How to Account for Impairment of Notes Payable
Businesses borrow money to finance activities, such as new product launches or building a new office building. Often these companies sign a note payable which creates a legally binding contract between the company and the lender. The lender provides money to the company and the company agrees to repay the money with interest. A promissory note documents the terms of the agreement and includes the maturity value, the interest rate and the length of the loan. Sometimes companies find themselves struggling financially and are unable to repay the note payable. The company may file for bankruptcy or negotiate with the note holder to pay a reduced amount. In either case, the note is impaired. The company adjusts the value of the note payable in its financial records.
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Instructions
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Read the promissory note for the note payable. Locate the face value of the note payable.
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Read the bankruptcy agreement or the letter from the lender confirming the reduction of the note. Locate the revised obligation of the company.
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Subtract the reduced obligation from the face value of the note payable. This equals the impairment amount.
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Write the journal entry to recognize the impairment. Record a debit to Note Payable for the impairment amount. Record a credit to Income from Impairment of Note Payable for the impairment amount.
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Tips & Warnings
The impact of recording the impairment of notes payable appears on both the income statement and the balance sheet. The amount recorded as Income from Impairment of Note Payable appears as revenue on the income statement. This increases the company’s net income for the period. An increase in net income leads to an increase in retained earnings. Retained earnings appear in the stockholder equity section of the balance sheet. Note Payable, which appears in the liability section of the balance sheet, decreases.
An impairment of note payable reflects negatively on the company’s ability to make payments and its credit rating. It demonstrates that the company was unable to pay its previous obligation and may not be able to pay future obligations. Lenders who do agree to provide financing in the future may charge higher interest rates or limit the amount available to the company.
