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 is known as the borrower or debtor and records the amount owed in a liability account such as Notes Payable. The person or organization that has the right to receive the money when the promissory note comes due is known as the lender or creditor and records that amount in an asset account such as Notes Receivable.
Under the accrual method of accounting, both the borrower and the lender must report any accrued interest as of each balance sheet date. The maker/borrower of the note will report interest expense and interest payable. The creditor/lender will report the accrued interest as 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 unable to pay one of its suppliers as agreed. In that situation, the supplier may demand that the company issue a promissory note. This results in the company replacing its account payable with a note payable, and the supplier replacing its account receivable with a note receivable.