Definition of Promissory Note
A promissory note is a written promise to pay an amount of money by a specified date (or perhaps on demand). The maker of the promissory note agrees to pay the principal amount and interest.
The maker of the promissory note (borrower) records the amount owed in a liability account such as Notes Payable. The person or organization that will be receiving the money (lender) records the amount it has a right to receive in an asset account such as Notes Receivable.
Under the accrual method of accounting, both parties must report any accrued interest as of each balance sheet date. The maker of the note will report interest expense and interest payable. The party with the right to receive the interest will report interest income and interest receivable.
Example of a Promissory Note
A promissory note is created when a company borrows money from its bank. However, a promissory note could also be used when a company is not able to pay its supplier. In that situation, the supplier may demand that the company replace its account payable with a note payable. This means that the supplier will be replacing its account receivable with a note receivable.