Notes Receivable Defined: What It Is & Examples

Interest is accrued daily, and this accumulation must be recorded periodically (each month for example). The Revenue Recognition Principle requires that the interest revenue accrued is recorded in the period when earned. Periodic interest accrued is recorded in Interest Revenue and Interest Receivable. The following example uses months but the calculation could also be based on a 365-day year. A written promise from a client or customer to pay a definite amount of money on a specific future date is called a note receivable. Such notes can arise from a variety of circumstances, not the least of which is when credit is extended to a new customer with no formal prior credit history.

Note how another contra account, the sales returns and allowances account, is used to record the debit entry for the previous two journal entries above. Its purpose is to track returns and allowances transactions separately, as opposed to directly recording them as a debit to sales. If amounts in this contra account become too high, it could indicate to management the possibility of future sales lost due to unsatisfied customers. When the maker of a note fails to make the required payment at the maturity date, the note is considered to be dishonored. At this point, the note should be transferred from the notes receivable to an open account receivable. The accounts receivable account is debited for the full maturity value, plus the principal and unpaid interest.

Days of Interest Earned Journal Entry

In the event, if the maker of a note is not able to pay the amount promised on the due date, the note receivable is dishonored. In accounting terms, the amount, therefore, is transferred from the note receivable account to the receivable account. At the maturity date of the note, the maker is obligated to pay the principal notes receivable plus interest. Hence, the holder records the interest earned and removes the note from its Notes Receivable account. The principal part of a note receivable that is expected to be collected within one year of the balance sheet date should be reported in the current asset section of the note holder’s balance sheet.

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

How to Calculate Interest Receivable & Interest Revenue for Notes Receivable

In this example, interest is based on the fact that the note has been outstanding for 62 days. This period of time is important in calculating the interest charges related to the notes. In some industries, it is common for a seller to insist on a note rather than an open account for certain types of sales. 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. Notes Receivable are a type of receivable that earns the company interest revenue.

According to Business Insider (April 15, 2015 article), Square has paid out over $100 million in small business financing over the past year. 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. 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. 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.

Dishonored Notes Receivable Definition

The articles and research support materials available on this site are educational and are not intended to be investment or tax advice. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly. The ability to raise cash in this way is important to small and medium-sized businesses, which may have limited access to finance. The Bullock Company’s journal entries for 1 November 2019, 31 December 2019, and 31 January 2020 are shown below.

Here are more examples to illustrate when notes receivable is debited and credited. Since the note has matured, the holder or payee removes the note from Notes Receivable and records the amount due in Accounts Receivable. The $18,675 paid by Price to Cooper is called the maturity value of the note.