Definition:
Notes receivables are written promissory notes which give the holder or bearer the right to receive the amount mentioned in the agreement. It is treated as an asset by the holder of the note receivable. Sometimes accounts receivables are converted into notes receivables to allow the debtors to pay the balance.
If the note receivable is due within a year, it’s treated as a current asset, treated as non-current assets.
What are the important components of notes receivables?
Important components of notes receivable:
- Principal value: The face value of the note mentioned in the note
- Maker: The person who makes the note and who promises to pay the holder of the note. He regards this note as notes payable.
- Payee: The person who holds the note and who is entitled to receive the payment
- Interest: The notes include the rate of interest to be charged on the due amount, the holder has to pay the principal with interest on the due date mentioned in the note itself.
- Due date of payment: The notes itself contain the due date of payment and its issue date.
Specimen of notes receivable:
Classification of notes receivable:
Notes receivables should be classified as a current asset if it is due within a year and non-current assets if it is due in more than a year.
If the note has more than a year and the customer doesn’t pay interest in the first year, unpaid interest should be added to the beginning principal balance in the second year, and interest is to be calculated on this new value.
Example:
The maker owes USD100,000 to the payee at 12% p.a. and pays no interest in the first year. The interest earned would be USD12,000 for the first year. So, the interest would be calculated on the new principal USD112,000 in the second year. So, the interest would be USD13440.
This is how the interest is calculated for notes receivables.
Notes receivable accounting:
Let us take an example and learn accounting for notes receivables.
MPC Co. sells goods to RSP for USD60,000 with payment due in 30 days. After 60 days of non-payment, notes payable are issued to MPC by RSP Co. for USD60,000 at an interest rate of 10% per annum and with a payment of USD20,000 due at the end of each of the next 90 days.
The accounting entry to record the conversion of accounts receivable to notes receivable is:
| Particulars | Debit ($) | Credit ($) |
| Notes receivable A/C Dr | 60,000 | |
| Accounts receivables A/C | 60,000 |
At the end of the month, RSP pays USD20,000 along with the interest due amount, which is calculated as 60,000*10%*30/365= USD494
The entry would be passed as
| Particulars | Debit ($) | Credit ($) |
| Cash A/C Dr | 20,494 | |
| Notes receivables A/C | 20,000 | |
| Interest income A/C | 494 |
At the end of the second month, RSP pays another USD20,000 and the interest of 40,000*10/100*30/365= USD 328.
The entry would be:
| Particulars | Debit ($) | Credit ($) |
| Cash A/C Dr | 20,328 | |
| Notes receivables A/C | 20,000 | |
| Interest income A/C | 328 |
At the end of the final month, RSP pays interest of 20,000*10/100*30/365= USD165 along with the payment of USD 20,000.
The entry would be:
| Particulars | Debit ($) | Credit ($) |
| Cash A/C Dr | 20,165 | |
| Notes receivables A/C | 20,000 | |
| Interest income A/C | 165 |
Now the note has been completely discharged, MPC has recorded an interest income of USD987.
The interest income would be recognized as:
First month
| Particulars | Debit ($) | Credit ($) |
| Interest receivable A/C Dr | 494 | |
| Interest income | 494 |
Second month
| Particulars | Debit ($) | Credit ($) |
| Interest receivable A/C Dr | 328 | |
| Interest income | 328 |
Third month
| Particulars | Debit ($) | Credit ($) |
| Interest receivable A/C Dr | 165 | |
| Interest income | 165 |
When the note’s maturity rises after the completion of 90 days, the interest amount is paid to MPC.
This is recorded as:
| Particulars | Debit ($) | Credit ($) |
| Cash A/C Dr | 987 | |
| Interest receivable | 987 |
Assume if RSP was unable to pay the final installment of USD20,000 and the related interest of USD165 and MPC has been accruing this interest income. MPC has to write off the remaining balance of the note with interest due.
The entry would be passed as:
| Particulars | Debit ($) | Credit ($) |
| Provision for doubtful debts A/C Dr | 20,165 | |
| Interest receivable | 165 | |
| Notes receivables | 20,000 |
Discounting notes receivables:
Notes can be converted to cash by discounting them to the financial institutions. If the maker dishonors the note, the company discounting the note pays to the financial institutions.
When notes are sold with conditions, the company creates contingent liability, and it is disclosed in the notes to financial statements.
The discount fee that the bank charges on discounting of notes receivables can be found by:
Discount = Maturity value of note* Discount rate*Discount period
The following entry is passed:
| Particulars | Debit ($) | Credit ($) |
| Cash A/C Dr | XXXXX | |
| Interest expense A/C Dr | XXXXX | |
| Notes receivables (Discounted note to bank) | XXXXX |