Accounting for Notes Receivable Explained

An automated financial management system, such as NetSuite Cloud Accounting Software, simplifies the journal entry process and integrates with cash management to more easily manage notes receivable. Some times notes can be converted into cash by selling them to a financial institution at a discount. The discount rate is the annual percentage rate that the financial institution charges for buying a note and collecting the debt.

However, companies must use the accrual method of accounting and follow some specific rules when recording notes receivable. This can make bookkeeping cumbersome, especially for companies that hold multiple notes receivable. Notes receivable is a receivable that specifically deals with promissory notes.

The Struggles of Private Company Accounting

In the wake of the COVID-19 pandemic and escalating tensions with China, American companies are actively seeking alternatives to mitigate their supply chain risks and reduce dependence on Chinese manufacturing. Nearshoring, the process of relocating operations closer to home, has emerged as an explosive opportunity for American and Mexican companies to collaborate like never before. The interest on a 90‐day, 12%, $10,000 note equals $300 if a 360‐day year is used to calculate interest, and the interest equals $295.89 if a 365‐day year is used. For example, interest on a four-month, 9%, $1,000 note equals $30.

• The face value of a note is called the principal, which equals the initial amount of credit provided.
• Notes receivable have several defining characteristics that include principal, length of contract terms, and interest.
• This entry eliminates from Sparky’s books the accounts receivable from JPG for the original invoice and establishes the new note receivable, due in six months.
• The note will likely also identify an amount of interest to be paid along with the principal.
• It is possible to combine the previous two entries by debiting Notes Receivable and crediting Sales.
• By reducing unpaid, “bad” debts, collecting interest income and facilitating contract sales, notes receivable can be a tool for enhancing cash flow.

Notes receivable are financial instruments that represent the debt owed by a debtor to the lender. The terms of notes receivable are such that they must be repaid by the borrower at some point in the future, typically within one year. There are several elements of promissory notes that are important to a full understanding of accounting for these notes. These are the note’s principal, maturity date, duration, interest rate, and maturity value. The process of transferring the company’s trade note receivable
to the supplier there by clearing the payment due to the supplier is known as
endorsing.

What is an example of notes receivable?

Accounting for notes receivable can be burdensome and error-prone if approached manually. Notes receivable are oftentimes accepted from customers that may need to extend the payment period over which a receivable is repaid. Notes receivable involve the creation of a promissory note, which is notes receivable the promise to repay a prescribed amount of money at, or over, a predetermined timeframe. As a trade note receivable can replace an invoice, to obtain
funding before the trade note maturity date, you can arrange with your bank
that the bank advances the amount due on the trade note.

• Promissory notes are a written promise to pay cash to another party on or before a specified future date.
• The transition from accounts receivable to notes receivable can occur when a customer misses a payment on a short-term credit line for products or services.
• That’s because of the signed promissory note, which can be presented as evidence in a legal proceeding.
• In some cases, the note is received in one accounting period and collected in another.
• The interest is the amount charged for lending the money until it is repaid.

Instead, the lender will convert the notes receivable and interest due into an account receivable. Sometimes a company will classify and label the uncollected account as a Dishonored Note Receivable. Using our example, if the company was unable to collect the $2,000 from the customer at the 12-month maturity date, the following entry would occur. Notes receivable are generally considered to be an asset on a company’s balance sheet.

Disclosures: Assets-Cash

Frequency of a year is the amount of time for the note and can be either days or months. We need the frequency of a year because the interest rate is an annual rate and we may not want interest for an entire year but just for the time period of the note. The difference between notes receivable and traditional loans is that banks do not make these loans directly to borrowers. Instead, they sell them to investors and institutions who purchase them as investments. Notes receivable are short-term loans made to companies or individuals.

If you discount a
trade note receivable with recourse, you must repay the advance to the bank if
your customer fails to pay. 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.

Example of Journal Entries for Notes Receivable

The discount period is the length of time between a note’s sale and its due date. Trade notes that consist of fresh obligations, which are usually
secure, can replace the related invoices. In such cases, when the trade note is
created, the invoice balance is reduced by the amount of the trade note, and a
new open entry of a payment document type is created for the trade note.