 Hello and welcome to this session. This is Professor Farhad and this session we would look at long-term notes payable. This topic is covered in an introductory accounting course as well as the CPA exam. As always I would like to remind you to connect with me on LinkedIn if you haven't done so. YouTube where you would need to subscribe. I have 1600 plus accounting, auditing, finance and tax lectures. This is a list of all the courses that I cover including many CPA questions. If you like my recording please click on the like button, share them, put them in playlists, subscribe, let the world know about them. If they benefit you it means they might benefit other people. Connect with me on Instagram. On my website farhadlectures.com you will find additional resources to help you supplement your accounting education and or pass your CPA exam. I strongly suggest you check out my website. So today's topic is about long-term notes payable and when you think about notes payable think about a bank. Now bank is one of the institution that lend money but anyone can lend you money but generally speaking when you think of a note think of a bank. The government also lend you money so the the government could also issue a note. So basically a company will have to pay back the lender. So you have the company will borrow money first from the bank then eventually the company will have to pay back the lender cash. They'll have to pay the note. Now the question is what is the repayment of the principal and interest going to be because what you're going to be paying back you're going to be paying back the original amount called the principal plus interest because no loan is made without interest. So we have to understand that with the loan we have two dates we have the issue date or the the note date the note the date the note was issued and the maturity date the day that you pay it off. So first you borrow the money then you pay off this is how it works. Now we have what's called long-term notes payable where you pay a single payment usually usually those are short-term so you borrow money and you make one single payment and usually those are short-term borrowing. We looked at this session we looked at these type of borrowing and another recording so basically those are usually short-term. So you make a single payment that include both the original amount plus the interest back to the lender. So you make a single payment for the whole loan. So the whole loan you borrow the money here and you make one payment as I said usually that one payment is less than a year. What we're going to be looking at today is long-term notes payable which you make regular payment a series of payment. Here the company borrows money and they make regular payments of principal plus interest. So you don't make one payment you make multiple payment back to the lender. So it would look something like this here's the date of the note was issued let's assume one one twenty twenty then every year or every month you will be making a payment. Notice here what's happening is we have a series of payments until the note mature. Once the note mature you pay back the note you pay back the note you pay back the whole note. Okay and what we're looking at here is something called installment notes. So when you make payment it's called installment so you're making several payments. So what is an installment? This is an installment you are making several you are making several payments. So on January 1st Foghawk borrows $60,000 from a bank to purchase equipment. It signs an 8% installment note requiring three annual payment of principal plus interest. So they borrowed the money and they agree to make three payments back. The payment will include both principal and interest. So when they borrow the money this is the entry that they make. They debit cash for 60,000 and now they have a loan called notes payable for 60,000. Now we have to compute the payment. This is how we compute the payment. Don't worry about how we computed the payment because we did not most likely you did not learn about the time value of money but basically we took the present value of the note which is $60,000 divided by the table. The table is annuity table in n equal to 3 i equal to 8%. We would look at those later. We'll take 60,000 divided by 2.577 from table B3. We'll get the payment of 23,000. Therefore this is your payment. Your payment is $23,282 and what you have to do you have to prepare a loan amortization schedule. So here's how it works. On 1231 you took out the balance. You took out the loan 60,000. You're going to be making a payment of 23,282 dollars. Some of it will be interest and some of it will be principal. The question is how much is principal and how much is interest? Well what you have to do is you have to take the book value of the loan as of the beginning of the period and as of the beginning of the period it was 60,000. You multiply that by 8%. 60,000 times 8% is 4,800 and that's going to be your interest. So you made a payment of 23,282. 4,800 is interest. The remaining which is 18,482 is principal. So notice what happened. As you pay the principal, the principal would reduce the loan. The loan was 60,000. Now we made a payment of 18,882. What happened is your new principal is 41,518. So this is your new balance. But first let's generalize the entry for the first year. So the first year you made a payment of 23,282. So you credit cash 23,282 of which 4,800 will be considered interest expense and 18,482 would reduce your principal. So this is your payment for the first. This is one of three payments. Now a year later you're going to have to make another payment. Now your principal amount is your loan balance is 41,518. Now we multiply this by 8%. Your interest expense now is 3,321. That's your interest expense. Now once again we'll use the same concept. We make a payment of 23,282 of which 3,321 is interest and the remaining, the remaining which is 19,961 is principal. Now the principal again the prior balance was 41,518. Now we're going to be reducing the principal by 19,819,961. The new principal is 21,557. This is the new balance or the new payoff amount or the new remaining principal. Here for the entry that we make for the second payment once again the payment is the same. Notice the cash is the same 23,000 of which 3,321 is interest and 19,961 is principal. And it should make sense when you're looking at the payment that your interest expense went down. The first payment your interest expense was 4,800. The second payment your interest expense is 3,321. So hopefully this makes sense. Hopefully this makes sense. Okay this should be 19 and this should be 2020. Okay and this makes sense because your principal went down. And the third payment once again you make the third payment. The interest component is based on the principle of 21,557. The remaining goes toward the bond sorry toward the loan and you will pay off the loan. Therefore notice after you make the three payments after you make the three payments your total payments for the loan are 60,000 because you have to pay back the loan and your interest for the three years in total is 9,846. So in total you paid back 69,846. And notice your third payment your interest is a smaller component. So if we look at this picture notice your first payment your interest is 4,800. Your second payment your interest component goes down and the third payment your interest component becomes even smaller. And this is how it works for a note. And hopefully this makes sense because as you pay off the loan your principal amount goes down. As your principal amount goes down also your interest expense goes down as well. The last thing we're going to look in this is the mortgage or secured notes and bonds. What is a mortgage? A mortgage is a legal document or a legal agreement that helps protect the lender if the borrower fails to make the required payment. Most likely you are familiar with mortgage for homes. For example when we borrow money we say it's a mortgage. The reason it's a mortgage because the home itself is a security collateral against the loan. Now it doesn't have to be home a company can put up their office building their warehouse or any asset as a security. It's called a mortgage note or a mortgage bond. It gives the lender the right to be paid out of the cash proceeds from the sale of the borrower's asset specifically identified in the mortgage contract. For example the bank they would say they will have your address and they would say in case you don't pay us this loan we're going to sell your home and get the money. Or for example they would sell the office building and they would sell the money. So the mortgage is basically a form of secured loan where if something goes wrong the lender is protected because the lender is interested in getting their money back that's what they're interested in. So if there is a fear that you may not pay them what they would do they will ask you for a collateral for some type of a security mortgage like a mortgage to protect themselves. In the next session we would look at debt types different debt types and the debt ratio. As always I would like to remind you to connect with me like this recording and visit my website for additional resources if you are looking to supplement your accounting education and pass the CPA exam. Good luck, study hard and stay safe during those coronavirus days.