A note receivable is similar to an account receivable but with a few extra components and different accounting rules. Generally accepted accounting principles instruct users to accrue interest on both their short- and long-term notes receivable and periodically re-evaluate the value of the note.
A note receivable is more enforceable and formal compared to a regular receivable, and it often contains an interest component. It's a formal document with a designated loan amount and maturity date. Companies often use notes receivables when they want to extend credit to new customers and don't have a credit history to rely on.
The determining factor of short- and long-term notes receivable is time. Short-term notes are notes due within 12 months or less. If the note is due in more than a year, it's a long-term note. Short-term notes receivable are considered a current asset. As such, they're included in the balance sheet under the current asset category. Long term notes are presented on the balance sheet along with other non-current assets.
Companies must recognize the interest portion of payments they receive on notes receivable. The interest portion is recorded as interest income and the rest of the payment decreases the balance of the note. The company also needs to accrue interest income when necessary. For example, if a company has "earned" interest on a note over a few months but hasn't received a payment by year end, it needs to debit interest receivable and credit interest income.
Companies don't always collect the entire sum of their notes receivable. Like accounts receivable, a company must maintain an allowance for bad debts on notes receivable if it thinks there's some chance it won't collect the full amount. Companies subtract the allowance balance from the note value to determine the net notes receivable account value. Generally accepted accounting principles also require companies to revalue their notes receivable if they think it's probable they won't collect them. If the fair value differs from what the company has calculated using the allowance method, the company must disclose it in its financial statements.