Accounting for Notes Receivable
Companies are often required to offer credit to their buyers, promising to make payment and settle dues at a later date in future. Credit is offered in two ways, notes receivable and accounts receivable. The latter stands for buyers, assuring payment by due date that’s generally shortly after having bought the goods, whereas the former stands for customers who promise to clear their dues after a prolonged length of time. The notes receivable require a buyer to sign a formal document, known as promissory note wherein they promise to make payment, including interest, at a specified date as per the stated value of the note. There are definite ways for accounting for notes receivable.
Accounting for notes receivable
If a company concurs to allow promissory note to its buyer, it needs to take into account notes receivable in its books of accounts. Each promissory note specifies the sum of credit offered plus the rate of interest to be charged and the date by which it has to be paid. While accounting for notes receivable these are treated as an asset and continued as usual debit balance. On receiving payment against the note from its client, the company debits the account of notes receivable by the amount received and credits sales.
Accounting of payments received against notes receivable
As the buyer pays against the promissory note, the interest is also paid along with. The interest due from the client is calculated by multiplying the amount stated in the note by the stated rate of interest for the time (number of days) the customer availed credit.
The company accounts for the funds collected by debiting cash for the total sum received and crediting the stated value of the promissory note and also the interest income by an amount equal to the earned interest.
Record Discounting Of Notes Receivable
At times the company may require funds before the customer has paid against the promissory note. The company may approach a financial institution like bank and get the note discounted. It simply means that the bank pays cash to the company against the right to collect proceeds against the note. Of course, the bank charges commission for rendering such services. The company computes the amount payable as commission by multiplying the maturity amount or stated value of promissory note with the rate of commission for the time that is still due for maturity of the note. The length of time for which interest is to be paid is calculated by dividing the number of days left for maturity of note by 365.
The company accounts for discounting of promissory note by debiting cash equaling the sum of cash received, it credits notes receivable by an amount equal to the stated value of promissory note and also credits the interest amount for the difference.
Accounting for notes receivable
The amount of time mentioned in the promissory note may vary from a couple of months to years. When the time is short of one year, it’s considered as a current asset. However, when the note falls due for payment beyond a year, it is shown as a non-current asset. All notes due for payment are shown as assets of the company. These assets are reported in the balance sheet of the company. Current notes are indicated as current assets and non-current notes are indicated in the non-current assets.