Notes receivable and how they are different from accounts receivable as well as an example of journal entries involving notes receivable.

1. Definition of notes receivable

In general, receivables arise from credit sales, loans, or other transactions and take a form of a note, loan, or other financial instrument. Receivables can be originated by the entity or bought from another organization. For example, accounts receivable can arise from credit sales or can be bought. Notes receivable are similar to accounts receivable, except that they require a formal instrument as a proof of debt and involve payment of interest by the debtor.

Note receivable is a claim that requires a formal instrument as proof of debt and usually provides for payment of interest by the debtor.

Notes receivable are also called promissory notes. That is, they require the debtor to pay the promised amount at a definite time or on demand. One making the promise (i.e., debtor) is called the maker, while one to whom the note is payable (i.e., the creditor) is called the payee. Due (maturity) date is the date when the note receivable is to be paid.

As mentioned earlier, notes receivable require an interest payment by the maker of the note. Notes receivable usually state the annual interest rate, regardless of the term of the note. Interest can be paid monthly, quarterly, semiannually, or annually. Short-term notes receivable (i.e., less than one year) usually require interest payment at the maturity date.

2. Example of accounting for notes receivable

Let’s assume that on April 1, 20X3 Vapaus Company (a fictitious entity) has a $10,000 past due account from Aanbod Company. Vacaus accepts a 60-day, 12% note receivable from Aanbod for $10,000. On April 1, 20X3 Vapaus would make the following journal entry to record the receipt of note receivable:

On May 30,20X3 – when the note receivable matures -- Vapaus Company would record interest revenue of $200 (i.e., $10,000 x 2%). If Aanbod pays the note receivable, Vapaus would record cash receipt. However, if Aanbod fails to pay the note receivable, Vapaus would transfer dishonored note receivable and interest into accounts receivable account; and if the account receivable account is deemed uncollectible, the company would write it off against the allowance for doubtful accounts.  In either case, Vacaus would record an Interest Revenue of $200.

If Aanbod pays the note receivable, Vacaus would make the following journal entry on May 30, 20X3:

When a note matures in the later fiscal period, the company holding the note receivable recognizes interest revenue at the end of each accounting period (i.e., along with interest receivable) for that period. Interest revenue is usually reported as Other Income.

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