Companies regularly extend credit to customers who promise to pay the amount due at a future date. This credit comes in two main forms, accounts receivables and notes receivables. Accounts receivables represent customer accounts who promise to pay by the due date, which occurs soon after making the purchase. Notes receivables represent customers who owe money and promise to pay over a longer period of time. Notes receivables occur when a customer signs a document called a promissory note and agrees to pay the face value of the note on a specific date along with interest.
Record Creation Of Notes Receivable
When a company agrees to accept a promissory note from a customer, it must record a notes receivable in its accounting records. Every promissory note includes the face value of the note, or the amount owed, the date due and the interest rate. The notes receivable account represents an asset and maintains a normal debit balance. When the company records the note received from the customer, it debits the notes receivable account for the amount owed and credits Sales.
Record Payment Of Notes Receivable
When the customer pays the promissory note, hes also pay the interest accrued on the note. The company calculates the interest owed by multiplying the face value of the promissory note times the interest rate times the time frame. The company calculates the time frame by dividing the number of days the note was outstanding by the number of days in a year, or 365.
The company records the payment received by debiting Cash for the full amount received, crediting Notes Receivable for the face value of the note and crediting Interest Revenue for the amount of interest calculated.
Record Discounting Of Notes Receivable
Sometimes a company needs cash before the customer pays the promissory note. The company can discount the note with a financial institution. The financial institution pays the company cash in exchange for the right to collect on the note. Financial institutions charge a discount rate for this service. The company determines the amount of the discount by multiplying the maturity value of the note, which is the face value plus the total interest, times the discount rate times the time frame remaining before the note becomes due. The company calculates the time frame by dividing the number of days until the due date by the number of days in a year.
The company records the discounting of the note by debiting Cash for the amount of money received, crediting Notes Receivable for the face value of the note, and crediting Interest Revenue for the difference.
Reporting Notes Receivable
The time frame for notes receivables varies from a few months to a few years. If a note receivable is due in less than one year, it represents a current asset. If a note receivable is due in more than one year, it represents a noncurrent asset. All notes receivable represent assets to the company. The company reports these assets on the balance sheet. Current notes receivable appear in the current assets section of the balance sheet. Noncurrent notes receivable appear in the noncurrent assets section of the balance sheet.