes payable, if there is a default on payment. What would you do if you found your school in this situation? Would you issue more debt? Are there alternatives? What are some positives and negatives to the promissory note practice?Īccounts Payable Conversion. This shorter payback period is also beneficial with amortization expenses short-term debt typically does not amortize, unlike long-term debt. ![]() In many cases, the interest rate is lower than long-term debt, because the loan is considered less risky with the shorter payback period. Short-term debt may be preferred over long-term debt when the entity does not want to devote resources to pay interest over an extended period of time. This leads to a dilemma-whether or not to issue more short-term notes to cover the deficit. However, revenues distributed fluctuate due to changes in collection expectations, and schools may not be able to cover their expenditures in the current period. The goal is to fully cover all expenses until revenues are distributed from the state. School boards approve the note issuances, with repayments of principal and interest typically met within a few months. Promissory Notes: Time to Issue More Debt?Ī common practice for government entities, particularly schools, is to issue short-term ( promissory) notes to cover daily expenditures until revenues are received from tax collection, lottery funds, and other sources. This payable account would appear on the balance sheet under Current Liabilities. A short-term note is classified as a current liability because it is wholly honored within a company’s operating period. Some key characteristics of this written promise to pay (see (Figure)) include an established date for repayment, a specific payable amount, interest terms, and the possibility of debt resale to another party. The company may consider a short-term note payable to cover the difference.Ī short-term note payable is a debt created and due within a company’s operating period (less than a year). Even if a company finds itself in this situation, bills still need to be paid. There is an ebb and flow to business that can sometimes produce this same situation, where business expenses temporarily exceed revenues. Once you receive that paycheck, you can repay the lender the amount you borrowed, plus a little extra for the lender’s assistance. You need enough money to cover your expenses until you get your next paycheck. If you have ever taken out a payday loan, you may have experienced a situation where your living expenses temporarily exceeded your assets. LO 11.4 Prepare Journal Entries to Record Short-Term Notes Payable
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