What Are Amortizing Notes and How Are They Accounted For?

An amortizing note is a loan that requires the borrower to make scheduled, periodic payments to a lender. Each payment consists of both a principal and an interest component, a structure that ensures the loan is paid off by its specified term. Unlike loans where you might pay only interest for a period, an amortizing note systematically reduces the outstanding loan balance with every payment. This repayment method is common for auto loans and home mortgages.

Core Components of an Amortizing Note

The principal is the initial amount of money borrowed. For instance, if a business secures a loan for $50,000 to purchase equipment, that amount is the principal. The entire repayment structure is built around returning this original amount, and all interest calculations are tied to the outstanding principal balance.

Interest is the cost of borrowing the principal, expressed as a percentage rate. The interest portion of a payment is calculated by multiplying the outstanding principal by the periodic interest rate. As the principal balance decreases with each payment, the amount of interest paid in subsequent payments also declines.

Periodic payments are the fixed, regular amounts paid by the borrower to the lender. These payments, often made monthly, are structured to cover both the interest accrued for the period and a portion of the principal.

Creating an Amortization Schedule

An amortization schedule requires the total loan amount (principal), the annual interest rate, and the loan term. This schedule provides a payment-by-payment breakdown of how the loan will be paid off. It separates the interest and principal components of each payment and shows the remaining loan balance after each is made.

The process begins by calculating the fixed periodic payment amount. For example, consider a $10,000 loan with a 6% annual interest rate to be paid over four years with annual payments. The annual payment is a fixed amount that covers both principal and interest over the four-year term.

For the first payment on this $10,000 loan, interest is calculated on the full principal. With a 6% annual rate, the interest for the first year is $600 ($10,000 0.06). If the annual payment is $2,885.91, the principal portion is $2,285.91 ($2,885.91 – $600), reducing the outstanding principal to $7,714.09. For the second payment, interest is calculated on this new balance, resulting in $462.85 of interest and a principal payment of $2,423.06.

By the final payment period, the dynamic has shifted. The outstanding principal is much lower, so the interest portion of the payment is minimal. The bulk of the final payment goes toward clearing the remaining principal balance, bringing the loan balance to zero.

| Payment Number | Payment Amount | Interest Paid | Principal Paid | Remaining Balance |
| :— | :— | :— | :— | :— |
| 0 | | | | $10,000.00 |
| 1 | $2,885.91 | $600.00 | $2,285.91 | $7,714.09 |
| 2 | $2,885.91 | $462.85 | $2,423.06 | $5,291.03 |
| 3 | $2,885.91 | $317.46 | $2,568.45 | $2,722.58 |
| 4 | $2,885.91 | $163.35 | $2,722.56 | $0.00 |

Accounting for Amortizing Notes

Borrower (Note Payable)

From the borrower’s perspective, the initial receipt of the loan proceeds creates a liability on the balance sheet. When the $10,000 loan is received, the borrower makes a journal entry that increases cash and establishes a liability account named Notes Payable. The entry is a debit to Cash for $10,000 and a credit to Notes Payable for $10,000. This reflects that the business has more cash but also has an obligation to repay that amount.

When the first annual payment of $2,885.91 is made, the borrower must account for the reduction of the liability and the recognition of interest expense. Using the amortization schedule, the borrower records a debit to Interest Expense for $600 and a debit to Notes Payable for $2,285.91. The total of these debits equals the cash outflow, recorded as a credit to Cash for $2,885.91. This entry reduces the loan liability on the balance sheet and recognizes the cost of borrowing for the period on the income statement.

Lender (Note Receivable)

For the lender, issuing the loan creates an asset, as it represents a future stream of cash inflows. When the $10,000 is disbursed, the lender records a Note Receivable, which is an asset account. The journal entry is a debit to Notes Receivable for $10,000 and a credit to Cash for $10,000. This entry shows the lender has exchanged cash for a claim to future payments.

Upon receiving the first payment of $2,885.91, the lender’s accounting entry reflects the receipt of cash, the earning of interest revenue, and the reduction of the note receivable. The lender debits Cash for $2,885.91. This is offset by a credit to Interest Revenue for $600 and a credit to Notes Receivable for $2,285.91. This process continues with each payment, mirroring the borrower’s entries from the opposite perspective.