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.
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.
Company A borrows $100,000 from a bank; agreeing to repay $105,000 in 12 months. Initially, Company A's balance sheet would include:
|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:
|Less: Discounts on Notes Payable||$2,500|
|Net Notes Payable||$102,600|