Discounts on Notes Payable

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

contra account, liability, notes payable, discounts on notes receivable, recognition of notes receivable, long-term notes payable