What Is the Meaning of a Promissory Note?
A promissory note is a term used in accounting for a statutory document that declares the intention of an individual or an entity to pay an amount on demand or at a specified time. A promissory note can be written on the face value of a debt or for an amount that would include accrued interest.
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Who Uses Promissory Notes
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Alternatives to paper money. When a promissory note is written, the entity making the promise is named "the maker," and the entity who will receive payment is called "the payee." The payee's name may or may not appear on the document. (Alternatively, the payee may be designated simply as "the bearer" of the note.) In many industries, particularly those that offer leisure pursuits, all credit sales are made using these kinds of notes. The introduction of promissory notes into certain forms of trading was a logical progression from the concept of loans.
Other Uses
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Credit may be given by a company or individual in exchange for a promissory note. A company or individual writes a promise to pay a particular sum of money on demand or at a specific time. In pure accounting terms this promissory note is regarded as "notes receivable" and legally bestows on the payee a more powerful claim to a company or individual's assets than the more traditional "accounts receivable." When an entity (an individual or a company), borrows or lends funds they can use promissory notes in the discharge of an amount owing in accounts receivable, or in circumstances where the credit amount and/or period exceed the usual limits. Promissory notes are also used in "short sales" of houses, since they fit very well into the "forgiveness of debt" paradigm.
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How To Write a Promissory Note
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Writing a Promissory Note There are three ways of writing a promissory note. The note can be written to be paid when it is presented for payment: "I promise to pay XXX on demand." Or it can be rendered on a specific date: "I promise to pay XXX on a stated date." Finally, it can be payable at the end of a specific time period: "I promise to pay XXX at the end of a stated period of time." (E.g.: one year from now I promise to pay XXX...)
Under specific conditions, such as the short-sale of a house, promissory notes are long-term notes, from 15 to 25 years accruing no interest. Using promissory notes with no interest greatly advantages the payer. And promissory notes are also unsecured, which means that they can be negotiated by an attorney.
How Promissory Notes Are Seen by Accountants
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In accounting terms, "notes payable" are a company's recorded obligations and they are in the form of written promissory notes. In a company's accounting infrastructure "notes payable" is frequently used instead of the more traditionally understood "accounts payable" because they are a more legally binding form of proof that an amount is owed and can therefore be collected more easily. A company may issue a promissory note to meet financing needs in the short-term. Promissory notes that are due to be paid within one year on the balance sheet are usually shown as current liabilities. The amount of assets received on issuing the note usually is equal to the actual value of the note.
Conclusions
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Promissory notes are useful forms of payment that find their way into all kinds of financial transactions. Companies use these to make funds liquid. Individuals find themselves dealing with promissory notes when negotiating a short sale on a house or taking a student loan. The oldest promissory note of them all is a bank note. In fact, this is the most basic form of banking, in which a bank holds an individual's or a company's money and promises to pay the money to them on demand.
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References
- Photo Credit paying image by Albert Lozano from Fotolia.com money money image by yannik LABBE from Fotolia.com man writing something in black book image by Ana de Sousa from Fotolia.com
