Notes receivable are written commitments without conditions in which an individual or business pledges to pay a specified amount at a predetermined date or upon request.
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Last Updated: January 2, 2024 In This ArticleNotes receivable represent assets associated with a written promissory note outlining the payment terms for a transaction between the "payee" (often a company, also known as a creditor) and the "maker" of the note (typically a customer or employee, also known a debtor).
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.
These notes find representation on the balance sheet , reflecting the monetary value of promissory notes owed to a business, anticipating future payments.
They grant the holder the entitlement to receive the specified amount stipulated in the contractual agreement. These notes essentially serve as written assurances of the debtor to remit cash to another party by a designated future date.
If a note receivable is expected to be collected within one year, it is classified as a current asset on the balance sheet. Otherwise, if the collection extends beyond one year, it is categorized as a non-current asset.
Frequently, businesses permit customers to transform overdue accounts ( accounts receivable ) into notes receivable, providing debtors with the advantage of an extended payment period.
Notes receivables constitute a written agreement where a borrower commits to repay a specific amount of money, including interest, to the lender on a set date in the future. Therefore, notes are considered negotiable instruments, like cheques and bank drafts.
Notes receivable may originate from various sources, such as loans granted to individuals or businesses, advances provided to employees, or customers with higher credit risk who require an extended payment period for outstanding accounts.
Notes can also find application in the context of property, plant, and equipment sales or the exchange of long-term assets.
In instances where notes stem from loans, they may specify collateral in the form of the borrower's assets, which the lender can take possession of if the note remains unpaid by the maturity date.
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.
The note presents all terms and conditions transparently to remove any possible misunderstandings between the parties in the future.
Additionally, it explicitly specifies both the principal amount, equivalent to the face value of the notes, and the accompanying interest that must be paid.
Businesses worldwide commonly engage in buying and selling on credit. A formal commitment to make payment on a designated future date is generated when a supplier sells goods on credit.
These formal commitments, often referred to as promissory notes, are considered notes receivable upon acceptance.
The following are the key components of notes receivable:
The following hypothetical example illustrates how notes receivable work:
Company XYZ sells machinery to Company ABC for $50,000; payment is initially expected within 60 days. However, Company B failed to make the payment within the given days. Both parties agree on a promissory note to settle the debt as per the following terms:
Example of Journal Entries for Notes Receivable
The accounting journal entries for the note receivable from Company XYZ can be summarized as follows:
| Entry 1 | Debit | Credit |
|---|---|---|
| Notes Receivable: Current – Company ABC | $50,000 | |
| Accounts Receivable – Company ABC | $50,000 |
Company XYZ's financial records no longer include the accounts receivable from
Company ABC for the initial invoice. Instead, a new note receivable has been created, with a maturity date set for six months from now.
| Debit | Credit |
|---|---|
| Entry 2 | |
| Cash | $51,504 |
| Notes Receivable: Current – Company ABC | $50,000 |
| Interest Income – Company ABC | 1,504 |
This record represents the complete settlement with cash upon maturity. It removes the notes receivable from Company ABC for the original amount and documents interest earnings based on the duration the note remained outstanding.
It is calculated as ($50,000 x 6%) multiplied by the ratio of days outstanding to 365 (183/365).
Let's comprehensively compare the differences between Notes Receivable and Notes Payable:
| Aspect | Notes Receivable | Notes Payable |
|---|---|---|
| Definition | A written commitment to receive a certain sum of money, often with interest, from another party. | A written commitment to repay a specified amount of money, often with interest, to another party. |
| Issued By | The creditor or lender issues a note to the debtor or borrower. | The debtor or borrower issues a note to the creditor or lender. |
| Listed By | Listed as an asset in the creditor's balance sheet. | Listed as a liability on the balance sheet of the debtor. |
| Purpose | Represents money owed to the entity. Typically arises from sales of goods or services, loans, or other credit transactions. | Represents the entity's obligation to pay a specified amount in the future, often related to borrowing funds or purchasing goods on credit. |
| Entry on Issuance | Debit: Notes Receivable Credit: Revenue or Cash | Debit: Notes Payable Credit: Cash or Goods/Services Received |
| Entry on Repayment | Debit: Cash Credit: Notes Receivable & Interest Revenue | Debit: Notes Payable & Interest Expense Credit: Cash |
| Interest Calculation | Interest may accrue on the outstanding principal, and the interest calculation depends on the terms of the note. | Interest may accrue on the outstanding principal, and the interest calculation depends on the terms of the note. |
| Position on Balance Sheet | Asset side (current or non-current assets) | Liability side (current or non-current liabilities) |
| Risk Perspective | Represents expected future cash inflow and is accompanied by the risk of non-payment by the debtor. | Represents a commitment to repay a specified amount in the future, with the associated risk of default by the entity. |
| Example Scenario | A company provides a loan to another and, in exchange, obtains a promissory note. | A company borrows funds from a financial institution and issues a promissory note in return. |
| Impact on Cash Flow | Positive impact when payments are received. | Negative impact when payments are made. |
The following are the advantages of a notes receivable account:
The following are the disadvantages of a notes receivable account:
Let's understand the differences between Accounts Receivable and Notes Receivable:
| Aspect | Accounts Receivable | Notes Receivable |
|---|---|---|
| Nature | Short-term obligations arising from credit sales. | Formal written promises to pay a specific sum of money, usually with interest, over a specified period. |
| Formation | Generated from the sale of goods or services on credit. | Typically, it results from a formal written agreement or promissory note. |
| Formal Agreement | Often informal, with no formal written agreement. | A formal written agreement or promissory note outlines terms, interest rates, and repayment schedules. |
| Maturity Period | Usually short-term, it is due within a few months. | It can be short-term or long-term. |
| Interest | Generally, it doesn't carry interest. | It may carry interest, providing a potential additional source of revenue for the holder. |
| Security | Unsecured, relying on the customer's creditworthiness. | It may be secured, with specific assets pledged as collateral to mitigate risk. |
| Risk | Generally considered a higher risk due to the informal nature and shorter terms. | Risk can vary depending on the terms and creditworthiness of the debtor. Secured notes may have a lower risk. |
| Accounting Treatment | Recorded as a current asset on the balance sheet. | Recorded as a current or non-current asset, depending on the expected timing of collection. |
| Usage | Common in everyday business transactions. | Often used in more formal or larger transactions where a written agreement is necessary. |
| Flexibility | Less formal, allowing for more flexibility in payment terms. | More formal, with terms and conditions explicitly stated, providing less flexibility. |
| Legal Recourse | Legal action may be considered in case of non-payment. | Legal action is typically more straightforward due to the formal written agreement. |
| Examples | Invoices issued to customers for goods or services delivered on credit. | Promissory notes are issued for loans, real estate transactions, or large purchases on credit. |
