 Hello and welcome to this session. This is Professor Farhad and this session we will look at short-term notes payable. This topic is covered in financial accounting introductory 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 is 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, let the world know about them. If they benefit you it means they might benefit other people, so share the wealth and connect with me on Instagram. On my website you will find additional resources to supplement your accounting education and help you pass the CPA exam. Please check out my website. Let's take a look at short-term notes. Short-term notes are no more than loans. So when you take out a loan from the bank you debit cash and you credit notes payable. So this is a loan basically let's assume you borrowed $10,000 debit cash credit notes payable. Another way to get a loan is to when you buy a car let's assume you bought a car. What you do is you have the car for $10,000 and now you have a notes payable. So simply put you did not pay any money you just borrowed the car borrowed money against the car. So the car is the asset not the money and you have the car but you have a loan and the third option with notes payable is when you have an account payable let's do. Let's assume you bought from your supplier $10,000 worth of inventory. So you bought from your supplier $10,000 worth of inventory and you bought them on account. You bought them using accounts payable and they gave you 30 days to pay. When the 30 days came due you did not have money to pay the $10,000. So what the supplier might say I will replace your accounts payable therefore I will replace your accounts payable I will debit your accounts payable and replace it with a notes payable of $10,000. So these are the options that you will have a notes payable either when we borrowed money we buy stuff buy a loan or replace an account payable with a notes payable those are the three most common scenario. So what is a short term note a short term note is basically a loan a short term loan a written promise to pay a specified amount of money on a future date within one year and the reason we say within one year that's why it is short term. Most notes bear interest it means the interest is stated so you'll know what the interest and the note may arise from an overdue accounts payable you cannot pay your account they will turn it into a note you're borrowing money from the bank or as I told you sometime you might buy a car or a vehicle using a note. Now note extended to for credit period so simply put what happened is as I said you owe someone some money you cannot pay them because you purchase something on account what they do is say okay we will replace your note with you would replace your account with a notes payable. So on August 31st a brandy company asked McGraw to accept a $100 cash and a 60 day 12% notes payable to replace it's existing accounts payable of 600 so we owe $600 so we have an account payable of $600 all what we have right now is a $100 in cash and the note is due. So what we say we tell the supplier look we're going to pay you we're going to pay you $100 we're going to pay you $100 in cash and the remaining is the remaining will be 500 if you're willing to accept a note and that note will be for $500 and we'll pay you 12% interest and we'll pay you this money in 60 days. So here what we did is we took out the accounts payable we debited the accounts payable we replaced it with a notes payable the note is only 500 because we paid cash of 100 so 100 to pay the cash and 500 for the note. Now obviously for the note we have to pay the note plus interest so what happened when we pay the note plus interest and this will be on October the 22nd now we're going to pay the note we're going to pay $500 plus $500 times 12% times 60 divided by 360 always do the fraction first and if you do the computation we're going to owe $10 in interest therefore we're going to debit the note $500 get rid of this note so this note here now we're paying it now we're going to pay the note the note is gone the note is zero we're going to pay the note and we're going to debit interest expense for $10 and in cash we're going to pay $510 in cash so what we did is we replaced an accounts payable with the note then we paid the note plus interest now we could be issuing note for borrowing money from the bank let's assume on September 30th a company borrows $2,000 from the bank at 12% interest well we debit cash we walked away with $2,000 and we created the notes of $2,000 30 60 days later November the 29th we have to pay back the note plus interest always compute how much you have to pay first it is $2,000 times 12% times 60 divided by 360 always do the fraction first and you will figure out that you have to pay $40 therefore you debit the note you get rid of this note you debit interest expense for $40 and in total you'll pay $2,040 $2,000 for the note and $40 for the interest so this is basically when you have a note this is what happened when you have a note and it's paid within the same accounting period the same year what happened if you have a note that extend over two periods what does that mean it means you borrow the money in one period and you have to pay it in another period so simply put the date of the note is here you borrow the money here you borrow the money in this period this is period one this is the end of the period then you have to pay back pay back in year period two year two so the date of the note is in this period you borrow the money the end of the period you have not paid the note yet then you have to pay it on the maturity date but the maturity date happens to be in period two what does that mean it means at the end of the period you have to make an adjusting entry. What is the adjusting entry for? The adjusting entry is for the interest expense that accrued from the date the note was signed until the end of the period. So you have an interest expense for this period one. So you have to record this interest expense. The best way to illustrate this is to work an example. And this is as complicated as it gets for a note's favor. It's when you borrow the money in one period and pay it in another period as far as a financial accounting student will have to deal with. So let's assume on December the 16th the company borrows $2,000 from a bank at 12% for 60 days. So now we borrowed the money. Let's just take a look at the timeline. We borrowed the money. Let's assume this is December 16th and we're borrowing the money for 60 days. It will not be due until February the 14th. So what happened is this. We borrowed the money in one period because December 31st is the end of the period. So we borrowed the money in one period. This is period one. This is period one. And we're going to have the money in period two. Pay it back the money in period. So what's going to happen between December 31st, December 16th and December 31st is we are going to accrue interest. Okay. So how much interest did we accrue? Well we have to compute which is $2,000 times the interest rate is 12% times 15 divided by 360. Again, do the fraction first. And the interest that you have to accrue is $10. Therefore, we debit interest expense $10 and we credit interest payable $10. Simply put, we have $10 that are due. We don't have to pay it yet until February the 14th. But it was accrued. It was accrued from December 16th till December 31st. On February the 14th, we have to pay the whole note plus interest. Well, the whole note is $2,000. The interest rate is 12%. And the time period is 60 divided by 360. That's the time. So we're going to have to pay in total an interest $40. Now, we have to pay back the note plus interest. So we have to pay in total $2,040. $2,000 for the note, $40 of interest. Now we debit the note because we got rid of the note. The note is gone basically by debiting the note. The note is gone. We have to debit this interest payable for $10. Why interest payable for $10 is because we already recorded $10 of interest expense. And we said we're going to pay it. Now we are paying it. Therefore, this interest payable is gone. Then we have to book an additional $30 of interest from January 1st to February the 14th, Valentine's Day. So from January 1st till February the 14th, we have 30 days of interest that we have to account for. Therefore, the remaining $30 is interest expense. So of the $40 interest expense, this is what we are saying, of the $40 interest expense, $10 was recorded in period one and $30 was recorded in period two. So period one happens to be 2019. Period two happens to be 2020. So this is what I meant by when a note is due within two accounting period. If you have any questions, please let me know. In the next recording, we would look at payroll liabilities. If you like this recording, please click on the like button, share it, subscribe and look at my website if you're looking for additional supplemental resources to supplement your accounting education and all your CPA studies. Good luck, study hard and stay safe during those coronavirus days.