A note payable is a liability that places an obligation on a company's resources. Crediting notes payable increases a company's liability whereas debiting notes payable decreases a company's liability. A note payable accumulates interest each month at the interest rate provided by the lender. When a company makes an interest payment on a note payable, it affects the company's cash account.
When a company borrows money from a lender, a journal entry must be made to debit cash for the amount borrowed and credit notes payable for the same amount. This increases a company's cash account while increasing a liability, since the company must pay off the loan. A note payable may be due in more than one year or less than one year, depending on the terms of the loan. When considering notes payable, a company must factor in the interest payment that must accompany payments made on the principal of the loan.
As interest builds on a loan, a company must recognize the accumulating interest, regardless of whether or not the interest is paid in the same period. For example, a company that borrows $10,000 with an 8 percent interest rate accumulates $800 a month in interest charges. The company must date the journal entry to indicate the time when the interest expense was recognized. In this scenario, a company must debit interest expense for $800. Debiting an expense account increases an expense, which decreases a company's net income.
A debit to a company's interest expense account must be accompanied by a matching credit to an interest payable account. If a company writes an entry in the general journal debiting interest expense for $800, the interest payable account must be credited for $800 to make the journal entry balance. Crediting an interest payable account increases a company's liability, meaning the business has an obligation to pay the accumulating interest on the loan.
Making an interest payment affects a company's cash account. For instance, a company that pays $800 for interest expense must withdraw cash from the business to pay the expense. The company must write a journal entry to debit interest payable. This entry decreases the company's liability by removing the interest payable obligation off the books. The company must credit cash for the same amount as the interest payable debit amount, since debits must equal credits. This transaction decreases the funds in a company's cash account.
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