Deferred-Payment Contracts: 3 Easy Journal Entry Examples
Deferred-payment contracts allow a company to acquire an asset now and pay later, usually through a long-term note. When the note has no stated interest or an unrealistic interest rate, U.S. GAAP (ASC 835-30) requires the asset to be measured at its cash-equivalent cost. Any difference between the note’s face amount and its initial present value is recorded as a discount and recognized as interest over the note’s life.
The three worked examples below explain present value and journal entries for a single future payment, year-end installments, and a purchase with a known cash price.
This matters even when the contract says “zero interest.” A promise to pay $24,200 two years from now is not economically identical to paying $24,200 today. Separating the purchase from its financing prevents asset cost and later depreciation from absorbing a hidden interest charge.
Video lesson with Professor Farhat
In this video, Property, Plant and Equipment (Valuation), Professor Farhat explains how to value assets you acquire, including purchases paid for with a zero-interest-bearing note. Watch it first, then use the worked examples below to separate the asset’s cost from the interest.
Why Do Deferred-Payment Contracts Use Present Value?
Present value means the amount today that is equivalent to specified future cash payments at an appropriate interest rate. Start with the most reliable evidence. Under FASB ASC 835-30, record the asset at the fair value of what you received (often its cash price) or the market value of the note, whichever is easier to determine reliably. If neither is available, discount the payments using an imputed rate, which is the rate a similar borrower would pay on a similar loan.
An imputed rate is an estimated market rate, not a number chosen to make the answer convenient. Consider the borrower’s credit quality, payment timing, maturity and similar borrowing terms. A zero stated rate means the contract does not separately label an interest payment; it does not prove that the financing has no economic cost.
| Payment pattern | Present-value approach |
|---|---|
| One amount at a future date | Future payment ÷ (1 + periodic rate)number of periods |
| Equal amounts at each period-end | Payment × ordinary-annuity present-value factor |
| Down payment plus future installments | Down payment + present value of future installments |
Keep the rate and periods consistent. Annual payments need an annual rate. A payment made today is already at present value. For the underlying mathematics, review present value of a single sum and present value of an ordinary annuity.
How Do You Record Equipment Bought With A Zero-Interest Note?
Hypothetical example. Lake Printing acquires equipment by issuing a zero-interest-bearing note for $24,200, due in two years. The appropriate annual market rate is 10%, and no separate cash price is available. Assume the equipment is ready to use immediately.
Present value = $24,200 ÷ 1.102 = $20,000. The note’s face amount is $24,200, but its initial net carrying amount is $20,000. The $4,200 difference is a discount on the note.
| Account | Debit | Credit |
|---|---|---|
| Equipment | $20,000 | — |
| Discount on Notes Payable | $4,200 | — |
| Notes Payable | — | $24,200 |
Discount on Notes Payable is a contra-liability with a debit balance. It reduces the liability’s face amount; it is not a separate asset. The balance sheet therefore presents a net obligation of $20,000 at acquisition. This is the financed-purchase application of PPE valuation and cash-equivalent cost.
Under the effective-interest method, multiply the opening net note balance by the effective interest rate established at initial recognition. Later changes in market rates do not change that rate for these notes. The net balance, also called the net carrying amount, is the face amount minus the unamortized discount. GAAP requires this method. Straight-line amortization is allowed only when the result is not materially different. With no payment until maturity, interest increases the net liability each year.
| Year | Opening net note | Interest at 10% | Ending net note before settlement |
|---|---|---|---|
| 1 | $20,000 | $2,000 | $22,000 |
| 2 | $22,000 | $2,200 | $24,200 |
At the end of year 1, debit Interest Expense $2,000 and credit Discount on Notes Payable $2,000. In year 2, debit Interest Expense $2,200 and credit the discount $2,200. At maturity, debit Notes Payable $24,200 and credit Cash $24,200. The discount has reached zero.
How Do Installment Payments Change The Interest?
Hypothetical example. Cedar Studio acquires equipment for two year-end payments of $12,100, with no stated interest. The appropriate rate is 10%, and no cash price is available. Present value is $12,100 ÷ 1.10 + $12,100 ÷ 1.102 = $11,000 + $10,000 = $21,000.
Record Equipment $21,000 and Discount on Notes Payable $3,200 as debits, with Notes Payable $24,200 as a credit. The total promised payments happen to equal Lake’s note, but earlier payment makes Cedar’s present value larger.
| Year | Opening net note | Interest | Cash payment | Closing net note |
|---|---|---|---|---|
| 1 | $21,000 | $2,100 | $12,100 | $11,000 |
| 2 | $11,000 | $1,100 | $12,100 | $0 |
For year 1, debit Interest Expense $2,100 and credit Discount on Notes Payable $2,100. Separately, debit Notes Payable $12,100 and credit Cash $12,100. The remaining face amount is $12,100; the remaining discount is $1,100, producing an $11,000 net liability. Repeat with $1,100 of interest in year 2, then pay the last $12,100.
If Cedar also paid $3,000 at acquisition in addition to these installments, equipment cost would be $24,000. The note and discount would be unchanged because the $3,000 has no deferred financing period. The examples isolate purchase financing; interest capitalization during construction is a separate lesson.
What If The Seller Quotes A Cash Price?
Hypothetical example. Birch Bakery can buy an oven for $45,000 cash today. Instead, it signs a zero-interest note for $54,450, due in two years. The cash price is the clearest evidence of the oven’s value, so record the oven at $45,000. You don’t need to choose a rate first.
| Account | Debit | Credit |
|---|---|---|
| Equipment | $45,000 | — |
| Discount on Notes Payable | $9,450 | — |
| Notes Payable | — | $54,450 |
The cash price also tells you the rate built into the deal. $54,450 ÷ $45,000 = 1.21, and 1.21 = 1.10 × 1.10. So the implied annual rate is 10%.
| Year | Opening net note | Interest at 10% | Ending net note before settlement |
|---|---|---|---|
| 1 | $45,000 | $4,500 | $49,500 |
| 2 | $49,500 | $4,950 | $54,450 |
Total interest is $4,500 + $4,950 = $9,450, which uses up the full discount. Exam tip: when a question gives you a reliable cash price, start there instead of discounting the note.
Common mistakes in deferred-payment contracts
Use this checklist when preparing journal entries for deferred-payment contracts:
- Separate asset cost from financing. Do not record the full future payment total as equipment merely because it appears on the note.
- Recognize interest over time. Do not amortize the entire discount on the acquisition date.
- Use the opening net carrying amount. Apply the effective interest rate established at initial recognition to that amount, rather than to the unchanged face amount.
- Follow the payment dates. Subtract payments when they occur.
- Check the first installment. If payment begins immediately, treat the first payment as a down payment or use an annuity-due factor. An ordinary-annuity factor applies to payments at each period-end.
For the buyer, amortizing Discount on Notes Payable creates interest expense. The seller who holds the note records the mirror image: a Discount on Notes Receivable that becomes interest revenue over the same period. Also keep financing separate from an equipment trade: nonmonetary exchange accounting asks whether a gain on the surrendered asset can be recognized. Review the nonmonetary exchange lessons in our Intermediate Accounting course.
Key Takeaways
- A deferred-payment contract splits into two pieces: the asset’s cost today and interest over time.
- Record the asset at its cash price or the note’s market value, whichever is clearer. If neither exists, discount the payments at an imputed market rate.
- Notes Payable is recorded at face value. The difference goes to Discount on Notes Payable, a contra-liability.
- Interest each period equals the opening net carrying amount times the effective interest rate established at initial recognition.
- The discount becomes interest expense. It is not part of the equipment’s purchase price, so it is not depreciated.
Interactive CPA FAR practice on deferred-payment contracts
Use this three-question exercise to distinguish the initial equipment cost from the face amount of a long-term note and identify how Discount on Notes Payable reduces the liability to present value. On the CPA exam, this topic falls under FAR Area II, Select Balance Sheet Accounts, which covers property, plant and equipment and debt.
Practice questions with explained answers
1. A $13,310 note is due in three years at a 10% market rate. What is the initial asset amount?
Answer: $10,000, because $13,310 ÷ 1.10³ = $10,000. Record a $3,310 discount against the $13,310 face amount.
2. A note opens the year at a net $18,000, the effective rate is 8%, and $5,000 is paid at year-end. What is the ending balance?
Answer: $14,440. Interest is $18,000 × 8% = $1,440; the closing net liability is $18,000 + $1,440 − $5,000.
3. Future installments have a present value of $32,000 and a $6,000 down payment is made now. What is asset cost?
Answer: $38,000. Add the immediate payment to the discounted future installments; do not discount the down payment again.
Want more practice like this? Work through timed questions in the Farhat Lectures FAR Test Bank.
Frequently asked questions
Why does a zero-interest note produce interest expense?
The financing charge can be embedded in the future payment amount. Discounting separates that charge from the cash-equivalent asset cost.
Is the discount depreciated with equipment?
No. The discount is amortized as interest. Equipment depreciation is based on its separately measured cost and other depreciation assumptions.
Should every short-term supplier invoice be discounted?
No. ASC 835-30 excludes payables to suppliers that arise in the normal course of business and are due on customary trade terms of approximately one year or less. The two-year equipment notes in this guide fall outside that customary trade-payable exception.
How Do You Pick The Interest Rate When The Contract Has None?
Use an imputed rate: the rate an independent borrower and lender would agree on for a similar loan. Look at the buyer’s credit standing, any collateral, the payment schedule, and current rates on similar debt. The rate the buyer would pay to borrow on similar terms is often a good starting point.
Can You Amortize The Discount Straight-Line?
Only if the result is not materially different from the effective-interest method. GAAP requires the effective-interest method, so use it on exam questions unless the question tells you otherwise.
Where Does The Discount Appear On The Balance Sheet?
It’s subtracted directly from the note’s face amount. Right after Lake Printing’s purchase, the note shows as $24,200 less a $4,200 discount, or $20,000. After year 1, the remaining discount is $2,200 and the net liability is $22,000. Because the note is now due within 12 months, it’s classified as a current liability.
Sources and lesson context
The current U.S. GAAP reference is FASB ASC 835-30, Imputation of Interest. FASB’s archived APB Opinion 21 explains the historical basis for present-value measurement and effective-interest amortization. The archive is background; the Codification governs current accounting.
This original guide supports Wiley Intermediate Accounting, section 9.3. All examples and practice questions are hypothetical and original. The discussion uses U.S. generally accepted accounting principles (GAAP).
About The Author
Mansour Farhat, DBA, CPA, CIA, is the founder of Farhat Lectures and a veteran accounting educator. He helps accounting students and CPA, CMA, and Enrolled Agent (EA) candidates build a strong understanding of accounting through clear explanations and step-by-step worked examples. Learn more about Professor Farhat.
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