Accounts Notes: Notes Receivable Accounting

Saturday 4 February 2012

Notes Receivable Accounting

A note receivable is a formal promise to receive a specific amount of cash from another party on one or more future dates. Overdue accounts receivable are sometimes converted into notes receivable, thereby giving the creditor more time to pay, while also sometimes including a personal guarantee by the owner of the creditor.

The payee is the party who receives payment under the terms of the note, and the maker is the party obligated to send funds to the payee. The amount of payment to be made, as listed in the terms of the note, is the principal. The principal is to be paid on the maturity date of the note.

A note receivable usually includes a specific interest rate, or a rate which is tied to another interest rate, such as a bank’s prime rate. The calculation of the interest earned on a note receivable is:

Principal x Interest rate x time period

If an entity has a large number of notes receivable outstanding, it should consider setting up an allowance for doubtful notes payable, in which it can accrue a bad debt balance that it can use to write off any notes payable that later become uncollectible. An uncollectible note receivable is said to be a dishonored note.