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Notes Receivable DefinitionThe notes receivable is an account on the balance sheet usually under the current assets section if its life is less than a year. Specifically, a note receivable is a written promise to receive money at a future date. The money is usually made up of interest and principal. Notes Receivable ExplainedA note receivable is often formed when a business, usually a bank, makes a loan to another business. A note will often be for less than a year, but some can be well in excess of this time frame. Recognize notes receivable income as interest income on the income statement. Thus, when payment is made the amounts effect the balance sheet as well as the income statement. Notes Receivable ExampleMoney Bank is extending a $100,000 90 day note to Toys Inc. so that they can fund some of its short term needs for financing during the year. The note has an interest rate of 5% and is recorded by the bank as a note receivable on Money’s balance sheet under the current assets section. At the end of the term, Toys inc. will pay the $100,000 in principal back to Money Bank, and approximately $1,233 (100,000 * 90/365 * .05) worth of
interest. Record the amount as interest income on the incomes statement at the end of the year. [box]Strategic CFO Lab Member Extra Access your Strategic Pricing Model Execution Plan in SCFO Lab. The step-by-step plan to set your prices to maximize profits. Click here to access your Execution Plan. Not a Lab Member? Click here to learn more about SCFO Labs[/box] A note receivable is a written promise to receive a specific amount of cash from another party on one or more future dates. This is treated as an asset by the holder of the note. Overdue accounts receivable are sometimes converted into notes receivable, thereby giving the debtor more time to pay, while also sometimes including a personal guarantee by the owner of the debtor. Notes Receivable TermsThe 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 = Interest earned If an entity has a large number of notes receivable outstanding, it should consider setting up an allowance for doubtful notes receivable, in which it can accrue a bad debt balance that it can use to write off any notes receivable that later become uncollectible. An uncollectible note receivable is said to be a dishonored note. Example of Notes Receivable AccountingFor example, Aruba Bungee Cords (ABC) sells a number of bungee cords to Arizona Highfliers for $15,000, with payment due in 30 days. After 60 days of nonpayment, the two parties agree that Arizona will issue a note payable to ABC for $15,000, at an interest rate of 10%, and with payment of $5,000 due at the end of each of the next three months. The initial entry to convert the account receivable to a note receivable is:
What if Arizona had instead agreed to pay all of the interest income on the maturity date of the note, which in the example is in 90 days? Then ABC accrues the interest in each of the three months of the note. For example, it would have made this entry at the end of the first month:
Classification of Notes ReceivableYou should classify a note receivable in the balance sheet as a current asset if it is due within 12 months or as non-current (i.e., long-term) if it is due in more than 12 months. If a note has a duration of longer than one year, and the maker does not pay interest on the note during the first year, it is customary to add the unpaid interest to the beginning principal balance in the second year, and use that as the basis upon which to calculate interest in the second year. For example, the maker owes $200,000 to the payee at a 10% interest rate, and pays no interest during the first year. The interest earned by the payee in the first year is $20,000, which is rolled into the $200,000 principal balance at the beginning of the second year; consequently, the interest earned in the second year of $22,000 is higher than in the first year, because the calculation is based on an increased principal balance of $220,000. A company's auditors will examine the classification of notes receivable from the most conservative perspective, and so will insist on their classification as short-term if there are reasonable grounds for doing so. Terms Similar to Notes ReceivableNotes receivable are also known as promissory notes receivable. In what section of the balance sheet should a note receivable be listed if its term is a 120 days B 6 years?Answer and Explanation: (a) Current assets since the note receivable will be converted to cash within one year.
In what section of the balance sheet should a note receivable be listed if its term is 120 days?The notes are due in 120 days, so the amount will be received in the current accounting period, So, 120 days notes receivables should be disclosed under current assets section of the balance sheet.
Where are notes receivable on classified balance sheet?If the note receivable is due within a year, then it is treated as a current asset on the balance sheet. If it is not due until a date that is more than one year in the future, then it is treated as a non-current asset on the balance sheet.
Is notes receivable included in balance sheet?Although accounts receivable and notes receivable both appear on the company's balance sheet as assets and indicate unpaid debts that customers or clients owe to the company, there are some differences between the two statuses.
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