Journal Entry for Issuance of Promissory Note

Introduction

Promissory note is a note that the issuer or payer issues to a receiver for a promise to pay a certain amount of the money within a certain period of time. Likewise, we can make the journal entry for the issuance of promissory note by recording the promised amount into the notes payable account.

We may issue the promissory note when we borrow the money from our friends and promise to pay them back within a certain period of time. However, we may also issue the promissory note to our supplier in business when we cannot settle our accounts payable on time.

Additionally, we could also issue a promissory note to our supplier in exchange for the merchandise purchased if our supplier agrees to it. This usually happens when we need to make a credit purchase, but we are sure that we won’t be able to pay it back within a short period of time (e.g. one month).

In a business transaction, there is usually a certain percentage of the interest attached with the promissory note. For example, if we cannot make payment on our credit purchase on time, we may negotiate with our supplier and issue the promissory note to pay the debt within 3 months period together with a certain percentage of interest on the amount owed.

Journal entry for issuance of promissory note

As mentioned, we need to record the promissory note in the note payable account when we issue the promissory note. However, the other side of the journal entry may be different depending on whether we issue the promissory note to borrow money, to extend our credit, or for the goods purchased.

Issue promissory note to borrow cash

We can make the journal entry for the issuance of the promissory note to borrow the cash by debiting the cash account and crediting the notes payable account.

In this journal entry, both total assets and total liabilities on the balance sheet will increase by the amount stated on the promissory note.

Issue promissory note to extend credit

Alternatively, we may issue the promissory note in order to extend our credit that comes from the credit purchase we have made previously. If this is the case, we will need to reclass our accounts payable to the notes payable for the amount that is stated in the promissory note.

In this case, we can make the journal entry for the issuance of the promissory note by debiting the accounts payable and crediting the notes payable account.

This journal entry does not impact the total assets or total liabilities on the balance sheet as a whole. What it does is simply reclass a certain amount from accounts payable to the notes payable account.

Issue promissory note for the purchase of goods

In another case, if we issue the promissory note in order to make a credit purchase, we will need to record our purchases with the notes payable account instead of accounts payable as below:

In this journal entry, the purchases account is a temporary account and we record this account if we use the periodic inventory system. However, if we use the perpetual inventory system, we need to record the debit side of the journal entry to the inventory account instead.

Paying the notes payable

When we reach the end of note maturity after a certain period of time has passed, we need to honor the promissory note by paying the promised amount to the note receiver.

In this case, we can make the journal entry for paying the notes payable by debiting the notes payable account and crediting the cash account.

This journal entry is made to eliminate the notes payable that we have recorded at the time of issuance of the promissory note. Likewise, in this journal entry, both total assets and total liabilities on the balance sheet will decrease by the amount of payment.

Interest on notes payable

As mentioned, there may be an interest attached when we issue the promissory note. If this is the case, we should record the accrued interest at the month-end adjusting entry as time passed. This is to avoid the understatement of expenses and liabilities when the maturity of the promissory note crosses the accounting period.

Accrued interest on notes payable

We can make the journal entry for accrued interest on notes payable by debiting the interest expense account and crediting the interest payable account.

This journal entry will increase both total expenses on the income statement and total liabilities on the balance sheet.

Later, when we make the payment for the interest, we can make the journal entry to eliminate the interest payable we have recorded by debiting the interest payable account and crediting the cash account.

Interest payment:

Issuance of promissory note example

For example, on January 1, we issue a promissory note to borrow $1,000 of cash from one of our friends who has a close personal and business relationship with us. In the promissory note, it states that we promise to pay back the $1,000 on March 31.

Later, on Mar 31, we pay back the full amount of $1,000 to our friend in order to honor the promissory note we have issued on January 1.

In this case, we can make the journal entry for issuance of the promissory note to borrow money from our friend on January 1 by debiting the $1,000 into the cash account and crediting the same amount into the notes payable account.

January 1:

In this journal entry, both our total assets and total liabilities on the balance sheet increase by $1,000 as of January 1.

Later, on March 31, when we pay back the $1,000 amount stated on the promissory note, we can make the journal entry for paying the notes payable with the debit of notes payable account and the credit of cash account.

March 31:

This journal entry will reduce our total assets and total liabilities by $1,000 as of March 31.

Example 2:

For another example, on November 1, we issue a promissory note with the face value of $10,000 to one of our supplies with the promise to pay the $10,000 amount that we owe on February 1 with an interest of 6% per annum. This $10,000 is the amount of the credit purchase that we have made in the previous month and fail to pay on November 1 which is a due date of payment on the purchase invoice.

Likewise, as of November 1, we still have this $10,000 in the accounts payable that we owe to our supplier. Hence, this issuance of the promissory note is made for the purpose of the extension of the credit period.

In this case, we can make the journal entry for issuance of promissory note on November 1 in order to extend our credit period to February 1 by reclassing the $10,000 of accounts payable to the notes payable as below:

November 1:

This journal entry does not impact the total liabilities on the balance sheet as a whole. It is just a classification from one category of liability to another.

As the promissory note we issue contain an interest of 6% per annum, we should make the journal entry for the accrued interest of $50 ($5,000 x 6% / 12) on notes payable at the end of each month as below:

November 30:

December 31:

January 31:

Later, on February 1, when we make the payment of $10,000 of the promissory note plus an interest of 8% which is $150 to our supplier to honor the note, we can make the journal entry for paying the notes payable of $10,000 and the interest payment of $150 as below:

February 1: