Note receivable is a written promise to receive money at a future date, comprising principal and usually interest. Depending on whether the note is for 1 year or less, it can be classified as either a current or a noncurrent asset. In other words, note receivable arise when customers or others obligate themselves to a business through a formal contract to repay the face amount of a loan at a specific date with interest calculated at a specific rate. For example, assume that Peter Tan borrows $5000 from ABC Company on May 4. The terms of the note require repayment within 60 days. Interest is to be calculated at 12%. The entry to reflect this transaction and subsequent payment of the loan is shown at diagram.
Discounting Notes Receivable
A business may not wish to wait until a note receivable matures before receiving cash. In such a case, it may discount or sell a note receivable to a bank. The bank will not pay the full maturity value of the note and will calculate a discount based on an agreed percentage.
Dishonored Notes Receivable
When the customer fails to pay a note receivable on the due date, the note is dishonored and is of no longer considered a valid asset of the company. In such cases, the face amount of the note receivable may be charged against an allowance account similar to that used for uncollectible accounts receivable. Any interest income that has been accrued and recorded as interest receivable would then be written off. As an alternative, the face amount of the note plus accrued interest may be converted to an account receivable and handled according to established procedures for that type of account.
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