What Are the Differences or Similarities Between Bonds and Notes Payable?
Both bonds and notes payable are classified as liabilities. If a note or bond payable is due for repayment within one year, it is a short-term or current liability. If they are not due for more than one year, then they are classified as long-term liabilities. Bonds and notes payable represent loans. Notes payable are loans from a lender, usually a financial institution and bonds are loans from investors.
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Notes Payable
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Notes payable are promissory notes by which the lender, also known as the drawer or issuer, of the note agrees to lend the borrower, also referred to as the maker of the note, a sum of money at a specific interest rate. Depending on the terms of the note payable, the maker repays the drawer interest payments at regularly scheduled intervals or one lump sum payment including accrued interest at the note’s maturity date.
Recording Notes Payable
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When the promissory note is issued, the company records the note as a debit to cash and credit to notes payable. If the company must make regular interest payments, on the payment date, the company debits the interest expense account and credits interest payable. If the company pays the note off in one lump sum of payment plus accrued interest, it debits interest expense for the interest only. It then debits the notes payable account for the principal amount of the note and credits cash for both the principal and interest paid on the note.
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Bonds Payable
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When investors purchase corporate bonds, they are loaning money to the company in exchange for a stream of interest payments over the term of the bond. At maturity, the company must repay the investors the face value of the bond. Bonds are a debt security and do not represent any type of ownership in the company. Companies may favor issuing bonds over obtaining loans because it can negotiate the time to maturity of the bond. For instance, a maximum term on a business loan may be 15 to 25 years, while the maximum date to maturity on a bond can be anywhere from 30 to 40 years.
Recording Bonds Payable
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When a company issues bonds, it debits the cash account and credits bonds payable. Companies make regular interest payments to its bondholders throughout the year and is recorded by debiting interest expense and crediting cash for interest paid. When a bond matures, the company must repay the bondholders the face value of the bond. To record this transaction, the company debits bonds payable and credits cash for the face value. If a final interest payment is made on the date of maturity, the company debits interest expense and credits cash for the interest paid.
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