Part cash part loan; the note at maturity; the current portion

Three ways to pay, one cost

How an asset is paid for never changes its cost. Cash, a note to the seller, a bank loan, part of each — the debit to the asset is the same; only the credits change. Module 4's ski fleet was 42,000 of Equipment against 12,000 of Cash and a 30,000 note. Here the same idea meets a bigger purchase, and then the financing runs to its end.

Worked example — the second groomer

On 1 September of Northlake's second year it buys a second groomer for 120,000: 20,000 cash, the rest by a bank loan.

Sep 1   Equipment                       120,000
            Cash                                    20,000
            Bank Loan Payable                      100,000
        Second groomer; 6 % bank loan for the balance.

The mark-losing version records only the cash — Dr Equipment 20,000 / Cr Cash 20,000 — and leaves 100,000 of asset and 100,000 of debt off the books. The trial balance still balances, which is why the error survives.

The note at maturity

The 30,000 note on the ski fleet was signed on 2 December of year 1, at 6 % for one year, interest at maturity. At the first 31 December one month had run and 150 was accrued (L5.6): Dr Interest Expense 150 / Cr Interest Payable 150. On 2 December of year 2 the note matures. Total interest for the year is $30,000\times 6\%\times \frac{12}{12}=1,800$ — but 150 of it is already an expense, and a liability, of year 1. Only the eleven months since, 1,650, are year 2's expense:

Dec 2   Notes Payable                    30,000
        Interest Payable                    150
        Interest Expense                  1,650
            Cash                                    31,800
        Note on the ski fleet paid at maturity with interest.

Debiting Interest Expense for the whole 1,800 counts December of year 1 twice — once when it was accrued and again now — and leaves a 150 payable that is never cleared. The accrual already did its work; the maturity entry settles it.

A payable becomes a note

Suppliers sometimes agree to wait if the debt is put in writing with interest. Bramble Lane Outfitters owes a supplier 15,000 on account and, unable to pay at 30 days, signs a 90-day, 8 % note for it. Nothing is bought and no cash moves: one liability replaces another, Dr Accounts Payable 15,000 / Cr Notes Payable 15,000. At maturity the note costs $15,000\times 8\%\times \frac{90}{365}=295.89$ of interest — days ÷ 365, because the term is in days.

Current and long-term: principal only

The groomer's loan is repayable 20,000 of principal each 30 June, with interest paid on the same date. At 31 December of year 2 the balance sheet must answer how much of this is due within a year?

Two rules. The liability for a loan is its principal: interest becomes a liability only as time passes, so the 2,000 accrued to date is a payable and the interest for the coming January–June is not — it has not been incurred. And the split is by the one-year test: principal due within twelve months of the balance-sheet date (or the operating cycle, if longer) is current; the rest is long-term. The whole 100,000 is not current just because payments are annual, and it is not all long-term just because the loan runs five years.