At the time you sign a promissory note, you enter a legal, binding agreement to repay the lender plus the interest stated in the agreement. When you sign a non-interest-bearing promissory note with a lender, you must record the transaction using an imputed interest rate -- a rate you would incur if you borrowed the funds from another source. Assume the purpose of illustration that you have signed a $40,000 five-year note in exchange for a piece of machinery. Imagine you determined an imputed interest rate on the note payable of 8 percent.
Calculate the present value of the note. Multiply the face value of the note by the present value factor -- a factor obtained by using a "present value of 1" table, where the variable "n" represents the life of the note. The present value of the note in this example is $27,240, or $40,000 x 0.681.
Create a journal entry to record the transaction to your ledger. Debit the account "machinery and equipment" for $27,240, the present value of the note.
Credit the liability account "notes payable" for $40,000, the face value of the note. Debit the account "discount on notes payable" for $12,760, the excess of the face value of the note over its present value. The complete entry should appear as follows: Debit Machinery and Equipment 27,240 Debit Discount on Notes Payable 12,760 Credit Notes Payable 40,000
Post the journal entry. You have recorded a note with imputed interest to your books.
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