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What is a promissory note?

A promissory note is a written promise to pay an amount of money by a specified date (or on demand). The promissory note could involve a loan from a bank, a loan from a relative, a replacement for an account payable, etc.

The written amount of money is referred to as the face amount. The face amount will be recorded in the promisor's (borrower's) general ledger with a credit to the liability account Notes Payable or Loans Payable. The promisee (lender) will record the face amount with a debit to its asset account Notes Receivable.

If the promissory note specifies a fair interest rate, it is used to accrue interest expense and interest payable on the books of the borrower. The lender will accrue interest revenue or income and interest receivable.

If the promissory note does not specify interest, it should be assumed that the face amount includes some interest. The estimated future amount of interest should be recorded by the borrower in the contra account Discount on Notes Payable. The lender should record the same amount in a contra account Discount on Notes Receivable. The discount is then amortized over the life of the note to Interest Expense (borrower) and Interest Revenue (lender).