Unit 2: accounting for receivables introduction

Accounting for Notes Receivable
Overview

Companies sometimes allow customers to sign a note receivable for sales. Also, companies sometimes ask for note to replace an account receivable, when a customer requests additional time to pay its past-due account. If the credit period is long, the customer usually charged interest.

This section explains the nature of and the computation of its maturity date and interest. It also discusses the basic accounting issues of notes receivable

Objectives:

After studying this section, you will be able to:

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  Define and account for notes receivable.
  
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  Compute the maturity date and interest.
  
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  Explain how notes receivables are recognized and valued in the accounts.
  
• 
  Record the honoring and dishonoring of a note.
  
• 
  Describe how discounting notes receivable.
  

2.1 Promissory Notes

Credit may also be granted in exchange for a formal credit instrument known as a promissory note.

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A promissory note is a written promise to pay a specified amount of money on demand or at a definite time.

Promissory notes may be used:

(1) When individuals and companies lend or borrow money

(2) When the amount of the transaction and credit period exceed normal limits, and
(3) In settlement of accounts receivable

In a promissory note, the party making the promise to pay is called Maker; the party to whom payment is to be made is called the payee. The payee may be specifically identified by name or may be designated simply as the bearer of the note.

Notes receivable gives the holder a stronger legal claim to assets than accounts receivable. Like accounts receivable, notes receivable can be readily sold to another party. Promissory notes are negotiable instruments (as are checks), which means that, when sold they can be transferred to another party by endorsement.

Notes receivable are frequently accepted from customers who need to extend the payment of an outstanding account receivable and are often from high-risk customers. The majority of notes, however, originate from lending transaction.

The basic issues in accounting for notes receivable are the same as those for accounts receivable
1- Recognizing notes receivable
2- Valuing notes receivable
3- Disposing of notes receivable

On the following pages, we will look at each of these issues. Before we do, though, we need to consider two issues that did not apply to accounts receivable.