for Accounting Long-Term Notes Payable
The use of notes payable in long-term debt financing is quite common. Long-term notes payable
are similar to short-term interest-bearing notes payable except that the terms of the notes exceed
one year. In periods of unstable interest rates, lenders may tie the interest rate on long-term notes
to changes in the market rate for comparable loans. Examples are the 8.03% adjustable rate notes
issued by General Motors and the floating-rate notes issued by American Express Company.
A long-term note may be secured by a document called a mortgage that pledges title to specific
assets as security for a loan. Individuals widely use mortgage notes payable to purchase homes,
as do many small and some large companies to acquire plant assets. For example, at one time
approximately 18% of McDonald's long-term debt related to mortgage notes on land, buildings,
and improvements.
Helpful Hint
Electronic spreadsheet programs can create
a schedule of installment loan payments.
This allows you to put in the data for your
own mortgage loan and get an illustration
that really hits home.
Like other long-term notes payable, the mortgage loan terms may stipulate either a fixed or an
adjustable interest rate. Typically, the terms require the borrower to make equal installment
payments over the term of the loan. Each payment consists of (1) interest the on unpaid balance
of the loan and (2) a reduction of loan principal. While the total amount paid remains constant,
the interest decreases each period and the portion applied to the loan principal increases.
Companies initially record mortgage notes payable at face value, and subsequently make entries
for each installment payment. To illustrate, assume that Porter Technology Inc. issues a
$500,000, 12%, 20-year mortgage note on December 31, 2010, to obtain needed financing for
the construction of a new research laboratory. The terms provide for semiannual installment
payments of $33,231 (not including real estate taxes and insurance). The installment payment
schedule for the first two years is as follows.
Illustration 10C- Mortgage installment payment
schedule
Porter Technology records the mortgage loan and first installment payment as follows.
Cash
500,000
Mortgage Notes Payable
(To record mortgage loan)
Interest Expense
Mortgage Notes Payable
(To record semiannual payment on mortgage)
In the balance sheet, the company reports the reduction in principal for the next year as a
current liability, and classifies the remaining unpaid principal balance as a long-term
liability. At December 31, 2011 (the end of semi-annual period 2), the total liability is $493,344,
of which $7,478 ($3,630 + $3,848) is current and $485,866 ($493,344 - $7,478) is long-term.