 In this discussion we will discuss the discussion question of discuss the journal entries needed over the life of an installment note. Support accounting instruction by clicking the link below giving you a free month membership to all of the content on our website broken out by category further broken out by course. Each course then organized in a logical, reasonable fashion making it much more easy to find what you need then can be done on a YouTube page. We also include added resources such as Excel practice problems, PDF files and more like QuickBooks backup files when applicable. So once again click the link below for a free month membership to our website and all the content on it. So if we see a discussion question or an essay question like this and we don't know exactly where to start. We can start by just saying what a note is and then try to think about well what does it mean to be an installment note possibly writing down the journal entry that to first record the note and then that could possibly jog our memory to go forward. So we'll just start from step one. What is a note? Well typically a note is going to be something that a company is going to do in order to get money. They're trying to get money. They're trying to finance the operations of the business. So if we think about that the first journal entry to record any kind of note any kind of loan is pretty straightforward. We're trying to get cash. So the first journal entry on a note is going to say cash is going to be the debit of some something let's say you know 100,000 and then we're going to credit something for 100,000 and that's going to be the note payable the liability. So and that and even if we don't know possibly this installment thing could throw us off even if we don't know what that is we can we can start here and just say I know what a note is and basically this is the journal entry for a note because we're going to debit cash we're going to credit the note the note payable. Now what often messes people up in this is first that the just determined installment could throw people off and two we start to overthink the role of interest and payments and how many payments and what not when we first record the note and notice we don't all that stuff doesn't really matter with just the recording of the note I mean it matters later on it matters with the negotiation of the note and it matters when we record the interest but to actually just record the note it doesn't even matter what the interest is or the life of the note or the term of the note because we're just going to record the journal entry which is that we got cash and we owe money back at some point in the future why is there not any interest expense when we first record the journal entry because we haven't we haven't had any purchasing we haven't used the money yet no time has passed the reason we're getting this cash is because we're renting purchasing power of money and and it's just like if we rented an office building so we don't owe rent on like the office building until time passes same with this cash here we don't owe rent on the purchasing power of this money until time passes therefore we don't record interest just like we wouldn't record rent before time has passed so this would be the first thing and if we look at the the note it's just going to be a promise to pay it'll typically be in writing you know we promise to pay you know the note was for we have the term of the note that's typically going to be there so what did I say a hundred thousand we're gonna have some type of life of the note so the number the number of years we might have let's say five years and it might be paid monthly or monthly and this are just kind of typical terms that we're gonna have some type of interest rate on the note so that's typically going to be given within the note now if you think about a note normally we think about this type of note that comes to most people mind most people's mind is an installment note so we think about a car payment or a mortgage where that's a kind of installment note and installment note just means that we're gonna pay periodically and that payment isn't going to include interest in principle as opposed to most bonds that we think about where we only pay back the rent it's like we only pay you can think of a the bond being more similar to renting an office space where we pay just the rent on the office space and then we give back the entire office space the bond is the same way if we had a bond we would just pay rent on the purchasing power of this hundred thousand and then pay back the entire hundred thousand at the end the entire principle for an installment note where it's kind of like we're paying back it's kind of like we have the apartment building and then we give back a square foot each time period and back to the to the leaser to the to the lease order and that's so in this case we're paying back some of the principle each time and paying some of the some of the expense obviously we're paying the expense and some of the principle each time we're having that most installment notes are going to be made to be even payments so the payments we make are going to be the same we're going to pay the same amount of cash and to make those payments the same over the life of this note we're going to have to change the amount allocated to interest in principle so in other words if we're making a payment and we're going to say that the payment is always going to be a thousand dollars obviously this is the math isn't going to work here because we didn't figure it all out but if we're paying a thousand and then we're going to allocate some of it to interest the amount allocated to interest in principle if it you know if it if it was six hundred and four hundred it's going to be something different next time right could it could be five seventy or something allocated to interest versus principle next time for the same thousand dollar payment and that's the that's the point the payment will remain the same the amount allocated to interest in principle will differ so you don't need to when you have an essay question like this you wouldn't need to go through the math on that and kind of figure it all out to make an installment note however you want to just explain what the journal tree will be and explain that the payments are going to be the same but the amount allocated to interest in principle will differ and you can go further than that and say well the amount that's going to be allocated to interest will will go down as the life of this goes by and the amount of allocated to principle of these thousand dollar payments will go up why because the carrying a value will go down each time so it started out at a hundred thousand after we make that first payment the carrying value will go down not by a thousand but by the amount that's going to be allocated to principle and therefore the next payment we make is going to be five percent divided by 12 on a monthly basis times whatever the new carrying values is so remember what what interest expense is it's going to be rent on the purchasing power that we have we got a hundred thousand of purchasing power every time that hundred thousand goes down the rent goes down because now we're paying rent on something less than the hundred thousand the purchasing power is going down so that's going to be the idea now to calculate that the interest payments if it's a monthly payment we would take the carrying value times the the the interest rate and then we'd have to divide it by 12 if we pay monthly so whatever the time period is or you can think about it as here's the yearly rate which is always given the yearly rate divided by in this case 12 to bring it to the monthly rate times the carrying value that'll be the amount of interest and then the payment minus the interest will give us the amount that we're going to reduce principal by and then we'll take the principal minus that amount to get to the new principal and then we'll continue the process the journal entries are always going to be when we when we make the payment we're obviously we're going to credit cash and the cash is always going to be the same again it's just making it up we're saying a thousand and then we're going to debit interest expense but the interest expenses is not going to be for the for the thousands going to be some component of it's going to be part based on the the the the carrying value times the interest rate divided by 12 in our case and the difference is going to go to the note payable so the note payable is going to go down and you may not even want to put numbers here to process this you might just want to put X is if they asked just for journal entries and don't ask for numbers numbers can help but but just to give some example of the journal entries this would be basically the journal entry this journal entry would be repeated for in this case five years monthly for five years and it would be the same however the cash would be the same with the amount allocated to interest in principal would differ the amount allocated to interest would go down and principal would go up as these payments were made and then once we get to the end once we get to the last payment after five years then the note payable amount on the books should then of course be down and go down to zero and we will have completely paid this off so note the difference between an installment note and like a bond there's no there's no payment at the end as there is with a bond where we just where we pay the the original amount off at the bond meaning a bond we pay just the interest throughout the time period and then we pay off the original that's what the reason the bond payments are fixed is because the principal doesn't go down the principal amount for a bond if it were 100,000 would be 100,000 the whole time therefore the interest payments that we make if we issued it at par the payments we make will always be the same because the principal is at 100,000 the note on the other hand and that that leads to us to have to make this balloon payment the principal portion back at the maturity of the bond but the notes on the other hand we we're gonna be reducing the principal as we go that's the point so we're gonna be making even payments the whole time and there is no balloon payment there's no big payment at the end because we we have evened it out over the life of the repayments of the note and so by the time we make the last payment on the note the note then should be gone and we don't have any note on the books and we're done