What Is a Promissory Note? Meaning, Negotiability and CPA Exam Rules
By SimplyCPA · 11 October 2026
On this page (7)
- Meaning: A signed, written promise by a maker to pay a fixed amount of money to a payee, on demand or at a set date.
- Note vs draft: A note is a promise to pay (two parties); a draft, such as a cheque, is an order to pay (three parties). An IOU is neither.
- Negotiable if: Written, signed, an unconditional promise, a fixed amount of money, payable on demand or at a definite time, and payable to order or bearer.
- Why it matters: A holder in due course takes a negotiable note free of most personal defences, but not real defences like forgery.
- On the exam: Negotiability is tested in REG business law; accounting for notes receivable at present value is tested in FAR.
Definition
A promissory note is a signed, written promise by one party (the maker) to pay a fixed amount of money to another party (the payee) or to whoever holds the note, either on demand or at a set future date. Loans, mortgages, seller financing and intercompany borrowing are all commonly documented with notes.
Note vs draft vs IOU
- A note is a promise to pay — two parties: maker and payee.
- A draft (such as a cheque) is an order to pay — three parties: drawer, drawee and payee.
- An IOU merely acknowledges a debt. It contains no promise to pay, so it isn't a negotiable instrument.
When is a note negotiable?
Under Article 3 of the Uniform Commercial Code (UCC), a note is a negotiable instrument only if it:
- is in writing;
- is signed by the maker;
- contains an unconditional promise to pay;
- is for a fixed amount of money (interest is allowed, even at a variable rate);
- is payable on demand or at a definite time;
- is payable to order or to bearer; and
- contains no other undertaking or instruction beyond the promise to pay.
Exam trap: "Payable when the buyer resells the property" is not a definite time, and "payable from the proceeds of the Smith contract only" makes the promise conditional. Both destroy negotiability.
Why negotiability matters
A negotiable note can be transferred to a holder in due course — someone who took it for value, in good faith, and without notice of problems. That holder takes it free of most "personal" defences the maker could have raised against the original payee (such as breach of contract or ordinary fraud in the inducement), though not "real" defences such as forgery, infancy or discharge in bankruptcy.
Accounting for notes
In FAR, notes receivable are recorded at present value. If a note carries no interest or an unreasonably low rate, the difference between face value and present value is recognised as a discount and amortised to interest income using the effective-interest method.
Where it's tested
Negotiable instruments and secured transactions sit in the business law portion of REG; see our topics on debtor-creditor relationships and contracts.