Notes receivables are written, not oral, obligations to pay a certain amount at a future time. They can be classified as current assets or noncurrent assets, all dependent upon when it will be collected. Notes receivables can be factored like accounts receivables, either with recourse or without recourse. However notes can also be discounted to banks or third parties.
Discounting notes helps the organization convert a note into cash quicker.
Example 1:
Adequate Disclosure audits Inadequately Disclosed for the year 201X. Inadequately disclosed is out of funds and writes a note promising to pay Adequate Disclosure $100,000. What is the journal entry on Adequate Disclosure’s books?
What is the journal entry on Inadequately Disclosed books?
Example 2:
Adequate Disclosure realizes that Inadequately Disclosed will most likely forfeit the note it owes, therefore Adequate Disclosure decides to discount the note to the bank. The note is due in 9 months under an interest rate of 9%. The note was issued on January 1st, however on May 1st; the local bank will factor the note for 12% interest. Calculate the amount of interest income Adequate Disclosure will receive.
First: Calculate the Maturity Value of the Note
$100,000 x 9/12 x 9% = $6,750
$100,000 + 6,750 = $106,750
Second: Calculate what the bank will pay Adequate Disclosure.
$106,750 (maturity value) x 4/12 (Factored in May) x 12% (Bank’s interest rate) = $4,270
$106,750 (Maturity Value) - $4,270 = $102,480
Third: Calculate the interest income for Adequate Disclosure:
$102,480 – $100,000(Face Amount of Note) = $2,480