How to Recognize a Face Value Notes Receivable
For the current asset section of the balance sheet, a note receivable is a short-term (coming due within 12 months of the balance sheet date) debt someone owes you. In many cases, this current asset arises from a trade receivable.
For example, a customer has cash flow problems that keep it from paying for purchases. So the customer asks the vendor for extended terms in the form of a formal written document, in place of the more informal agreement to pay for the goods or services per the terms of the invoice.
A note receivable has three major components:
Principal: The amount the debtor owes the lender
Rate: The amount of interest the debtor pays on the principal
Time: The period in which the debtor has to pay back the note
As with A/R, any note receivable (N/R) involves three important considerations: recognition, valuation, and disposition. Recognition involves booking the N/R at face value or other than face value.
Making sure the note receivable reflects properly (valuation) on the balance sheet involves the vexing subject of estimating plus impairment. Disposition is what happens ultimately to get the receivable off the books.
A note receivable reflects only in the current asset part of the balance sheet because the debt you anticipate will be paid back within 12 months of the balance sheet date. Any portion of the note receivable that extends past that 12-month period gets put in the long-term asset section of the balance sheet.
The easiest type of note to account for, the present value of the notes, is the same as its face value, which is the amount stated on the note. This fact is true because the effective (or market) interest rate and the stated (what’s printed on the face of the note receivable) interest rates are the same.
Market is what the interest rate is for a note of similar risk.
Easy-peasy to account for. Now consider that one company loans another $5,000 at an effective and stated rate of 10 percent due in three years. The journal entry for the lender to record issuance of the note is to debit notes receivable and credit cash for $5,000.
Then each year, the lender records interest revenue at $500 ($5,000 x .10). When the debtor pays at the end of the three years, the lender records a debit to cash and a credit to notes receivable for $5,000.
Accounting Glossary
accounting equation
The equation Assets = Liabilities + Equity, which demonstrates the two-sided nature of accounting and is useful for explaining the concept of double-entry accounting (or double-entry bookkeeping).
Accounting Glossary
accounting period
The time period for which financial information is being tracked in a business, such as monthly, quarterly, or annually.
Accounting Glossary
accounts receivable
An account that records the amounts that customers owe to a business.
Accounting Glossary
adjusting entry
A correction made to a bookkeeping account that adjusts for accounting errors or other necessary changes at the end of the accounting period.
Accounting Glossary
cash flows
Used to describe the source or sources of cash or how cash is used.
Accounting Glossary
Chart of Accounts
A list of all the accounts used by a business, including what types of transactions go into each account.
Accounting Glossary
debit
An accounting entry that increases an asset or expense account, and decreases a liability or income account.
Accounting Glossary
dividends
A portion of a company’s profits paid by share of common stock on a quarterly or annual basis.
Accounting Glossary
FASB
Financial Accounting Standards Board. FASB is the highest-ranking authority in the private (non-government) sector of the U.S. for making pronouncements on GAAP and for keeping accounting standards up-to-date.
Accounting Glossary
Federal Unemployment Tax
In the U.S., the fund that used to be known simply as Unemployment. Employers contribute to the fund, and states also collect taxes to fill their unemployment fund reserves. (The acronym FUTA means Federal Unemployment Tax Act.)
Accounting Glossary
fidelity bonds
A type of insurance — typically carried by employers for their employees — that helps guard against theft and reduce the risk of loss.
Accounting Glossary
FIFO
First-in, first-out. A method for costs of goods sold in which a business charges out product costs to cost of goods sold expense in the chronological order in which the goods were acquired.
Accounting Glossary
fungible
Describes a product that is interchangeable and virtually indistinguishable from another product.
Accounting Glossary
General Ledger
A summary of all of a business’s accounts and transactions.
Accounting Glossary
IASB
International Accounting Standards Board. The IASB (based in London) is the main authoritative accounting standards setter outside the U.S.
Accounting Glossary
Journals
The location in which bookkeepers keep records (in chronological order) of daily company transactions.
Accounting Glossary
LIFO
Last-in, first-out. A method for costs of goods sold that selects the last item you purchased first, and then works backward until you have the total cost for the total number of units sold during the period.
Accounting Glossary
LLP
Limited liability partnership. A legal structure that state laws offer to qualified professionals in which all the partners have limited liability.
Accounting Glossary
PC
Professional corporation. A legal structure that state laws offer to qualified professionals who otherwise would have to operate as an unlimited partnership liability.
Accounting Glossary
petty cash
A cash account that businesses keep on hand for unexpected expenses.
Accounting Glossary
revenue
Monies that are collected in the process of selling a company’s goods and services.
Accounting Glossary
salvage value
The amount that an asset is worth after it has been fully depreciated.
Accounting Glossary
statement of cash flows
A financial statement that summarizes a business’s cash inflows and outflows during an accounting period.
Accounting Glossary
transactions
Economic exchanges between a business or other entity and the parties with which the entity interacts and makes deals.
Accounting Glossary
worker’s compensation insurance
A type of insurance carried by employers that covers its employees in case they are injured on the job.
