Note receivable: Definition, Explanation, Journal entry, and Example

He currently researches and teaches economic sociology and the social studies of finance at the Hebrew University in Jerusalem. For example, a company may provide a loan to another company in exchange for a note. Chartered accountant Michael Brown is the founder and CEO of Double Entry Bookkeeping. He has worked as an accountant and consultant for more than 25 years and has built financial models for all types of industries. He has been the CFO or controller of both small and medium sized companies and has run small businesses of his own.

Sometimes a company receives a note when it sells high-priced merchandise; more often, a note results from the conversion of an overdue account receivable. When a customer does not pay an account receivable that is due, the company may insist that the customer give are notes receivable current assets 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.

What are Notes Receivable?

Some companies will issue zero-interest-bearing notes as a sales incentive. Even though the interest rate is not stated, the implied interest rate can be derived because the cash values lent and received are both known. In most cases, the transaction between the issuer and acquirer of the note is at arm’s length, so the implicit interest rate would be a reasonable estimate of the market rate. Current notes receivable are typically short-term loans extended to customers or partners with the expectation of receiving payment in full within a specified period.

In comparison, a note receivable is a loaner’s written promise to pay a specified amount at a specified date, typically with interest. The key difference between the two is that an accounts receivable does not involve a formal written agreement, while a note receivable does. The payee of a note receivable is the company or individual expected to receive payment from the debtor. Unlike accounts receivable, which are usually paid off within one year, a note receivable can have time to pay that extends beyond the year of the balance sheet date.

What is notes receivable?

Inventory includes raw materials and finished goods that can be sold relatively quickly. Your company receives a $10,000, 4 year, 2% annual interest note, paid semi-annually. This section is important for investors because it shows the company’s short-term liquidity. According to Apple’s balance sheet, it had $135 million in the Current Assets account it could convert to cash within one year. This short-term liquidity is vital—if Apple were to experience issues paying its short-term obligations, it could liquidate these assets to help cover these debts. A note receivable is a promissory note made by a maker to a payee promising to repay a specified amount at a future time.

Using our example, if the company was unable to collect the $2,000 from the customer at the 12-month maturity date, the following entry would occur. Notes receivable can arise due to loans, advances to employees, or from higher-risk customers who need to extend the payment period of an outstanding account receivable. Notes can also be used for sales of property, plant, and equipment or for exchanges of long-term assets. Notes arising from loans usually identify collateral security in the form of assets of the borrower that the lender can seize if the note is not paid at the maturity date. Here, they include receivables due to Exxon, along with cash and cash equivalents, accounts receivable, and inventories.

Notes Receivable Terms

If a business makes sales by offering longer credit terms to its customers, some of its receivables may not be included in the Current Assets account. Notes receivable come in the form of a written document that borrowers pay to their lenders. Unlike usual trading balances and credits, notes receivable balances come with additional terms. The accounting treatment of interest that is accrued but remains unpaid up to balance sheet date, depends on whether the interest is compound or simple.