Financial Accounting: An Integrated Statements Approach, 2nd Edition

Chapter 10 Liabilities 443

The interest expense is reported in the Other Expense section of the income statement

for the year ended December 31, 2007. The interest expense account is closed at

December 31.

The preceding entries for notes payable are similar to those we discussed in

Chapter 8 for notes receivable. Notes payable entries are presented from the viewpoint

of the borrower, while notes receivable entries are presented from the viewpoint of the

creditor or lender. To illustrate, the following entries are journalized for a borrower

(Bowden Co.), who issues a note payable to a creditor (Coker Co.):

Sometimes a borrower will issue a creditor a discounted note rather than an interest-

bearing note. Although such a note does not specify an interest rate, the creditor sets

a rate of interest and deducts the interest from the face amount of the note. This in-

terest is called the discount. The rate used in computing the discount is called the dis-

count rate. The borrower is given the remainder, called the proceeds.

To illustrate, assume that on August 10, Cary Company issues a $20,000, 90-day

note to Seinfeld Company in exchange for inventory. Seinfeld discounts the note at a

rate of 15%. The amount of the discount, $750, is debited to Interest Expense. The pro-

ceeds, $19,250, are debited to Merchandise Inventory.Notes Payableis credited for the

face amount of the note, which is also its maturity value. This entry is shown below.

When the note is paid, the entry is recorded as follows:^2

2 If the accounting period ends before a discounted note is paid, an adjusting entry should record the

prepaid (deferred) interest that is not yet an expense. This deferred interest would be deducted from

Notes Payable.

Oct. 30 Notes Payable 1,000

Interest Expense 30

Cash 1,030

Aug. 10 Merchandise Inventory 19,250

Interest Expense 750

Notes Payable 20,000

Nov. 8 Notes Payable 20,000

Cash 20,000

May 1. Bowden Co. purchased
merchandise on account from
Coker Co., $10,000, 2/10, n/30.
The merchandise cost Coker Co.
$7,500.

May 31. Bowden Co. issued a
60-day, 12% note for $10,000
to Coker Co. on account.

July 30. Bowden Co. paid
Coker Co. the amount due on
the note of May 31. Interest:
$10,00012%60/360.

Bowden Co. (Borrower)

Merchandise Inventory 10,000

Accounts Payable 10,000

Accounts Payable 10,000

Notes Payable 10,000

Notes Payable 10,000

Interest Expense 200

Cash 10,200

Coker Co. (Creditor)

Accounts Receivable 10,000

Sales 10,000

Cost of Merchandise Sold 7,500

Merchandise Inventory 7,500

Notes Receivable 10,000

Accounts Receivable 10,000

Cash 10,200

Notes Receivable 10,000

Interest Revenue 200

Q.In buying a used deliv-
ery truck, a business issues
an $8,000, 60-day note
dated July 15, which the
truck’s seller discounts at
12%. What is the cost of
the truck (the proceeds)?

A.$7,840 [$8,000 

($8,00012%

60/360)]

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