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Chapter 16

Chapter 16. Notes Receivable and Notes Payable. LO1. Term. Payee. Principal. Interest Rate. Maker. Due Date. Learning Objective 1 Describe a promissory note.

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Chapter 16

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  1. Chapter 16 NotesReceivable andNotes Payable

  2. LO1 Term Payee Principal Interest Rate Maker Due Date Learning Objective 1Describe a promissory note. A promissory note is a written promise to pay a specified amount of money, usually with interest, either on demand or at a definite future date. $1,000.00 July 10, 2011 Ninety days after date I promise to pay to Barton Company, Los Angeles, CA the order of One thousand and no/100 --------------------------------- Dollars First National Bank of Los Angeles, CA Payable at 12% Value received with interest at per annum Julia Browne 42 Oct. 8, 2011 No. Due

  3. LO2 Learning Objective 2Compute the maturity date and interest due on a promissory note. On March 1, 2010, Matrix, Inc.purchases a copier for $12,000 from Office Supplies, Inc. Matrix gave Office Supplies a 9% note due in 90 days in payment for the copier. What is the maturity date of the note? In this example, we add 30 days in March, 30 days in April, and 30 days in May to add up to the note term of 90 days. The note is due and payable on May 30, 2010. How much interest will Matrix pay to Office Supplies, Inc. on this note?

  4. LO3 Learning Objective 3Record the receipt of a note receivable. Here are the entry on March 1, 2006, to record the sale and note receivable. On May 30, 2010, Office Supplies, Inc. receives the principal amount of the note plus interest.

  5. LO4 Maturityvalue = Principal + Interest due at Maturity Maturityvalue = $12,000 + $270 = $12,270 Learning Objective 4Record the honoring, discounting, and dishonoring of a note and the adjustment for interest. On March 31, 2010, Office Supplies decides that it needs cash and cannot hold the note any longer. The company goes to First National Bank and discounts the note at 12%. The bank pays Office Supplies cash and deposits the amount in its checking account. Step 1: Calculate the maturity value of the note. Step 2: Determine days in discount period.

  6. LO4 Discount Charge MaturityValue DiscountRate DiscountPeriod = × × Discount Charge = $12,270 × 12% × 60/360 = $245.40 Note Discounted before Maturity Step 3: Compute the bank discount charge. Step 4: Compute proceeds from the discounting. Proceeds = Maturity Value – Discount Charge $12,024.60 = $12,270.00 – $245.50

  7. LO4 Note Discounted before Maturity Let’s look at the journal entry to record the discounting of the note receivable. Now let’s assume that Office Supplies held the note to maturity. At maturity, Matrix informs Office Supplies that it is unable to pay the note or interest. The note has matured and is no longer valid.

  8. LO4 Accrued Interest on Notes Receivable Using the same purchase of a copier example between Matrix and Office Supplies, Inc. that we just reviewed, let’s change the date of the note to December 1st instead of March 1st. On December 1, 2010, Matrix, Inc. purchases a copier for $12,000 from Office Supplies, Inc. Matrix issues a 9% note due in 90 days in payment for the copier. What adjusting entry is required on December 31, year-end of Office Supplies? $12,000 × 9% × 30/360 = $90

  9. LO4 Accrued Interest on Notes Receivable Let’s look at the entry Office Supplies, Inc. will make on March 1st.

  10. LO5 Learning Objective 5Prepare entries to account for notes payable. On March 15, 2010, Western, Inc. issues a $10,000, 12%, 90-day note to First Bank for cash. Let’s make the journal entry. Let’s calculate interest to maturity. $10,000 × 12% × 90/360 = $300

  11. LO5 Interest to Maturity $40,000 × 6% × 90/360 = $600 Discounting a Note Payable On March 31, 2010, Webb Co. discounts its $40,000, 6%, 90-day note at First Bank for cash. Let’s make the journal entry. When the note matures on May 30th, Webb makes the following journal entry.

  12. LO6 Learning Objective 6Explain the types and payment patterns of notes. An installment note requires a series of payments over the life of the note rather than one payment at maturity. On January 1, 2010, Gear, Inc. signs a $60,000 note to First Bank. The note bears interest at 10% annually and requires payments of $15,827.85 at the end of each of the next five years.

  13. LO7 Learning Objective 7Compute the interest times earned ratio and use it to analyze liabilities. When a company has long-tem liabilities, lenders want to know if there will be sufficient earnings to pay interest as it comes due. Lenders can use this ratio to help decide if they should accept the risk. Experience shows that when times interest earned falls below 1.5 to 2.0 and remains at that level or lower for several periods, the default rate on liabilities increases sharply.

  14. End of Chapter 16

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