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. Both accounts receivable and notes receivable can be used to generate immediate cash. The payee is the party who receives payment under the terms of the note, and the maker is the party obligated to send funds to the payee.

• In some cases, the term of the note is expressed in days, and the exact number of days should be used in the interest computation.
• The first set of entries show collection of
  principal, followed by collection of the interest.
• Interest is accrued daily, and this accumulation must be recorded periodically (each month for example).
• A note’s
  maturity date is the date at which the principal
  and interest become due and payable.
• A separate subsidiary ledger for notes receivable may also be created.

When interest is due at the end of the note (24 months), the company may record the collection of the loan principal and the accumulated interest. The first set of entries show collection of principal, followed by collection of the interest. Interest on a note receivable is calculated by multiplying the principal balance of the note by the interest rate and by the number of days that have elapsed since the last interest payment was made divided by 365. The journal entry for interest on a note receivable is to debit the interest income account and credit the cash account.

Notes receivable debit or credit

The amount of payment to be made, as listed in the terms of the note, is the principal. 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.

In November 2014, Square announced that it would be accepting Apple Pay. (b)”Four months after date, I promise to pay…” When the maturity is expressed in months, the note matures on the same date in the month of maturity. For example, one month from July 18 is August 18, and two months from  July 18 is  September 18. If a note is issued on the last day of a month and the month of maturity has fewer days than the month of issuance, the note matures on the last day of the month of maturity.

• FV is the payment at the end of six months’ time (future value) of $5,000.
• The amortized discount is added to the note’s carrying value each year, thereby increasing its carrying amount until it reaches its maturity value of $10,000.
• Harold Averkamp (CPA, MBA) has worked as a university accounting instructor, accountant, and consultant for more than 25 years.
• BWW issued Sea Ferries a
  note in the amount of $100,000 on January 1, 2018, with a maturity
  date of six months, at a 10% annual interest rate.

The maker of a note is the party who receives the credit and promises to pay the note’s holder. The payee is the party that holds the note and receives payment from the maker when the note is due. Dino-Kleen, a customer of Terrance Inc. owes a $10,000 invoice that is past due. Terrance Inc. agrees to grant Dino-Kleen a longer period of time to pay the invoice in exchange for 5% interest. This means the interest on the note is earned in the January, February, March, and April accounting periods.

Financial Accounting

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. The discount or premium resulting from the determination of present value in cash or noncash transactions is not an asset or liability separable from the note that gives rise to it. Therefore, the discount or premium shall be reported in the balance sheet as a direct deduction from or addition to the face amount of the note. Similarly, debt issuance costs related to note shall be reported in the balance sheet as a direct deduction from the face amount of that note.

What is the Normal Balance of Notes Receivable?

Notes receivable are amounts owed to the company by customers or others who have signed formal promissory notes in acknowledgment of their debts. Promissory notes strengthen a company’s legal claim against those who fail to pay as promised. The maturity date of a note determines whether it is accounting cycle definition placed with current assets or long‐term assets on the balance sheet. Notes that are due in one year or less are considered current assets, and notes that are due in more than one year are considered long‐term assets. Accounts receivable is recorded as current assets in the balance sheet.

You should classify a note receivable in the balance sheet as a current asset if it is due within 12 months or as non-current (i.e., long-term) if it is due in more than 12 months. Notes receivable are treated as accounts receivable, which are listed on the balance sheet as assets. When an account receives payment, it is credited to the account and only then is it subsequently debited to Cash or Accounts Receivable.

What is the Journal Entry to Record the Issuance of a Note Receivable?

Any portion of the notes receivable that is not due within one year of the balance sheet date is reported as a long term asset. The debit impact of this transaction is a recording of the notes receivables in the books. This recording is due to receipt of a promissory note from the party and recorded in the books. On the flip side, the credit impact of this journal entry is the removal of the receivable balance as it has been provided in exchange for the promissory note.

When is Interest on a Note Receivable Paid?

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. The accrued interest on notes receivable is recorded as a current asset in the balance sheet if it is expected that interest will be collected within one year. On the other hand, if the accrued interest on the note is not expected to be received in one year, it is reported as a long-term asset. Discount on notes receivable arises when the present value of the future cash flows (principal repayment + interest income) is less than the face value of the note receivable. In other words, if the PV of the future cash flow is less than the value of the notes receivable at the time of the agreement, the situation is said to create the discount on the notes receivables.

Company A sells machinery to Company B for $300,000, with payment due within 30 days. Alternatively, the note may state that the total amount of interest due is to be paid along with the third and final principal payment of $100,000. Often, a business will allow customers to convert their overdue accounts (the business’ accounts receivable) into notes receivable. By doing so, the debtor typically benefits by having more time to pay. On the other hand, the lender is the one who receives a promissory note to receive the interest and principal repayment. The lender records note as an asset of the business under-investment (line item).

What are Notes Receivable in Accounting?

Interest Receivable decreasing (credit) reflects the 2018 interest
owed from the customer that is paid to the company at the end of
2019. The second possibility is one entry recognizing principal and
interest collection. Interest revenue from year one had already been recorded in 2018, but the interest revenue from 2019 is not recorded until the end of the note term. Thus, Interest Revenue is increasing (credit) by $200, the remaining revenue earned but not yet recognized. Interest Receivable decreasing (credit) reflects the 2018 interest owed from the customer that is paid to the company at the end of 2019. The second possibility is one entry recognizing principal and interest collection.

BWW agreed to lend the $250,000 purchase cost (sales price) to
Waterways under the following conditions. The conditions of the
note are that the principal amount is $250,000, the maturity date
on the note is 24 months, and the annual interest rate is 12%. When the maker of a promissory note fails to pay, the note is said to be dishonored. Assuming D. Brown dishonors the note but payment is expected, the company records the event by debiting accounts receivable from D. Brown for $2,625, crediting notes receivable for $2,500, and crediting interest revenue for $125. To illustrate notes receivable scenarios, let’s return to Billie’s Watercraft Warehouse (BWW) as the example.