 Companies may issue a notes payable when borrowing cash, purchasing assets, or in settlement of a past due account's payable. Notes payable is just the opposite side of the same transaction as notes receivable. The source document of a notes payable is a promissory note. A promissory note is a legal document that binds parties in a contract. A student loan is a type of promissory note. Here are some terms related to notes payable that you want to be familiar with. You might want to pause the video and write down these definitions. Computing interest is an important part of properly accounting for notes payable. You've probably learned how to do this calculation before in some business or financial math class, but we'll revisit it here anyway. Interest is calculated by taking the principle of the note times the annual interest rate of the note times the term of the note. I remember this with the acronym PERT, principle times rate times time. Make sure to remember that interest is always stated in terms of an annual rate, so time must also be in terms of one year. Here are some examples to reinforce that point. We have three notes here. Let's calculate interest for each of them. For note one, interest is $10,000 times 6% interest times $120,360 fifths, which is equal to $197. You can see that the term 120 days is converted into years by dividing 120 by 365. For note two, the interest is $50,000 times 4% interest times 612, which equals $1,000. You can see the term six months is converted into years by dividing 6 by 12. Finally, note three is for one year, so it's just the principle times the rate times one. Let's look at a typical example. The Motley Crue Company issues a $5,000 three month 6% promissory note dated May 1 to settle a past due accounts payable. The journal entry to record the note is a debit to accounts payable for $5,000 and a credit to notes payable, since the note was issued to settle the past due account, and it's also for the $5,000. Assume on August 1, Motley Crue pays off the note and accrued interest. The journal entry to record the settlement of the note is a debit to notes payable for $5,000, a debit to interest expense for $75, and that's for three months of interest, and a credit to cash for $5,075. This amount equals the principal plus the interest. You can see the interest calculations on the slide. So these are the basic journal entries for issuing and then settling or paying off a notes payable. But before we wrap up this video, let's complicate this example just a bit. In this case, assume the transaction is dated December 1 rather than May 1. How does this change any of the journal entries? Well, let's take a look at that. The issuance of the note is exactly the same. But now we have to make an adjusting entry on December 31 to accrue the amount of interest expense incurred for the month of December. So the adjusting entry would be $25 because that's for one month of interest. Finally, paying off the note on March 1 is a lengthy journal entry, but we can work through it. Notes payable is still debited for $5,000 because that's the amount of the note, and that balance needs to be zero after Motley Crue pays it off. Interest payable, which has a credit balance of $25 from the December 31 adjusting entry, also needs to be debited for $25 because that account balance needs to be zero after the note is paid off. Interest expense is debited for $50 because that's the amount of interest incurred in the new year. Finally, cash is still credited for $5,075, which is the principal and interest paid.