Notes receivable represents
claims for which formal instruments of
credit are issued as evidence of
debt
Debt is an obligation that requires one party, the debtor, to pay money Loan, borrowed or otherwise withheld from another party, the creditor. Debt may be owed by a sovereign state or country, local government, company, or an individual. Co ...
, such as a
promissory note
A promissory note, sometimes referred to as a note payable, is a legal instrument (more particularly, a financing instrument and a debt instrument), in which one party (the ''maker'' or ''issuer'') promises in writing to pay a determinate sum of ...
. The credit instrument normally requires the
debtor to pay
interest
In finance and economics, interest is payment from a debtor or deposit-taking financial institution to a lender or depositor of an amount above repayment of the principal sum (that is, the amount borrowed), at a particular rate. It is distinct f ...
and extends for time periods of 30 days or longer. Notes receivable are considered
current assets if they are to be paid within one year, and non-current if they are expected to be paid after one year.
Measurement
In concept, notes receivables are initially measured at present value. When referring to the present value, it means the sum of all future cash flows discounted using the prevailing market rate of interest for similar notes. In terms of short-term notes receivable, it is measured at face value.
The initial measurement of long-term notes receivable depends on whether the notes are interest-bearing or noninterest-bearing.
Interest-bearing notes have a specified interest rate payable on top of their face value. Notes with rates below market rates, or those with no stated interest (noninterest-bearing notes), may still have an implicit interest component. This implicit interest is the difference between the borrowed amount and the repayment amount, and it is included to make the notes more attractive for sale.
Journalizing dishonoured notes receivable
In a
journal entry
A journal entry is the act of keeping or making records of any transactions either economic or non-economic.
Transactions are listed in an accounting journal that shows a company's debit and credit balances. The journal entry can consist of ...
, a dishonored note is one that the maker did not pay by its due date. When this happens, the payee transfers the note from Notes Receivable to
Accounts Receivable. The payee should debit Accounts Receivable for the full amount due, credit Notes Receivable for the note's face value, and credit Interest Revenue for the interest earned.
References
Legal documents
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