What is a Note Receivable? Definition Meaning Example
To simplify the math, we will assume every month has 30 days and each year has 360 days. There are two situations where a company may receive a short-term note. The ability to raise cash in this way is important to small and medium-sized businesses, which may have limited access to finance.
- Our work has been directly cited by organizations including Entrepreneur, Business Insider, Investopedia, Forbes, CNBC, and many others.
- On January 1,
2018, Waterways purchased merchandise in the amount of $250,000. - In November 2014, Square announced that it would be accepting Apple Pay.
- Note that the interest component decreases for each of the scenarios even though the total cash repaid is $5,000 in each case.
So far, our discussion of receivables has focused solely on
accounts receivable. Companies, however, can expand their business
models to include more than one type of receivable. This receivable
expansion allows a company to attract a more diverse clientele and
increase asset potential to further grow the business. Notes receivable can arise in various business relationships involving interactions with other businesses, financial institutions, or individuals. Typically, these situations occur when a buyer requires an extended period beyond the usual billing terms to settle payment for a purchase.
3.2 Maturity (Due) Date
If it is still unable to collect, the company may consider
selling the receivable to a collection agency. When this occurs,
the collection agency pays the company a fraction of the note’s
value, and the company would write off any difference as a
factoring (third-party debt collection) expense. Let’s say that our
example company turned over the $2,200 accounts receivable to a
collection agency on March 5, 2019 and received only $500 for its
value. The difference between $2,200 and $500 of $1,700 is the
factoring expense. The principal part of a note receivable that is expected to be collected within one year of the balance sheet date is reported in the current asset section of the lender’s balance sheet.
Components of Notes Receivable
The articles and research support materials available on this site are educational and are not intended to be investment or tax advice. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly. The Bullock Company’s journal entries for 1 November 2019, 31 December 2019, and 31 January https://simple-accounting.org/ 2020 are shown below. It is possible to combine the previous two entries by debiting Notes Receivable and crediting Sales. Together, the principal and interest portions represent the note’s maturity value. Notes receivable are initially recognized at the fair value on the date that the note is legally executed (usually upon signing).
Accounted by
In
contrast, notes receivable (an asset) is a more
formal legal contract between the buyer and the company, which
requires a specific payment amount at a predetermined future date. The length of contract is typically over a year, or beyond one
operating cycle. There is also generally an interest requirement
because the financial loan amount may be larger than accounts
receivable, and the length of contract is possibly longer. A note
can be requested or extended in exchange for products and services
or in exchange for cash (usually in the case of a financial
lender).
At the maturity date of a note, the maker is responsible for the principal plus interest. The payee should record the interest earned and remove the note from its Notes Receivable account. Thus, the payee of the note should debit Accounts Receivable for the maturity value of the note and credit Notes Receivable for the note’s face value and Interest Revenue for the interest.
Accounts Receivable is debited for the full maturity value, including the principal and unpaid interest. This is because not all the sales made to a particular customer are recorded in the customer’s subsidiary accounts receivable ledger. The duration of notes receivable is the length of the time that notes are outstanding or the number of days called for by the notes. There are several types of notes receivable that arise from different economic transactions. For example, trade notes receivable result from written obligations by a firm’s customers. Finally, at the end of the 3 month term the note receivable is honored by the customer together with the accrued interest, and the following journal completes the transaction.
Although it may seem peculiar to record interest revenue on defaulted notes receivable, the Zoe Company is still obligated to pay both the interest and the principal. In some cases, the note is received in one accounting period and collected in another. Below are some examples with journal entries involving various stated rates compared to market rates. All financial assets are to be measured initially at their fair value which is calculated as the present value amount of future cash receipts.
For example, a note dated 15 July with a maturity date of 15 September has a duration of 62 days, as shown below. The first journal is to record the principal amount of the about raise grants. Since the note has matured, the holder or payee removes the note from Notes Receivable and records the amount due in Accounts Receivable. The $18,675 paid by Price to Cooper is called the maturity value of the note. Maturity value is the amount that the company (maker) must pay on a note on its maturity date; typically, it includes principal and accrued interest, if any.
Related AccountingTools Courses
For non-current asset classification, the company must reevaluate the note receivable at the end of each accounting period to identify if its classification has changed. Finally, a note receivable will also mention the timeframe of the loan. It is similar to the maturity date of loans, representing a future point at which the borrower will repay the lender.
The note payable is essentially an undertaking which serves as a surety of payment by the borrower or debtor for the amount owed. Square, the mobile payments company, allows small businesses to take credit cards by swiping customer credit cards using a small square device attached to the audio jack found on mobile devices. Since its founding in 2009 and the launch of its first app in 2010, Square has found its way into many small businesses – and large businesses. Starbucks uses Square to process transactions with credit or debit card customers. In November 2014, Square announced that it would be accepting Apple Pay.
When a note’s due date is expressed in days, the specified number of days is divided by 360 or 365 in the interest calculation. You may see either of these figures because accountants used a 360‐day year to simplify their calculations before computers and calculators became widely available, and many textbooks still follow this convention. In current practice, however, financial institutions and other companies generally use a 365‐day year to calculate interest.
Interest on long‐term notes is calculated using the same formula that is used with short‐term notes, but unpaid interest is usually added to the principal to determine interest in subsequent years. For example, a two‐year, 10%, $10,000 note accrues $1,000 in interest during the first year. The principal and first year’s interest equal $11,000 when compounded, so $1,100 in interest accrues during the second year.
This is treated as an asset by the holder of the note, and a liability by the borrower. Overdue accounts receivable are sometimes converted into notes receivable, thereby giving the debtor more time to pay, while also sometimes including a personal guarantee by the owner of the debtor entity. The guarantee provision makes the note receivable easier to collect than a standard account receivable.
The remaining principal of the note receivable is reported in the noncurrent asset section entitled Investments. To log a note receivable, simply debit the notes receivable account and credit the cash account. From the perspective of the note issuer, the document is referred to as notes payable, indicating the obligation to repay a designated amount on a predetermined future date to the holder of the notes receivable. A note receivable of $300,000, due in the next 3 months, with payments of $100,000 at the end of each month, and an interest rate of 10%, is recorded for Company A.
