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Notes Payable

Notes payable represent formal written promises to pay a certain sum of money on a specified date. Notes payable to banks or loan companies are included in these accounts. Notes payable may also arise from purchases, financing or other transactions. In some industries, a note payable is required as part of the sale transaction instead of extending credit based on an open account. These notes are often referred to as trade notes payable. Notes payable may be long-term or short-term depending on the length of time until the maturity of the note. 

Bonds issued at a premium or discount: The investment community values bonds based on the present value of their future cash flows, which vary depending on the applicable market interest rate, the coupon payments of the bond, and the principal. As a result, bonds may be sold at a discount or a premium. A bond is sold at a discount when the market rate of interest is higher than the stated rate on the bond, and the fair value of the bond is less than its face value. A bond is sold at a premium when the market rate of interest is lower than the stated rate on the bond, and as a result the bond can be sold for more than its face value. The reason that the face value of the bond changes when the market rate is different than the stated rate on the bond is because investors want to earn an effective rate of interest on the bond that is equal to the market rate. Because they cannot change the stated rate of interest, investors will pay less for a bond that offers them less interest than the market rate and more for a bond that offers them more interest than the market rate. The change in the fair value of the bond will be equal to an amount necessary to make the effective rate of interest that the investor earns equal to the market rate.

There are two methods used for accounting for bonds that are issued at a discount or a premium: the straight line method or the effective interest method.