assignment of notes receivable

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Assignment of Accounts Receivable: Meaning, Considerations

Adam Hayes, Ph.D., CFA, is a financial writer with 15+ years Wall Street experience as a derivatives trader. Besides his extensive derivative trading expertise, Adam is an expert in economics and behavioral finance. Adam received his master's in economics from The New School for Social Research and his Ph.D. from the University of Wisconsin-Madison in sociology. He is a CFA charterholder as well as holding FINRA Series 7, 55 & 63 licenses. He currently researches and teaches economic sociology and the social studies of finance at the Hebrew University in Jerusalem.

Charlene Rhinehart is a CPA , CFE, chair of an Illinois CPA Society committee, and has a degree in accounting and finance from DePaul University.

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What Is Assignment of Accounts Receivable?

Assignment of accounts receivable is a lending agreement whereby the borrower assigns accounts receivable to the lending institution. In exchange for this assignment of accounts receivable, the borrower receives a loan for a percentage, which could be as high as 100%, of the accounts receivable.

The borrower pays interest, a service charge on the loan, and the assigned receivables serve as collateral. If the borrower fails to repay the loan, the agreement allows the lender to collect the assigned receivables.

Key Takeaways

• Assignment of accounts receivable is a method of debt financing whereby the lender takes over the borrowing company's receivables.
• This form of alternative financing is often seen as less desirable, as it can be quite costly to the borrower, with APRs as high as 100% annualized.
• Usually, new and rapidly growing firms or those that cannot find traditional financing elsewhere will seek this method.
• Accounts receivable are considered to be liquid assets.
• If a borrower doesn't repay their loan, the assignment of accounts agreement protects the lender.

Understanding Assignment of Accounts Receivable

With an assignment of accounts receivable, the borrower retains ownership of the assigned receivables and therefore retains the risk that some accounts receivable will not be repaid. In this case, the lending institution may demand payment directly from the borrower. This arrangement is called an "assignment of accounts receivable with recourse." Assignment of accounts receivable should not be confused with pledging or with accounts receivable financing .

An assignment of accounts receivable has been typically more expensive than other forms of borrowing. Often, companies that use it are unable to obtain less costly options. Sometimes it is used by companies that are growing rapidly or otherwise have too little cash on hand to fund their operations.

New startups in Fintech, like C2FO, are addressing this segment of the supply chain finance by creating marketplaces for account receivables. Liduidx is another Fintech company providing solutions through digitization of this process and connecting funding providers.

Financiers may be willing to structure accounts receivable financing agreements in different ways with various potential provisions.​

Special Considerations

Accounts receivable (AR, or simply "receivables") refer to a firm's outstanding balances of invoices billed to customers that haven't been paid yet. Accounts receivables are reported on a company’s balance sheet as an asset, usually a current asset with invoice payments due within one year.

Accounts receivable are considered to be a relatively liquid asset . As such, these funds due are of potential value for lenders and financiers. Some companies may see their accounts receivable as a burden since they are expected to be paid but require collections and cannot be converted to cash immediately. As such, accounts receivable assignment may be attractive to certain firms.

The process of assignment of accounts receivable, along with other forms of financing, is often known as factoring, and the companies that focus on it may be called factoring companies. Factoring companies will usually focus substantially on the business of accounts receivable financing, but factoring, in general, a product of any financier.

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What are Notes Receivable?

Key components of notes receivable.

• Example of Notes Receivable
• Example of Journal Entries for Notes Receivable

Notes Receivable vs Notes Payable

Additional resources, notes receivable.

Written promissory notes that give the holder the right to receive the amount outlined in an agreement

Notes receivable are a balance sheet item that records the value of promissory notes that a business is owed and should receive payment for. A written promissory note gives the holder, or bearer, the right to receive the amount outlined in the legal agreement. Promissory notes are a written promise to pay cash to another party on or before a specified future date.

If the note receivable is due within a year, then it is treated as a current asset on the balance sheet. If it is not due until a date that is more than one year in the future, then it is treated as a non-current asset on the balance sheet.

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.

• A note receivable is also known as a promissory note.
• When the note is due within less than a year, it is considered a current asset on the balance sheet of the company the note is owed to. If its due date is more than a year in the future, it is considered a non-current asset.
• The interest income on notes receivable is recognized on the income statement. Therefore, when payment is made on a note receivable, both the balance sheet and the income statement are affected.

Here are the key components of notes receivable:

• Principal value: The face value of the note
• Maker: The person who makes the note and therefore promises to pay the note’s holder. To a maker, the note is classified as a note payable.
• Payee : The person who holds the note and therefore is due to receive payment from the maker. To a payee, the note is classified as a note receivable
• Stated interest: A note receivable generally includes a predetermined interest rate; the maker of the note is obligated to pay the interest amount due, in addition to the principal amount, at the same time that they pay the principal amount.
• Timeframe: The length of time during which the note is to be repaid. Notes receivable are not usually subject to prepayment penalties, so the maker of the note is free to pay off the note on or before the note’s stated due, or maturity, date.

Example of Notes Receivable

Company A sells machinery to Company B for $300,000, with payment due within 30 days. After 45 days of nonpayment by Company B, both parties agree that Company B will issue a note payable for the principal amount of $300,000, at an interest rate of 10%, and with a payment of $100,000 plus interest due at the end of each month for the next three months. 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.

In this example, Company A records a notes receivable entry on its balance sheet, while Company B records a notes payable entry on its balance sheet. The principal value is $300,000, $100,000 of which is to be paid monthly. In addition, the agreed upon interest rate on the note is 10%.

Example of Journal Entries for Notes Receivable

Still using the example delineated above, with companies A and B:

A note receivable of $300,000, due in the next 3 months, with payments of $100,000 at the end of each month, and an interest rate of 10%, is recorded for Company A.

The proper journal entries for Company A are as follows:

At the end of the first month, Company B pays $100,000 as well as an interest payment = $2,465.75 (calculated as $300,000 x 10% x 30 / 365 days = $2,465.75).

At the end of the second month, Company B pays $100,000, along with interest of $200,000 x 10% x 30 / 365 days = $1,643.84. Note that the amount of interest is lower because the outstanding principal amount is now only $200,000 ($300,000 – $100,000), having been reduced by the previous month’s payment.

At the end of the third and final month, Company B pays the remaining principal of $100,000, as well as the interest of $100,000 x 10% x 30 / 365 days = $821.92

At the end of the three months, the note, with interest, is completely paid off.

It is not unusual for a company to have both a Notes Receivable and a Notes Payable account on their statement of financial position . Notes Payable is a liability as it records the value a business owes in promissory notes. Notes Receivable are an asset as they record the value that a business is owed in promissory notes. A closely related topic is that of accounts receivable vs. accounts payable.

Thank you for reading our guide to Notes Receivable. To continue learning and advancing your career in corporate finance, you may find the additional free CFI resources below helpful:

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Notes Receivable

• 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.

Before deciding to pursue his  MBA , Andy previously spent two years at Credit Suisse in Investment Banking, primarily working on  M&A  and  IPO  transactions. Prior to joining Credit Suisse, Andy was a Business Analyst Intern for  Capital One  and worked as an associate for Cambridge Realty Capital Companies.

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What are Notes Receivables?

Understanding notes receivables, components of notes receivable, example of notes receivable, notes receivable vs notes payable, advantages of notes receivables, disadvantages of notes receivables, accounts receivable vs notes receivable, notes receivables faqs.

Notes 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.

Key Takeaways

• A note receivable is also called a promissory note or simply a note.
• The interest earned on it shows up on the income statement. So, when a payment is received on a note, it affects both the balance sheet and the income statement.
• Unlike accounts receivable, notes receivable involve a formal written agreement or promissory note. This document includes essential details such as principal amount, interest rate, repayment terms, maturity date, and collateral.

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:

• Principal Amount: The principal amount, also known as the face value or principal sum, is the initial sum of money the borrower agrees to repay the lender. It forms the basis for interest calculations and represents the primary amount lent or borrowed.
• Interest Rate: The interest rate is the percentage applied to the initial amount for a designated duration, influencing the expense of borrowing or the earnings on an investment for the lender.
• Maturity Date: The maturity date signifies the deadline by which the borrower must repay the principal amount and any accumulated interest to the lender. It establishes the repayment schedule, differentiating between short-term and long-term notes.
• Terms of Repayment: The terms of repayment encompass the schedule and method by which the borrower will make payments. It includes details such as the frequency of payments (monthly, quarterly, annually) and whether payments are in equal installments or structured differently. Clearly defined repayment terms ensure both parties are aware of their obligations and help in financial planning.
• Interest Accrual Method: The interest accrual method determines how interest is calculated and accrued over time. Common methods include simple interest or compound interest. The chosen method affects the total interest amount and the financial implications for both the borrower and the lender.
• Collateral (if any): Collateral is an asset pledged by the borrower to secure the note. It serves as a form of security for the lender in case of default.
• Default and Remedies: The terms outline what constitutes a default (failure to fulfill obligations) and the remedies available to the lender in case of default. Clearly defined default provisions help protect the lender's interests and provide a legal framework for addressing default situations.
• Negotiability and Transferability: Notes may be negotiable or non-negotiable, and the terms of the note may restrict their transferability. This impacts the ease with which the note can be transferred to another party, potentially influencing liquidity.

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:

• Maker: Company ABC
• Principal: $50,000
• Time frame: 6 months due at maturity
• Interest rate: 6% per year

Example of Journal Entries for Notes Receivable

The accounting journal entries for the note receivable from Company XYZ can be summarized as follows:

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.

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:

The following are the advantages of a notes receivable account:

• Formal Agreement:  These notes establish a formal, written agreement between the creditor and debtor, clearly outlining essential terms such as the principal amount, interest rate, and repayment schedule.
• Legal Protection:  It can function as a legally recognized record, offering proof of the debtor's commitment to settle the owed sum. This documentation is significant in situations involving disputes or when legal proceedings are necessary.
• Interest Income:  If interest is charged on the note, the creditor can earn additional income beyond the principal amount. This interest can contribute to the overall profitability of the transaction.
• Flexibility:  They offer flexibility in negotiating terms. Creditors and debtors can adjust the repayment schedule, interest rates, and other terms based on their mutual agreement.
• Financial Planning:  The company can improve its cash flow planning by keeping notes receivables, indicating when they will receive payment.

The following are the disadvantages of a notes receivable account:

• Default Risk:  Failure by the borrower to fulfill the responsibilities specified in the promissory note, such as delayed payments or non-repayment of the entire agreed-upon sum, can expose the lender to potential financial liabilities.
• Liquidity Concerns:  Unlike cash, promissory notes are not as liquid. It may take time to convert the promissory note into cash, especially if the debtor faces financial difficulties.
• Interest Rate Risk:  Creditors face a potential risk when interest rates change. With a fixed-interest rate loan, the creditor may lose the chance to capitalize on higher returns if the prevailing market rates increase.
• Administrative Burden:  Managing and tracking promissory notes can be administratively burdensome. This includes monitoring payment schedules, ensuring compliance with terms, and potentially dealing with late payments.
• Dependence on Debtor's Financial Health:  The effectiveness of promissory notes depends on the financial stability of the debtor. The debtor's financial challenges could impact their ability to fulfill the repayment obligations.

Let's understand the differences between Accounts Receivable and Notes Receivable:

Notes receivable are written commitments made by individuals or businesses to pay a specific amount of money at a predetermined date or upon request.

A promissory note contains information such as the initial borrowed amount, any applicable interest rate , the repayment conditions, the designated maturity date, and specifics regarding collateral or security interests if they exist.

It can be involved in various transactions, including loans, real estate transactions, large credit purchases, and other situations where a formal written agreement is needed.

To log a note receivable, simply debit the notes receivable account and credit the cash account.

Interest on a Note Receivable is calculated based on the agreed-upon interest rate and the outstanding principal amount. Common methods include simple interest or compound interest .

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Assignment of Accounts Receivable

The financial accounting term assignment of accounts receivable refers to the process whereby a company borrows cash from a lender, and uses the receivable as collateral on the loan. When accounts receivable is assigned, the terms of the agreement should be noted in the company's financial statements.

Explanation

In the normal course of business, customers are constantly making purchases on credit and remitting payments. Transferring receivables to another party allows companies to reduce the sales to cash revenue cycle time. Also known as pledging, assignment of accounts receivable is one of two ways companies dispose of receivables, the other being factoring.

The assignment process involves an agreement with a lending institution, and the creation of a promissory note that pledges a portion of the company's accounts receivable as collateral on the loan. If the company does not fulfill its obligation under the agreement, the lender has a right to collect the receivables. There are two ways this can be accomplished:

General Assignment : a portion of, or all, receivables owned by the company are pledged as collateral. The only transaction recorded by the company is a credit to cash and a debit to notes payable. If material, the terms of the agreement should also appear in the notes to the company's financial statements.

Specific Assignment : the lender and borrower enter into an agreement that identifies specific accounts to be used as collateral. The two parties will also outline who will attempt to collect the receivable, and whether or not the debtor will be notified.

In the case of specific assignment, if the company and lender agree the lending institution will collect the receivables, the debtor will be instructed to remit payment directly to the lender.

The journal entries for general assignments are fairly straightforward. In the example below, Company A records the receipt of a $100,000 loan collateralized using accounts receivable, and the creation of notes payable for $100,000.

In specific assignments, the entries are more complex since the receivable includes accounts that are explicitly identified. In this case, Company A has pledged $200,000 of accounts in exchange for a loan of $100,000.

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Receivables Finance And The Assignment Of Receivables

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A receivable represents money that is owed to a company and is expected to be paid in the future. Receivables finance, also known as accounts receivable financing, is a form of asset-based financing where a company leverages its outstanding receivables as collateral to secure short-term loans and obtain financing.

In case of default, the lender has a right to collect associated receivables from the company’s debtors. In brief, it is the process by which a company raises cash against its own book’s debts.

The company actually receives an amount equal to a reduced value of the pledged receivables, the age of the receivables impacting the amount of financing received. The company can get up to 90% of the amount of its receivables advanced.

This form of financing assists companies in unlocking funds that would otherwise remain tied up in accounts receivable, providing them with access to capital that is not immediately realised from outstanding debts.

FIG. 1: Accounts receivable financing operates by leveraging a company’s receivables to obtain financing.  Source: https://fhcadvisory.com/images/account-receivable-financing.jpg

Restrictions on the assignment of receivables – New legislation

Invoice  discounting  products under which a company assigns its receivables have been used by small and medium enterprises (SMEs) to raise capital. However, such products depend on the related receivables to be assignable at first.

Businesses have faced provisions that ban or restrict the assignment of receivables in commercial contracts by imposing a condition or other restrictions, which prevents them from being able to use their receivables to raise funds.

In 2015, the UK Government enacted the Small Business, Enterprise and Employment Act (SBEEA) by which raising finance on receivables is facilitated. Pursuant to this Act, regulations can be made to invalidate restrictions on the assignment of receivables in certain types of contract.

In other words, in certain circumstances, clauses which prevent assignment of a receivable in a contract between businesses is unenforceable. Especially, in its section 1(1), the Act provides that the authorised authority can, by regulations “make provision for the purpose of securing that any non-assignment of receivables term of a relevant contract:

• has no effect;
• has no effect in relation to persons of a prescribed description;
• has effect in relation to persons of a prescribed description only for such purposes as may be prescribed.”

The underlying aim is to enable SMEs to use their receivables as financing to raise capital, through the possibility of assigning such receivables to another entity.

The aforementioned regulations, which allow invalidations of such restrictions on the assignment of receivables, are contained in the Business Contract Terms (Assignment of Receivables) Regulations 2018, which will apply to any term in a contract entered into force on or after 31 December 2018.

By virtue of its section 2(1) “Subject to regulations 3 and 4, a term in a contract has no effect to the extent that it prohibits or imposes a condition, or other restriction, on the assignment of a receivable arising under that contract or any other contract between the same parties.”

Such regulations apply to contracts for the supply of goods, services or intangible assets under which the supplier is entitled to be paid money. However, there are several exclusions to this rule.

In section 3, an exception exists where the supplier is a large enterprise or a special purpose vehicle (SPV). In section 4, there are listed exclusions for various contracts such as “for, or entered into in connection with, prescribed financial services”, contracts “where one or more of the parties to the contract is acting for purposes which are outside a trade, business or profession” or contracts “where none of the parties to the contract has entered into it in the course of carrying on a business in the United Kingdom”. Also, specific exclusions relate to contracts in energy, land, share purchase and business purchase.

Effects of the 2018 Regulations

As mentioned above, any contract terms that prevent, set conditions for, or place restrictions on transferring a receivable are considered invalid and cannot be legally enforced.

In light of this, the assignment of the right to be paid under a contract for the supply of goods (receivables) cannot be restricted or prohibited. However, parties are not prevented from restricting other contracts rights.

Non-assignment clauses can have varying forms. Such clauses are covered by the regulations when terms prevent the assignee from determining the validity or value of the receivable or their ability to enforce it.

Overall, these legislations have had an important impact for businesses involved in the financing of receivables, by facilitating such processes for SMEs.

Digital platforms and fintech solutions: The assignment of receivables has been significantly impacted by the digitisation of financial services. Fintech platforms and online marketplaces have been developed to make the financing and assignment of receivables easier.

These platforms employ tech to assess debtor creditworthiness and provide efficient investor and seller matching, including data analytics and artificial intelligence. They provide businesses more autonomy, transparency, and access to a wider range of possible investors.

Securitisation is an essential part of receivables financing. Asset-backed securities (ABS), a type of financial instrument made up of receivables, are then sold to investors.

Businesses are able to turn their receivables into fast cash by transferring the credit risk and cash flow rights to investors. Investors gain from diversification and potentially greater yields through securitisation, while businesses profit from increased liquidity and risk-reduction capabilities.

References:

https://www.tradefinanceglobal.com/finance-products/accounts-receivables-finance/  – 28/10/2018

https://www.legislation.gov.uk/ukpga/2015/26/section/1/enacted  – 28/10/2018

https://www.legislation.gov.uk/ukdsi/2018/9780111171080  – 28/10/2018

https://www.bis.org/publ/bppdf/bispap117.pdf  – Accessed 14/06/2023

https://www.investopedia.com/terms/a/asset-backedsecurity.asp  – Accessed 14/06/2023

https://www.imf.org/external/pubs/ft/fandd/2008/09/pdf/basics.pdf  – Accessed 14/06/2023

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Managing Notes Receivable: Recording Entries and Adjustments for Your Assignment

In the realm of financial accounting, notes receivable are a crucial element that demands precise management and accurate recording. This process necessitates a thorough understanding of how to document the issuance of notes, accrue interest over time, and manage the collection or potential dishonor of these notes. Students working on financial accounting assignments , mastering the complexities of notes receivable is indispensable. Properly handling notes receivable is essential for ensuring the accuracy and integrity of financial statements, making it a vital skill in any financial accounting assignment.

Notes receivable, as formal written promises for payment, differ from accounts receivable due to their structured terms, including interest and specific maturity dates. This added complexity necessitates a methodical approach to ensure all financial transactions are correctly recorded and adjustments are made to reflect the true financial position of the business.

By focusing on the correct procedures for recording and adjusting entries related to notes receivable, this resource will help students develop a solid foundation in financial accounting. This knowledge is crucial for preparing accurate financial statements and maintaining the integrity of financial records. Whether you are a student preparing for exams or an aspiring accountant looking to sharpen your skills, understanding notes receivable is a fundamental aspect of financial accounting that cannot be overlooked.

Understanding Notes Receivable

A note receivable is a formal, written promise that a customer will pay a fixed amount of money by a specific date. This promise usually includes the principal amount, an interest rate, and the maturity date. Notes receivable can arise from various transactions, including sales, loans, or other financial agreements. They are classified as either short-term (due within one year) or long-term (due beyond one year).

Notes receivable differ from accounts receivable primarily due to their formalized nature and the inclusion of interest. While accounts receivable are generally short-term and non-interest-bearing, notes receivable come with a written agreement and typically accrue interest over time.

The Importance of Notes Receivable

Notes receivables are vital for several reasons:

• Revenue Recognition: They help businesses recognize revenue that will be received in the future.
• Interest Income: The interest component of notes receivable adds to the overall income of the business.
• Legal Documentation: They provide a formal agreement, which can be useful for legal purposes if disputes arise.

Recording Entries for Notes Receivable

Accurate journal entries are crucial when dealing with notes receivable. Here’s a detailed approach to recording these entries:

For example, if a business sells goods worth $10,000 on a note, the notes receivable account is debited with $10,000, indicating an asset. Simultaneously, the sales account is credited with the same amount, reflecting the revenue earned.

For instance, if the note mentioned above has a 5% annual interest rate, interest will accrue over the life of the note. Assuming a monthly interest accrual, the interest for one month would be calculated as follows:

In this case:

Monthly Interest = $10,000 × (5%\12) = $41.67

This amount is recorded as interest receivable and interest revenue, ensuring that your financial statements reflect the earned interest.

Collection of the Note Upon collection of the note, including the principal and interest, record the transaction to reflect the cash received. This involves recognizing the receipt of cash and removing the note receivable from your records.

Continuing with our example, when the note matures and is collected, the business would receive $10,000 in principal plus the accrued interest. This total amount is recorded in the cash account. The notes receivable account is reduced by the principal amount, and the interest receivable account is reduced by the interest amount. Any additional interest earned during the collection period is recognized as interest revenue.

Adjusting Entries for Notes Receivable

Adjusting entries ensure that all financial activities are recorded in the correct accounting period. This is especially important for notes receivable, as interest may accrue over multiple accounting periods. Here’s how to handle necessary adjustments:

For example, if the fiscal year ends in December and a note receivable was issued in October, you need to record the accrued interest for October, November, and December. This involves calculating the interest for each month and making an adjusting entry to recognize the interest receivable and interest revenue.

For instance, if a $10,000 note is dishonored, the business would convert this amount to accounts receivable. Any accrued interest up to the date of dishonor would also be added to the accounts receivable. This ensures that the business still recognizes the debt owed by the customer.

Practical Tips for Your Assignments

Handling notes receivable in your assignments requires attention to detail and a solid understanding of the underlying principles. Here are some practical tips to help you succeed:

• Understand the Terms Ensure you grasp the note’s terms, including the principal amount, interest rate, and maturity date. Understanding these elements is crucial for accurate recording and interest calculation.
• Accurate Calculations Double-check your interest calculations to avoid errors. Use the correct formulas and ensure that you apply the interest rate accurately over the appropriate time period.
• Timely Adjustments Make sure all adjusting entries are recorded in the correct accounting period. This is essential for ensuring that your financial statements accurately reflect all accrued interest and outstanding notes receivable.
• Clear Documentation Keep thorough records of all transactions and adjustments related to notes receivable. Clear documentation helps in verifying entries and can be crucial if discrepancies arise.
• Consistency Be consistent in your recording methods and calculation processes. Consistency ensures that your financial statements are reliable and comparable over different periods.
• Review and Revise Regularly review your notes receivable records and make any necessary revisions. This practice helps in maintaining accuracy and catching errors early.

Real-World Applications

Understanding how to manage notes receivable is not just useful for academic purposes; it has real-world applications in various business scenarios. Businesses of all sizes encounter notes receivable, and effectively managing them can significantly impact financial health.

For instance, companies that extend credit to their customers often use notes receivable to formalize the credit agreement. Proper management ensures that these companies accurately track the amounts owed and recognize interest income, contributing to better cash flow management and financial planning.

Common Challenges and Solutions

Managing notes receivable can present several challenges. Here are some common issues and their solutions:

• Complex Interest Calculations: Interest calculations can become complex, especially for notes with varying terms. To address this, use financial calculators or software designed for accounting purposes. These tools can help ensure accuracy and save time.
• Tracking Multiple Notes: Businesses may have multiple notes receivable with different terms and maturity dates. Implementing an organized tracking system, such as a spreadsheet or specialized accounting software, can help manage these notes effectively.
• Handling Dishonored Notes: Dishonored notes can disrupt expected cash flows and complicate accounting records. Establish clear policies for handling dishonored notes, including converting them to accounts receivable and pursuing collection efforts promptly.
• Adjusting Entries: Adjusting entries require careful attention to ensure all accrued interest is recorded accurately. Regularly review your notes receivable and interest receivable accounts to ensure all necessary adjustments are made.

Managing notes receivable involves understanding their nature, accurately recording entries, and making necessary adjustments. By following the steps outlined in this guide, you’ll be well-equipped to handle notes receivable in your accounting assignments, ensuring accurate and comprehensive financial statements. Remember, practice and attention to detail are key to mastering these concepts. Whether for academic purposes or real-world business applications, effective management of notes receivable is a valuable skill that contributes to sound financial practices and successful accounting careers.

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Notes Receivable

Written by True Tamplin, BSc, CEPF®

Reviewed by subject matter experts.

Updated on June 08, 2023

Fact Checked

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Table of Contents

Notes receivable refers to a written, unconditional promise made by an individual or business to pay a definite amount at a definite date or on demand.

The individual or business that signs the note is referred to as the maker of the note. The person to whom the payment is to be made is called the payee .

Format of Notes Receivable

A common format of notes receivable is shown below. In this example, J. Hart is the maker and C. Brecker is the payee.

In this example, C. Brecker records the note as an asset and J. Hart records the note as a payable item. The journal entries to record the notes receivable for each individual on 5 April 2019 (the date of the note) are:

As a quick note, in this article we are mainly concerned with accounting for notes receivable; however, the concepts that we will consider apply equally well to notes payable .

Types of Notes Receivable

There are several types of notes receivable that arise from different economic transactions. For example, trade notes receivable result from written obligations by a firm's customers.

In some industries, it is common for a seller to insist on a note rather than an open account for certain types of sales .

A case in point is the sale of equipment or other personal or real property in which payment terms are normally longer than is customary for an open account.

In other cases, a customer's credit rating may cause the seller to insist on a written note rather than relying on an open account.

Also, if customers are known to default on paying their accounts, the seller may insist that they sign a note for the balance.

Other notes receivable result from cash loans to employees, stockholders, customers, or others. In this discussion, we will refer to all notes as promissory notes .

Elements of Promissory Notes

There are several elements of promissory notes that are important to a full understanding of accounting for these notes. These are the note's principal, maturity date, duration, interest rate, and maturity value .

1. Principal

The principal of the note is the amount that is lent or borrowed. It does not include the interest portion.

Together, the principal and interest portions represent the note's maturity value. The principal portion is often referred to as the face value .

2. Maturity Date

The maturity date is the date that the note becomes due and payable. This date is either stated on the note or can be determined from the facts stated on the note.

For example, a note may have a stated maturity date of 31 December or it may be due in a specific number of days or months (e.g., three months after the note's date).

The note shown above is due 90 days after its date (5 April), which means it is due on July 4. This July 4 maturity date is computed as follows:

3. Duration

The duration of notes receivable is the length of the time that notes are outstanding or the number of days called for by the notes.

This period of time is important in calculating the interest charges related to the notes.

To determine the duration of the notes, both the dates of the notes and their maturity dates must be known. For example, a note dated 15 July with a maturity date of 15 September has a duration of 62 days, as shown below.

In this example, interest is based on the fact that the note has been outstanding for 62 days.

4. Interest Rate

Interest is the income or expense from lending or borrowing money. To the lender or payee, interest is income, and to the maker or borrower, it is an expense.

The total interest related to a particular note is based on the note's principal, rate of interest, and duration. It can be calculated using the following formula:

Interest = Principal x Interest rate x Time

I = P x R x T

In applying this formula, interest rates are assumed to be stated in annual terms. For example, the total interest related to a $10,000, 12% note that is due in 1 year is $1,200, or

$1,200 = $10,000 x 0.12 x 1

If the same note had a term of only 5 months, the interest would be $500, calculated as follows:

$500 = $10,000 x 0.12 x 5/12

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.

However, for simplicity, we will assume a year with 360 days. For example, the interest related to a $10,000, 12% note with a 90-day term is $300. This is worked out as follows:

$300 = $10,000 x 0.12 x 90/360

Accounting for Notes Receivable

When a note is received from a customer, the Notes Receivable account is debited. The credit can be to Cash , Sales, or Accounts Receivable , depending on the transaction that gives rise to the note.

In any event, the Notes Receivable account is at the face, or principal, of the note. No interest income is recorded at the date of the issue because no interest has yet been earned.

If the note extends beyond one period, interest is recorded at the maturity date or at the end of the accounting period using an adjusting entry .

Receipt of the Note

To show the initial recording of notes receivable, assume that on 1 July, the Fenton Company accepts a $2,000, 12%, 4-month note receivable from the Zoe Company in settlement of an open account receivable.

The following entry is made to record this transaction:

In some situations, the receipt of the note results from the sale of merchandise . For example, suppose that a $5,000 sale is made to a customer for a trade note receivable. In this case, the following two entries are made:

It is possible to combine the previous two entries by debiting Notes Receivable and crediting Sales.

However, doing so will result in a loss of information.

This is because not all the sales made to a particular customer are recorded in the customer's subsidiary accounts receivable ledger.

Payment of the Note

When the payment on a note is received, Cash is debited, Note Receivables is credited, and Interest Revenue is credited.

For example, assume that the $2,000 note from the Zoe Company recorded on 1 July is paid in full on 31 October. The entry is:

In some cases, the note is received in one accounting period and collected in another. In these situations, interest must be accrued at year-end.

For example, assume that the Bullock Company has received a 3-month, 18% note for $5,000 dated 1 November 2019 in exchange for cash. The firm's year-end is 31 December, and the note will mature on 31 January 2020.

The Bullock Company's journal entries for 1 November 2019, 31 December 2019, and 31 January 2020 are shown below.

Defaulted Notes Receivable

When the borrower or maker of a note fails to make the required payment at maturity, the note is considered to have defaulted.

At this point, the note should be transferred to an open account receivable. Accounts Receivable is debited for the full maturity value, including the principal and unpaid interest.

For example, if the Zoe Company defaults on its $2,000, 12% note, the Fenton Company will make the following entry on 31 October:

Although it may seem peculiar to record interest revenue on defaulted notes receivable, the Zoe Company is still obligated to pay both the interest and the principal.

The accounts receivable is just as valid a claim as are the notes receivable, as well as the interest.

Furthermore, by transferring the note to Accounts Receivable, the remaining balance in the notes receivable general ledger contains only the amounts of notes that have not yet matured.

The Fenton Company should also indicate the default on the Zoe Company's subsidiary accounts receivable ledger.

Subsequently, if the accounts receivable prove uncollectible, the amount should be written off against the Allowances account.

Using Notes Receivable to Generate Cash

Both accounts receivable and notes receivable can be used to generate immediate cash.

Accounts receivable can be assigned, pledged, or factored. Essentially, in all these situations, the company that owns the receivable either sells it to the bank (or another lender) or borrows against it to obtain immediate cash.

The ability to raise cash in this way is important to small and medium-sized businesses, which may have limited access to finance.

Accounting for the assigning or factoring of accounts receivable are topics that are typically covered in an intermediate accounting text.

Notes Receivable FAQs

What are notes receivable, how do i record a note receivable in my accounting records.

To record a note receivable, you will need to debit the cash account and credit the notes receivable account.

What is the journal entry for interest on a note receivable?

The journal entry for interest on a note receivable is to debit the interest income account and credit the cash account.

How do I calculate interest on a note receivable?

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.

What is the maturity date of a note receivable?

The maturity date of a note receivable is the date on which the final payment is due.

About the Author

True Tamplin, BSc, CEPF®

True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.

True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide , a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University , where he received a bachelor of science in business and data analytics.

To learn more about True, visit his personal website or view his author profiles on Amazon , Nasdaq and Forbes .

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Understanding and Managing Notes Receivable in Financial Reporting

Explore the intricacies of notes receivable, from initial recognition to liquidity analysis, to enhance your financial reporting accuracy.

Notes receivable are an essential element of financial reporting, representing claims for payments not immediately realized. These instruments reflect a company’s right to receive money in the future and play a significant role in its cash flow management and credit practices.

Their importance is underscored by their impact on liquidity and profitability, influencing how stakeholders view a firm’s financial health. Properly managing notes receivable is crucial for accurate financial statements and strategic decision-making.

Fundamentals of Notes Receivable

As we delve into the intricacies of notes receivable, it’s important to understand their foundational role in financial reporting. These instruments serve as a formal promise for future cash inflows, which can affect a company’s financial strategy and its relationships with clients and lenders.

Definition and Recognition

Notes receivable are written promissory notes that obligate a borrower to pay the lender a specified sum of money, either on demand or at a predetermined future date. They arise from a variety of transactions, such as loans to customers or the sale of goods and services on credit terms. For recognition in financial statements, a note must meet certain criteria. It should be a legal, binding agreement, and the collection of the amount due must be reasonably assured. The Financial Accounting Standards Board (FASB) in the United States, through the Accounting Standards Codification (ASC), provides guidance on the recognition of notes receivable, typically under ASC 310 on receivables.

Initial Measurement

Upon recognition, notes receivable are initially measured at their face value, which is the principal amount the borrower agrees to pay. However, if the transaction is conducted at a discount or premium — meaning the cash received differs from the face value — the note is measured at the present value of the future cash flows, discounted at the market rate of interest at the time of issuance. This initial measurement ensures that the note is recorded at a fair representation of its value, aligning with the accrual basis of accounting, which matches revenues and expenses to the period in which they are incurred.

Subsequent Measurement

After the initial recognition, notes receivable are subject to subsequent measurement at each reporting date. The carrying amount of the note may be adjusted for amortization of discounts or premiums, and for any allowance for credit losses. The allowance reflects management’s estimate of the likelihood that some receivables will not be collected and is based on historical experience, current conditions, and reasonable and supportable forecasts. The subsequent measurement process ensures that the notes receivable on the balance sheet continue to represent the expected future cash flows and remain in compliance with the relevant accounting standards, such as ASC 326 on credit losses, which introduced the current expected credit loss (CECL) model.

Notes Receivable in the Balance Sheet

When examining a company’s balance sheet, notes receivable are typically categorized under current or non-current assets, depending on the maturity date of the promissory notes. Current notes receivable are expected to be settled within one year, while non-current notes have a longer term. This classification is crucial for assessing the company’s short-term liquidity and long-term financial stability. The placement of notes receivable on the balance sheet provides insight into the timing of future cash inflows, which is valuable information for investors and creditors.

The valuation of notes receivable on the balance sheet also reflects any interest accrued to date that has not yet been received. This accrued interest increases the carrying amount of the note, representing the income earned by the company for extending credit. It is important to note that this accrued interest is recognized as a separate line item from the principal amount of the notes receivable, ensuring clarity in the financial statements.

Accounting for Interest Income

Interest income from notes receivable is a critical component of a company’s earnings, reflecting the profitability of extending credit. This income is recognized over the life of the note, aligning with the time value of money principle. As the lender provides the borrower with the opportunity to use funds, the interest compensates the lender for parting with the liquidity over a specific period. The recognition of interest income follows the effective interest method, which spreads the income evenly over the payment period, based on the carrying amount of the note.

The effective interest rate is the rate that exactly discounts the expected stream of future cash payments through the life of the note receivable to the net carrying amount of the financial asset. This method captures the financial reality of the transaction more accurately than the straight-line method, which would allocate the same amount of interest income to each period regardless of the actual passage of time. The effective interest rate takes into account the impact of compounding, providing a more precise measure of the return on investment for the lender.

Notes Receivable Disclosures

Financial statement disclosures provide a comprehensive view of a company’s notes receivable, offering transparency and aiding stakeholders in understanding the associated risks and benefits. These disclosures typically include the nature and terms of the notes, such as interest rates, collateral requirements, and maturity dates. Additionally, companies must disclose the accounting policies used to recognize interest income and any significant terms that may affect the amount, timing, and certainty of future cash flows.

The disclosures also encompass information about the credit quality of notes receivable, including the credit risk profile and any changes in the risk during the reporting period. This may involve detailing past due or impaired notes, as well as the movements in the allowance for credit losses. Such transparency is crucial for users of financial statements to gauge the likelihood of collection and the potential impact on future earnings.

Impaired Notes Receivable

When a note receivable is considered impaired, the company must recognize an impairment loss, which reflects a decline in the anticipated cash flows from the note. Impairment may occur due to a variety of factors, such as the borrower’s deteriorating financial condition, which casts doubt on their ability to make payments. The assessment of impairment is a judgment call that requires significant estimation and consideration of current economic conditions. If a note is impaired, the loss is measured as the difference between the carrying amount of the note and the present value of expected future cash flows, discounted at the note’s original effective interest rate.

The impairment of notes receivable necessitates detailed disclosures, including the amount of impairment recognized in the income statement and the methodology used to determine the impairment. This information is vital for stakeholders to understand the financial impact of credit losses and the company’s approach to managing credit risk. The impairment loss also serves as an indicator of the company’s credit management effectiveness and may influence future lending practices.

Notes Receivable in Liquidity Analysis

The role of notes receivable in liquidity analysis cannot be understated. They are a key indicator of a company’s ability to convert assets into cash and meet short-term obligations. Analysts often scrutinize the aging schedule of notes receivable, which categorizes outstanding notes by their due dates. This schedule helps in evaluating the timing of cash inflows and the potential need for additional liquidity sources if collections are delayed. Moreover, the turnover ratio of notes receivable, which measures how quickly a company collects on its receivables, provides insights into the efficiency of the company’s credit and collection processes.

The liquidity of notes receivable is also influenced by their negotiability. If notes are easily transferable or can be used as collateral for financing, they enhance a company’s liquidity position. In contrast, notes with restrictive covenants or those tied to complex transactions may be less liquid. Understanding these nuances helps stakeholders assess the company’s liquidity risk and informs their investment or lending decisions.

Right of Use Asset Accounting in Modern Finance Practices

The role of cancelled checks in modern finance management, you may also be interested in..., managerial accounting techniques for effective decision-making, understanding capital assets: types, valuation, and business impact, managing an accounting firm: strategies for success, manual accounting systems: types, impact, and transition.

• Receivables
• Notes Receivable
• Credit Terms
• Cash Discount on Sales
• Accounting for Bad Debts
• Bad Debts Direct Write-off Method
• Bad Debts Allowance Method
• Bad Debts as % of Sales
• Bad Debts as % of Receivables
• Recovery of Bad Debts
• Accounts Receivable Aging
• Assignment of Accounts Receivable
• Factoring of Accounts Receivable

Accounting for Receivables

Receivables are amounts that a company is entitled to receive in cash/bank, with a receipt being due either at present or in future. Receivables may arise as a consequence of the company’s main operations i.e. the usual business or they may sometimes originate from other transactions.

Receivables are broadly classified into trade-receivables and non-trade receivables. Trade receivables are those receivables which originate from sales of goods and services by a business in the ordinary course of business. Non-trade receivables are the amounts due from third parties for transactions outside the primary course of business. Another way receivables may be classified is whether interest is chargeable on the amount outstanding.

Receivables are normally current assets, but some may have a non-current portion depending on their maturity.

Trade receivables include:

Accounts receivable

Notes receivable.

Accounts receivable are current assets which represent amounts to be collected from customers for goods sold or services provided. When a company sells goods or provides services, the customers usually do not make a payment on the spot. Instead, they are required to make payment within a certain time period, called credit period. The terms that determine the due date and the discount available if payment is made by a certain date are called credit terms .

When sales are made on credit, accounts receivable are created, which are recorded through the following journal entry:

The accounts receivable balance is presented on the balance sheet, net of any allowance for doubtful accounts as follows.

When cash is collected from the customer, the accounts receivable balance on the balance sheet is reduced through the following journal entry:

Many companies allow customers a certain percentage as cash discount when they make the payment quickly. The cash discount depends on the credit terms of the sale.

Note receivable are receivables supported by a written statement by the debtor to pay a specified sum on a specified date. Like accounts receivable, notes receivable arise in the ordinary course of business; but unlike accounts receivable they are in written form. Notes receivable usually require the debtor to pay interest. They may be current and non-current.

When a company receives a note receivable it records it using the following journal entry:

Interest on notes receivable is accrued as follows:

Non-trade receivables

None-trade receivables are receivables that arise from transactions other than those related to the company’s main course of business. Examples include:

• Advances to employees
• Advance tax paid
• Deposits placed with other companies (if advancing money is not the primary business)

Scarlet Systems, Inc. (SS) developed an ERP software for Johnson Tools, LLC (JT) for $200,000 due within 30 days of successful testing of the system. Testing was completed on 30 April and the software became operational. JT paid an amount of $100,000 on 15 May.

JT had to settle another large liability in April which resulted in it not being able to pay the remaining invoice amount (i.e. $100,000) by 30 May. On 1 June, JT CFO convinced SS finance team to accept a note receivable due within 60 days carrying interest rate of 5% per annum for the remaining outstanding balance. JT paid the interest and principal of the note receivable at its maturity.

Required: Journalize the above transactions.

The sale of software and related services is recorded through the following journal entry:

Payment by JT on 15 May is journalized as follows:

Conversion of accounts receivable to a note receivable on 1 May is booked via the following journal entry:

The following journal entry is made to account for the receipt of note receivable principal and interest:

Whereas, the interest income is calculated as: $100,000 × 5% × 60/360

by Irfanullah Jan, ACCA and last modified on Oct 24, 2020

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Account Receivables

• First Online: 04 November 2018

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Receivable is a general term which refers to all monetary obligations owed to the business by its customers or debtors. As long as a business expects to recover the money from the debtors, it records its receivables as assets in its balance sheet because it expects to derive future benefits from them. It does not matter whether they are due in the current period or not.

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Lessambo, F.I. (2018). Account Receivables. In: Financial Statements. Palgrave Macmillan, Cham. https://doi.org/10.1007/978-3-319-99984-5_4

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The Difference Between Assignment of Receivables & Factoring of Receivables

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How to Decrease Bad Debt Expenses to Increase Income

What does "paid on account" in accounting mean, what is a financing receivable.

• What Do Liquidity Ratios Measure?
• What Are Some Examples of Installment & Revolving Accounts?

You can raise cash fast by assigning your business accounts receivables or factoring your receivables. Assigning and factoring accounts receivables are popular because they provide off-balance sheet financing. The transaction normally does not appear in your financial statements and your customers may never know their accounts were assigned or factored. However, the differences between assigning and factoring receivables can impact your future cash flows and profits.

How Receivables Assignment Works

Assigning your accounts receivables means that you use them as collateral for a secured loan. The financial institution, such as a bank or loan company, analyzes the accounts receivable aging report. For each invoice that qualifies, you will likely receive 70 to 90 percent of the outstanding balance in cash, according to All Business . Depending on the lender, you may have to assign all your receivables or specific receivables to secure the loan. Once you have repaid the loan, you can use the accounts as collateral for a new loan.

Assignment Strengths and Weaknesses

Using your receivables as collateral lets you retain ownership of the accounts as long as you make your payments on time, says Accounting Coach. Since the lender deals directly with you, your customers never know that you have borrowed against their outstanding accounts. However, lenders charge high fees and interest on an assignment of accounts receivable loan. A loan made with recourse means that you still are responsible for repaying the loan if your customer defaults on their payments. You will lose ownership of your accounts if you do not repay the loan per the agreement terms.

How Factoring Receivables Works

When you factor your accounts receivable, you sell them to a financial institution or a company that specializes in purchasing accounts receivables. The factor analyzes your accounts receivable aging report to see which accounts meet their purchase criteria. Some factors will not purchase receivables that are delinquent 45 days or longer. Factors pay anywhere from 65 percent to 90 percent of an invoice’s value. Once you factor an account, the factor takes ownership of the invoices.

Factoring Strengths and Weaknesses

Factoring your accounts receivables gives you instant cash and puts the burden of collecting payment from slow or non-paying customers on the factor. If you sell the accounts without recourse, the factor cannot look to you for payment should your former customers default on the payments. On the other hand, factoring your receivables could result in your losing customers if they assume you sold their accounts because of financial problems. In addition, factoring receivables is expensive. Factors charge high fees and may retain recourse rights while paying you a fraction of your receivables' full value.

• All Business: The Difference Between Factoring and Accounts Receivable Financing

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Unit 10: Receivables

Accounting for notes receivable.

 Notes receivable 

Remember from earlier in the chapter, a note (also called a promissory note ) is an unconditional written promise by a borrower to pay a definite sum of money to the lender (payee) on demand or on a specific date. On the balance sheet of the lender (payee), a note is a receivable.  A customer may give a note to a business for an amount due on an account receivable or for the sale of a large item such as a refrigerator. Also, a business may give a note to a supplier in exchange for merchandise to sell or to a bank or an individual for a loan. Thus, a company may have notes receivable or notes payable arising from transactions with customers, suppliers, banks, or individuals.

Most promissory notes have an explicit interest charge. Interest is the fee charged for use of money over a period. To the maker of the note, or borrower, interest is an expense; to the payee of the note, or lender, interest is a revenue. A borrower incurs interest expense; a lender earns interest revenue. For convenience, bankers sometimes calculate interest on a 360-day year; we calculate it on that basis in this text. (Some companies use a 365-day year.)

The basic formula for computing interest is:

                      Principal x Interest Rate x Frequency of a year

Principal is the face value of the note. The interest r ate is the annual stated interest rate on the note. Frequency of a year is the amount of time for the note and can be either days or months.  We need the frequency of a year because the interest rate is an annual rate and we may not want interest for an entire year but just for the time period of the note.

To show how to calculate interest, assume a company borrowed $20,000 from a bank. The note has a principal (face value) of  $20,000, an annual interest rate of 10%, and a life of 90 days. The interest calculation is:

$20,000 principal x 10% interest rate x (90 days / 360 days) = $500

Note that in this calculation we expressed the time period as a fraction of a 360-day year because the interest rate is an annual rate and the note life was days.  If the note life was months, we would divide by 12 months for a year.

The maturity date is the date on which a note becomes due and must be paid. Sometimes notes require monthly installments (or payments) but usually all of the principal and interest must be paid at the same time. The wording in the note expresses the maturity date and determines when the note is to be paid. A note falling due on a Sunday or a holiday is due on the next business day. Examples of the maturity date wording are:

• On demand. “On demand, I promise to pay…” When the maturity date is on demand, it is at the option of the holder and cannot be computed. The holder is the payee, or another person who legally acquired the note from the payee.
• On a stated date. “On July 18, 2015, I promise to pay…” When the maturity date is designated, computing the maturity date is not necessary.
• At the end of a stated period.

(a )”One year after date, I promise to pay…” When the maturity is expressed in years, the note matures on the same day of the same month as the date of the note in the year of maturity.

(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. A one-month note dated  January 31, matures on February 28.

(c)  “ Ninety days after date, I promise to pay…” When the maturity is expressed in days, the exact number of days must be counted. The first day (date of origin) is omitted, and the last day (maturity date) is included in the count. For example, a 90-day note dated  October 19 matures on  January 17 of the next year, as shown here:

Sometimes a company receives a note when it sells high-priced merchandise; more often, a note results from the conversion of an overdue account receivable. When a customer does not pay an account receivable that is due, the company may insist that the customer  gives a note in place of the account receivable. This action allows the customer more time to pay the balance due, and the company earns interest on the balance until paid. Also, the company may be able to sell the note to a bank or other financial institution.

To illustrate the conversion of an account receivable to a note, assume that Price Company  had purchased $18,000 of merchandise on August 1 from Cooper Company on account. The normal credit period has elapsed, and Price cannot pay the invoice. Cooper agrees to accept Price’s $18,000, 15%, 90-day note dated September 1 to settle Price’s open account. Assuming Price paid the note at maturity and both Cooper and Price have a December 31 year-end, the entries on the books of Cooper are:

 Note:  Maturity date calculated as November 30 since it was a 90 day note – 29 days left in September (30 days in Sept – note day Sept 1) – 31 days in October leaves 30 days remaining in November.

The $18,675 paid by Price to Cooper is called the maturity value of the note. Maturity value is the amount that the company (maker) must pay on a note on its maturity date; typically, it includes principal and accrued interest, if any.

Sometimes the maker of a note does not pay the note when it becomes due. The next section describes how to record a note not paid at maturity.

A dishonored note is a note that the maker failed to pay at maturity. Since the note has matured, the holder or payee removes the note from Notes Receivable and records the amount due in Accounts Receivable.

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.

 Accounting in the Headlines

How does square account for the amounts it loans to small businesses.

Square , the mobile payments company, allows small businesses to take credit cards by swiping customer credit cards using a small square device attached to the audio jack found on mobile devices. Since its founding in 2009 and the launch of its first app in 2010, Square has found its way into many small businesses – and large businesses.  Starbucks uses Square to process transactions with credit or debit card customers.  In November 2014, Square announced that it would be accepting Apple Pay. Whole Foods uses Square in select locations.

Square has recently gotten into lending money to its customers through its Square Capital program.  According to Business Insider ( April 15, 2015 article ), Square has paid out over $100 million in small business financing over the past year.

See Jack Dorsey, co-founder of Square, explain the small business loan concept in this CNN Money video (2:26 minutes) at http://money.cnn.com/video/technology/2014/05/28/t-square-capital-dorsey.cnnmoney/  Essentially, the business owner clicks on a link in the Square Capital app to let Square know that the business would like to borrow a certain amount of money.  Square Capital calls this step “requesting capital.” The next morning, the funds are deposited in the checking account of that business.   The business pays Square back the funds by having a certain percentage of each day’s receipts deducted for the payback.

For example, if a business wants to borrow $7,000, Square might charge a total of $7,910 for the loan.  Upon approval, the $7,000 is deposited into the business’s checking account the next day and then Square charges 9% of the business’s credit card sales each day until the $7,910 is fully paid.  Square says that the advantage of this percentage-of-sales method is that the business does not have to make large payments when business is slow. The percentage that Square charges stays constant until the loan is paid off fully.

Square determines the amount to be charged for the loan and the percentage to be charged each day using data analytics.  Each Square account has potentially different terms based on its history and trends.

• Square Capital states that the first step for business owners is to “request capital.” Are the business owners actually requesting capital?
• In the example given in the blog post, the business borrows $7,000 and pays back $7,910 by paying 9% of its credit card receipts each day until paid in full. Is the 9% the interest rate charged? Why or why not?
• Is the amount of cash deposited by Square Capital in its customers’ (the small businesses requesting funds) checking accounts classified as ACCOUNTS RECEIVABLE or NOTES RECEIVABLE by Square Capital? Explain.
• What is the difference between the amount of funds deposited in the customers’ accounts and the total amount paid back by customers classified as by Square Capital?
• What do you think of this practice by Square Capital?
• Accounting Principles: A Business Perspective.. Authored by : James Don Edwards, University of Georgia & Roger H. Hermanson, Georgia State University. . Provided by : Endeavour International Corporation.. Project : The Global Text Project.. License : CC BY: Attribution
• How does Square account for the amounts it loans to small businesses?. Authored by : Dr. Wendy Tietz, CPA, CMA, CGMA. Located at : http://www.accountingintheheadlines.com/ . License : CC BY-NC: Attribution-NonCommercial
• Interest Bearing Notes Receivable. Authored by : NotePirate. Located at : https://youtu.be/DDWmiuUKUFc . License : All Rights Reserved . License Terms : Standard YouTube License