These days most people use credit cards to pay for services or products. When using a credit card, a person buys a product, but agrees to pay for it later. In such situations, the amount of money that the retailer expects to get in the future from the customer is called an account receivable. Accounts receivable are created only when the payment term is short or when the amount to be received is small. However, a note receivable is used when a company expects to collect a receivable in, let's say, a year, or when the amount of the receivable is large.

Notes receivable are claims that require a formal instrument as proof of the debt and usually provide for payment of interest by the debtor. Notes receivable are often long-term claims to be settled in more than 90 days.

A note receivable document usually includes the following information: debtor, creditor, maturity date, rate of interest, other credit terms.

Similar to a note receivable, if a company acquires goods, but is allowed to pay in the future, the amount due is called an account or note payable (also look into previous topics about payables). Recall that notes payable are obligations that require a written promissory note as proof of the debt. Notes payable are often long-term obligations to be settled in more than 90 days.

Accounts and notes receivable are shown as assets in the balance sheet. Accounts and notes payable are presented as liabilities.

Receivables represent future cash receipts. Sometimes, though, it is not possible to collect all outstanding amounts. For example, when a customer can buy a car on account, the dealership records an account receivable on its books. At some point after the purchase, the customer goes bankrupt and can't pay the outstanding balance. The receivable amount that is not collective is called a bad debt.

Companies recognize the fact that not all amounts will be collected by reporting (on the balance sheet) accounts receivable less an allowance for accounts whose collection is deemed doubtful.

Allowance for doubtful accounts (also called allowance or reserve for bad debts) is the company's best estimate of uncollectible accounts receivable. It is determined based on certain historical or current data about the company's financial activity.

The net realizable value is the amount that a company is actually expecting to receive in the future.

Net realizable value is what the company expects to collect from its customers. This value is determined by subtracting the estimate of uncollectible accounts (allowance for doubtful accounts) from accounts receivable.

For example, if a company has $10,000 in accounts receivable and based on calculations, $500 of that balance will not be collected, then the net realizable value is $9,500 ($10,000 - $500). Accounts receivable without subtracting the allowance for doubtful accounts are sometimes called gross accounts receivable:

While calculating the total assets on the balance sheet, an entity uses the net realizable value amount (i.e., accounts receivable less allowance), and not gross accounts receivable.

As to payables, it is customary to report them at face (full) value. This takes place because a company having payables on its books is expected by users of the financial statements to pay those amounts in full, without any allowances or hopes to pay less than what's required.

Allowance method of accounting for bad debts is the practice of reporting accounts receivable at the net realizable value. This method involves estimating uncollectible accounts at the end of each period.