What Are Bills Payable in Accounting?

In business accounting, a liability representing a formal, written promise to pay a specific amount of money to another party by a predetermined future date is called a note payable. While the term “bills payable” is sometimes used, a note payable specifically refers to a formal debt instrument, such as a promissory note, that outlines the principal amount, the maturity date, and any applicable interest. This represents a legally binding obligation for the business to settle a debt.

This formal promise is recorded in a company’s accounting system. A formal note payable is often tracked separately from routine vendor invoices due to its specific terms, indicating a more structured debt arrangement than routine trade credit.

Notes Payable vs. Accounts Payable

A primary distinction between notes payable and accounts payable lies in their formality. Notes payable are evidenced by a formal, written legal document, such as a promissory note, that legally obligates the borrower to pay. In contrast, accounts payable are less formal, arising from invoices or bills received from suppliers for goods or services purchased on credit.

Another difference involves interest. Notes payable often include an explicit interest component that the borrower must pay in addition to the principal amount. Accounts payable are generally non-interest-bearing, with payment terms like “net 30,” meaning the full amount is due in 30 days. Interest on accounts payable usually only accrues if the payment becomes overdue.

The timeframe for repayment also separates these two liabilities. Accounts payable are almost always short-term, with payment expected within 30 to 60 days. Notes payable offer more flexibility and can be structured as either short-term or long-term obligations extending beyond one year.

Recording a Note Payable Transaction

The accounting for a note payable begins when the debt is incurred. Imagine a company borrows $10,000 from a bank on January 1, signing a six-month promissory note with a 5% annual interest rate. To record this, a journal entry increases cash and recognizes the new liability. The entry would be a debit to the Cash account for $10,000 and a credit to the Notes Payable account for $10,000.

When the note matures six months later, on June 30, the company must repay the principal along with the accrued interest. The interest expense is calculated for the six-month period: $10,000 (principal) x 5% (annual rate) x (6/12) (months), which equals $250.

The final repayment requires a journal entry that eliminates the liability and records the interest cost. The company would debit Notes Payable for $10,000, debit Interest Expense for $250, and credit the Cash account for the total amount paid of $10,250.

Presentation on the Balance Sheet

On a company’s balance sheet, notes payable are reported within the liabilities section. The specific classification within this section depends on the timing of the required payment. The primary distinction is their classification as either current or non-current liabilities. If a note payable is due within one year or the company’s operating cycle, whichever is longer, it is classified as a current liability. A 90-day promissory note used to purchase inventory would be a current liability.

If the payment on a note payable is due more than one year from the balance sheet date, it is categorized as a non-current (or long-term) liability. A five-year note taken out to finance the purchase of equipment is a common example. The portion of a long-term note that is due within the upcoming year must be reclassified and shown as a current liability on the balance sheet.