Person or business that signs note is called creator. The payee receives the payment.
Notes Receivable Format
A typical notes receivable format is below. This example involves J. Hart making and C. Brecker paying.
This article focuses on notes receivable, although the fundamentals apply to notes payable as well.
Notes Receivable Types
Different economic transactions generate different notes receivable. For instance, trade notes receivable are client commitments in writing.
For specific sales, sellers often require a note rather than an open account.
When selling equipment or other personal or real property, payment periods are usually longer than for an open account.
Sometimes a customer’s credit rating will force the merchant to require a written notice instead of an open account.
If consumers default on payments, the seller may require a note for the remainder.
Cash loans to employees, stockholders, consumers, and others create other notes receivable. We will call the notes promissory notes.
Promissory notes components
Accounting for promissory notes requires understanding numerous factors. Note principle, maturity date, length, interest rate, and maturity value.
The loan or borrowing amount is the note’s principal. It excludes interest.
Principal and interest make up the note’s maturity value. Face value refers to the primary portion.
2. Mature Date
Note maturity is when it becomes due and payable. This date is on the note or can be established from its facts.
A note may mature on 31 December or in a certain number of days or months.
Notes receivable last the number of days stated on the notes.
This timeframe is crucial for computing note interest.
To calculate note duration, note dates and maturity dates must be known. As seen here, a note dated 15 July with a maturity date of 15 September has 62 days.
Since the note has been outstanding for 62 days, interest is calculated.
Interest is the cost or benefit of borrowing or lending. Interest is income to the lender or payee and an expense to the maker or borrower.
Notes Receivable Accounting
Notes Receivable are debited when customers send notes. The note can credit Cash, Sales, or Accounts Receivable, depending on the transaction.
Notes Receivable is the note’s face or principal. Interest income is not recorded at the issuance date because no interest has been earned.
If the note is longer than one period, an adjustment entry records interest at maturity or the end of the accounting period.
Assume that on July 1, the Fenton Company receives a $2,000, 12%, 4-month note receivable from the Zoe Company to satisfy an open account receivable.
To combine the previous two entries, debit Notes Receivable and credit Sales.
However, this will erase data.
Because not all sales to a client are reflected in their subsidiary accounts receivable ledger.
Payment of Note
Cash, Note Receivables, and Interest Revenue are debited and credited when a note is paid.
The note may be received in one accounting period and collected in another. These cases need year-end interest accrual.
Assume the Bullock Company gets a $5,000, 3-month, 18% note on November 1, 2019 for cash. The firm’s year-end is 31 December, and the note matures 31 January 2020.
The Bullock Company’s journal entries for November 1, December 31, and January 31, 2020 are below.
If the borrower or manufacturer of a note fails to pay at maturity, the note defaults.
Transfer the note to an open account receivable. Accounts Receivable is debited for the maturity value, including principle and interest.
Although it may seem odd to declare interest revenue on defaulted notes receivable, the Zoe Company must pay both the interest and principal.
Accounts receivable, notes receivable, and interest are all viable claims.
The notes receivable general ledger now only contains unmatured notes after transferring the note to Accounts Receivable.
The Fenton Company should note the Zoe Company’s subsidiary accounts receivable ledger default.
If accounts receivable are uncollectible, write them off against Allowances.
Generate Cash from Notes Receivable
Receivables and notes receivable might generate cash immediately.
You can assign, pledge, or factor receivables. All of these possibilities involve the receivable owner selling or borrowing against it to get cash.
Small and medium-sized firms with limited financing need this flexibility to raise capital.
Accounts receivable assignment and factoring are addressed in intermediate accounting texts.