What Is a Note Receivable: Its Examples and Journal Entries

Introduction

Receivables are a fundamental component of businesses’ accounting operations, and understanding their different types is paramount to ensuring efficient cash flow management. One important type of receivable in the list is notes receivable. 

Notes receivable are the asset accounts tied to a formal written agreement that outlines specific terms and conditions for the debt repayment. They give businesses the advantage of formalizing credit terms, mitigating the chances of a payment dispute. 

To help you gain a better understanding, let’s discuss in detail what notes receivable are and how they work in business transactions.

What Are Notes Receivable?

Notes receivable are formal promissory notes in which a debtor acknowledges a debt to a creditor and commits to repay the debt at a predetermined future date. They are recorded as assets on the company’s balance sheet, representing the amount of money customers owe to the business.

On a promissory note:

The payee is typically a business or creditor expecting payment on a specific date.

The maker is another business or debtor who signs a legal agreement to repay the debt, including interest charges.

Notes receivable are different from other types of receivables, as here, the time frame for a customer to pay off the credit is extended. Unlike trade receivables, which are usually settled within a few weeks, notes receivable allow customers additional time to pay beyond standard billing terms. Additionally, a note receivable often includes a predetermined interest rate. The maker is obligated to pay both the principal amount and the interest as compensation for the extended payment period.

6 Key Components of Notes Receivable

While creating a note, it is essential to furnish it with all the vital information and details. Here are six key components of the notes receivable:

1. Payee: The payee is the business that has extended the credit and expects the payment along with the interest from the customer.
2. Maker: The maker is the customer or borrower who is obligated to pay the debt to the business following agreed payment terms.
3. Principal: It is the original amount of the note. The principal amount represents the face value of the note, the amount that the debtor will pay back.
4. Interest: It is the cost of borrowing money. This is the amount of money the debtor needs to pay in addition to the principal.
5. Interest rate: The interest rate stated on the promissory note determines the percentage of interest applied to the principal amount. 
6. Time frame: It refers to the time period within which the maker is expected to pay back the money to the payee. The end date of this time period is called the maturity date.

Example of Notes Receivable

Some of the notes receivable examples include overdue accounts (accounts receivable of the business) that are converted into notes receivable, giving debtors more time to pay them back. It may also include employee cash advances, loan agreements, sales agreements, etc.

Let’s illustrate with a scenario:

ABC Company, a construction machinery manufacturer, sells $100,000 worth of heavy equipment to XYZ Construction Company, with payment due in 30 days. Due to cash flow constraints, XYZ requests a promissory note, and ABC agrees to extend the payment period to 6 months based on their long standing relationship. A promissory note is issued outlining the terms of the credit agreement:

Promissory Note Terms:

• Payee: ABC Company
• Maker: XYZ Company
• Principal: $100,000
• Time Frame: 6 months due at maturity
• Interest Rate: 6% per annum

When recording the notes receivable in the accounting books, calculate the interest using:

Journal Entries for Notes Receivable

In accounting , notes receivable are recorded as an asset on the balance sheet. To be precise, a payee records a note receivable as an asset, representing the principal owed by the customer. The related interest income from the note receivable is recorded in the income statement.

Example of Journal Entries for Notes Receivable

Let’s see how the notes receivable journal entry looks with the example ABC Company (in the above example) will make the journal entry for the promissory note issued to XYZ Company:

Notes Receivable vs. Notes Payable

Now that you understand what notes receivable are and how to do a journal entry, let’s cover how they differ from notes payable. Notes payable are financial documents that represent different perspectives in a credit transaction. So, notes receivable appear as assets on the creditor’s or payee’s balance sheet, whereas notes payable appear as liabilities on the debtor’s or maker’s balance sheet.

Furthermore, notes Receivables are promises from debtors to pay a specific amount of money with interest to creditors at a future date. Businesses typically issue notes receivable to formalize agreements for extended payment terms, loans to customers, or other credit transactions. On the other hand, businesses typically incur notes payable when borrowing money, issuing bonds, or entering into agreements where they owe payments to external parties.

How HighRadius Can Help Manage Receivables?

By now, we know how crucial it is for businesses to manage different types of receivables to ensure a steady cash flow. However, businesses deal with numerous complex transactions with multiple customers, which can sometimes be daunting to manage. With HighRadius’ Order to Cash software, businesses can easily navigate the complexities of managing receivables efficiently.  

These solutions enable businesses to automate their entire account receivable process, accelerating cash flow, improving efficiency, and reducing operational costs. From invoice delivery and tracking to receivable collections, worklist prioritization, payment predictions, and cash projections, businesses can reduce manual effort, minimize errors in accounts receivable.

FAQs

1) What is the difference between an accounts receivable and a notes receivable?

Accounts receivable represent amounts owed for goods or services provided on credit without necessarily formalized terms. In contrast, notes receivable involve written promises to pay a specified amount by a certain date, often with interest. However, both of them are assets on a balance sheet.

2) Are notes receivable current assets?

Yes, notes receivable are typically classified as current assets if they are expected to be collected within one year. This is because current assets are assets that are expected to be converted into cash or used up within a relatively short period, usually within 12 months.

3) Are notes receivable, debit, or credit?

Notes receivable are recorded as a debit on the balance sheet of the company extending credit. They represent an asset to the company, indicating amounts owed to them by debtors. The corresponding entry on the debtor’s balance sheet would be a credit to reflect the liability owed.

4) What type of account is notes receivable?

Notes receivable are classified as an asset account on a company’s balance sheet. They represent amounts owed to the company by customers or counterparties who have signed promissory notes, promising to pay a specified amount of money at a future date, typically with predetermined interest.