Hello, and welcome everyone to our lesson today. Today I am going to focus on an example distinguishing between interest-bearing note versus non interest-bearing note. We'll see how to account differently for both of them and what is the effect of each one on the way we report and record the transaction. Let's start with example. On August 1st, 2020, universal company issued at $200,000, 12%, ten-month note to Global Bank, with interest and principle payable at maturity. If the interest is payable, then obviously it is whether it's at maturity or periodically, then obviously it's an interest-bearing note. We're going to take the three stages, the issuance and then during the life of the note, the adjusting entry. Assuming that the fiscal year ends December 31st, and then finally the maturity of the note. Let's take step by step. Number one, the issuance, which is the easiest one. That's I collected the cash, 200,000, I issued a note payable for 200,000. What about accruing the interest? When I accrued the interest, I will actually from this, from August 1st, the issuance of the note, until December 31st. That's five months worth of interests. Then obviously I will accrue the interest based on the face value of the note times the 12%, which is the interest rate, times 5 over 12. Which is the period from August 1st till December 31st. That's basically an interest payable accrued interest. And at the maturity of the note here will be a little bit tricky because at that time, actually the payoff will be, three things will be paid off. Number one, the interest payable actually that was accrued. It's coming the second line in the entry, but that is what was accrued in the payable from the five months in the earlier year. And then another five months interest because now I am accruing the interests up till maturity. So it's from January 1st until maturity, another because it was all for ten months, the period of the note. So that's additional five months, another 10,000. I will pay the face value of the note, which is the 20,000, 200,000, and that's paying off 220,000 in cash. That's interest bearing note. Let's take the scenario, what would the case be if it's non interest bearing note? Let's read the wording of a non interest bearing note. Suppose in the previous example that Universal Company's note had been a non interest bearing note with interest to be discounted at 12% discount rate. Then obviously at the issuance here, that's the difference between interest bearing and non interest bearing note. In the non interest bearing note, you are not going to calculate the face value of the note because you are going to discount it. To take into consideration the interest that you are not going to pay at maturity. Now let's take a look at how would we record that at the issuance? And the issuance of the note that basically I will generate a discount for that interest that you're not going to pay at maturity. Now I'm discounting it from the face value of the note, and that's what we can see. The 200,000 times 12%, times the 10 over 12. Obviously here, time value of money is not a big element because it's a short term, it's a 10-month, so that's why I'm using when I accrue. When I calculate the discount, I basically calculated it based on the face value of the note and simple interest type of calculation. 200,000 times 12%, times 10 over 12. Very good. What about accruing the interest? In the interest-bearing note, we accrued the interest in a payable. Now here when you accrued the interest, you're actually going to amortize the discount. You're taking a bite of the discount. Let's take a look. How much of the discount will be amortized? The discount now will be decreased. And remember, the discount on notes payable is a contra liability account that will be deducted from the face value of the note to calculate the carrying value of it. So in the interest here, when I accrue the interest. The interest expenses a debit, but as you notice the credit is the discount on notes payable to amortize portion of the discount. Here, the amount of the amortization that I will take is 5 over 12, which is half of it. But it's not always, it's just because five months have passed since August from August 1st till December 31st. And that's the amount that will be actually amortized of the discount, and recorded as an interest expense at the end of the fiscal year. At maturity, when it comes to maturity. Now I will actually amortize the remaining portion of discount, which is for the remaining five months. And then I will pay off the face value of the note, which is the $200,000 of the note. As you can see here, there is no payment of additional interest because it has been already discounted upfront from the non interest-bearing note. That emphasize that the interest-bearing note or the non interest-bearing note both of them bear interest, but in a different way that we record the interest overtime. Hopefully this example clarify the differences between interest-bearing versus non interest-bearing note. And how to account for it, and the idea of the discount that is being generated with respect to the non interest-bearing note. Thank you very much.
