7. Receivables and Investments
Notes Receivable are a type of receivable that earns the company interest revenue.
Notes Receivable Definitions
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Alright. So let's learn a few more details about notes receivable. So recall that a note receivable is very similar to an account receivable except that it's supported by a formal written contract. Okay. We have a formal written contract which kind of solidifies this arrangement and on top of there being this this contract, what we see is that the note receivable uh different from a. R. Right. Another difference here is that they have a maturity date. So there's gonna be a specific date where the note receivable matures and has to be paid back and they earn interest. Okay. That's a big difference there is that there's gonna be an interest rate and you're earning interest on this note receivable, you're gonna be getting interest revenue. Okay. So we have two things. We've got principle. If you've heard of loans you've probably heard these terms before. You've got the principal of the loan and this is the amount that was loaned or borrowed. Right? We've got notes receivable and notes payable. So it goes either way. The principle is that amount that's loaned or borrowed and the interest. Well that's the cost of borrowing the principal. Right? So if we lent money they're gonna pay us interest for for borrowing that money. So when we calculate interest we're gonna use a very simple formula. We're gonna have the face value of the note the principal, right? This is the principal amount. And we're gonna multiply it by this interest rate they're gonna give us an uh an interest rate in the question. So this is generally gonna have to be given And we're gonna have to multiply it by a time factor. Usually these notes receivable are for short terms for the most part when we talk about notes receivable, they're gonna be current. They're gonna be things like a note receivable that's for you know, 90 days or six months or maybe one year, nine months. Right? They're generally pretty short terms. So what happens We're not gonna earn in most cases a full year of interest. Right? If it's a 90 day note receivable, we're only going to earn interest for 90 days, not a whole year. So we're gonna have to multiply the interest rate which is usually given or which is pretty much always given as a annual amount. And we have to multiply it to give it for the actual amount the actual time period. So let's see some examples here with the interest rate. The first one, we've got a note that's $1,800 note with a 12% interest rate, annual interest rate and it's out for 90 days. So let's calculate the total interest that will be paid on this note. What we need to do is we need to multiply the principle the face value of the note times the interest rate 0.12 as a percentage, right? As a decimal. And then we have to multiply it by the time factor, right? This time factor that I mentioned. Well in this case we're not having it for a whole year, right? We're only gonna have it for a portion of the year. And when we talk about days, they usually simplify, they don't talk about 365 days. They usually just say 360 just to keep it simple double check with your professor and make sure they use 360. It just makes the math a lot simpler in these classes. So we don't get it for a whole year for a whole 360 days. We only get it for 90 out of those 360 days. Okay? So this is how we're gonna calculate the total interest on that loan. Let's see what it is, 1800 times .12. So $216 would be for an entire year. But we're only having it for 90 days of the year. So 90 times 90, divided by 360, gives us $54. All right. So you should have got $54 total interest for those 90 days outstanding. Alright, let's try the next one. So now we've got $2,000 8. But notice this time it's in months, not days and not years. So we're still gonna multiply the principal 2000 times the interest rate 8%, which is 0.08. But now we're gonna multiply by the time factor this time it's nine months, right? We still don't get a whole year's worth. We get nine months. But we're talking in months. So we're not gonna talk about 360 days anymore. We're gonna talk about 12 months. So in this case we're gonna have it for nine out of the 12 months, right? So let's see how much total interest will be earned in this case. What we've got 2000 times 20000.8. So in a whole year there would have been 100 and $60 worth of interest. But we only get 9 12 times nine, divided by 12 is 100 and $20. So there would be 100 $20 total interest in this case. All right. Last but not least. Let's try this last 1. 40 500 Times 4.5%. So don't get tripped up with the decimal there. 4.5%.. Right? 0.045 times. Well, in this case it's out for one year. Right? So it would just be one times 1/1. It's out for one full year. So, it would just be one. That doesn't matter. Alright, so 4500 times 45000.45. Did I do that right? 4500 times 45000.45. There it is $202.50. That's the total interest on that one. Alright, So that's how we calculate interest. Let's go ahead and pause real quick and then we'll discuss maturity date in the next video.
Notes Receivable:Calculating the Maturity Date
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So like I said notes receivable have two distinct features that accounts receivable don't, there's uh the interest that we just learned how to calculate and the maturity date, there's gonna be a specific date that it's do just like we saw it's going to be doing 90 days. It's gonna be doing nine months, right? That is the due date. So how do we find that due date? Well the maturity date like I said the day the day the note is due and on that due date they're gonna pay the principal plus the interest, everything gets paid on the due date. Okay. They don't pay the interest ahead of time, generally it all happens on the due date. Alright. So let's see how do we find the maturity date of of a note? Okay. They'll they'll usually make you do this and you want to make sure that when you count days, you don't count the day the issue date the very first day. But you do count the maturity date the last day. Okay. It's very simple to do this. So let's go ahead and do this. Find the maturity date of a 60 day note uh issued on July 17. So on july 17th we need to think of how many days are left in the month. Okay So what we do is we're gonna do july 31 minus 17 right? There's 31 total days in july 17 that we're not counting. So 31 minus 17 equals 14 days in july And then how about August August, well we're looking for 60 total days. The whole month of August isn't gonna include that. So that's gonna be another 31 days in August, so that's 31 days now. How many total days do we have so far? 45 days so far? Right. So that means there's we're not gonna get through an entire other month, right? There's only 60 total days on this note. So we want to find out what the last day is gonna be. It's gonna be sometime in September, right? And it's gonna be how many days are left? There's 60 total -45. Well, it's 15 days into September and that is going to be our answer september 15. Okay. So notice how we did that. If it was a longer note, we would have to count a few more months. Right. But you want to keep tally of how many days you've already expired and how many days are left for that final month where it does get paid. Alright, let's go ahead and move on to the next video
Notes Receivable:Acquiring and Disposing
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Alright. A couple more details about notes receivable. Let's see what happens when we acquire notes receivable and dispose of them. So we're gonna talk about two different ways that we generally acquire a note receivable. The first is a customer on account having difficulty paying. Okay? So a customer that has difficulty paying. Well they're gonna ask for a note. They're gonna offer a note receivable for more time to pay. Okay? The goods company gets a notice from their regular customer consistent chris that he will not be able to pay his $15,000 account on its due date of august 1st. On that day, consistent chris delivered a 15,005% 120 day note. Okay. So we got a lot of information. But what we'll notice is that previously remember that previously Um there was a journal entry when we made the sale to consistent Chris Right? We made a sale to consistent Chris and he had an account receivable for $15,000 and we had earned revenue of $15,000 on his account. All right. But now that time finally came around and he asked for more time. So what ends up happening? Now when we get this note receivable? Well, we are receiving a note receivable, Right. Note receivable is going to be our debit because it's a it's an asset Note receivable for 15,000. But what's our credit? What did we give up to get this note receivable? We got a note receivable. What we gave up was the previous account receivable. Right? We had an account receivable with consistent chris, well we no longer have an account receivable. Now we have a note receivable with consistent chris. So this credit of 15,000 gets the account receivable off of our books. Right. So do we see we see that they are in the first entry? Well let's not even do the first century. All we see is that we're having a swap from no from account receivable of 15,000. Now it's a note receivable of 15,000. Right? So notice in this situation we didn't just loan him out cash, right? We didn't loan them cash. And they gave us a note receivable? No, they were a customer that owed us money and now they're gonna owe us with interest. Okay, let's look at the second way a company might acquire a note receivable. And this is just when they have extra cash on hand, they had a successful quarter. They've got extra cash, they don't know what to do with, well they loan it out to earn some interest revenue. The good company had 12,000 extra cash on hand at the end of the corner which it loaned to. Quick Cash International with a 3.5% 30 day note. Alright, so how do we put this onto our books While we received a note receivable? Right? We gave them cash. We got a note receivable. So we're going to debit note receivable Uh for 12,000 were in a credit cash, right? We actually gave them cash in this situation. Uh it wasn't a customer with an account receivable, nothing like that. But notice we just use these face values right? We recorded them at face value which is generally what you're going to have to do in this class. So this journal entry ends up being pretty easy. We don't have to calculate interest, nothing like that. Remember that the interest we earn over time. Right now all we did was acquire the note receivable. We haven't earned any interest yet. Time is gonna pass and we'll earn some interest. Okay So let's finish up this lesson here with the the disposing of the note receivable. And this is on the maturity date? On the maturity date the note receivable becomes due. And we're going to receive cash. The cash we received is gonna be the principal plus the interest that we earned. Okay. And that will be on the maturity date. So let's see this example on april 1st the goods company had a $12,000 extra cash on hand At the end of the quarter which it loaned to quick cash international with a 3.5% 30 day note on April 30. Quick cash paid the note back. Okay so they paid the note back uh those 30 days later. And what are they going to pay back? They're gonna pay back the principal the 12,000 plus interest. So let's see how much interest there is going to be. So the first thing is to calculate the interest which is the 12,000 times the 3.5%. Which is 0.035 times our annual Ization our time factor. Right. So what do we have here? We have 30 days out of, remember we're assuming a 360 day years. It always makes the math more simple. So we just assumed 3 60 rather than 3 65. Especially when you're just learning this stuff right now. So 30 hour of 360 right? It's a 30 day note out of a 360 day year. So how much interest will this earn? 12,000 times 3600.35 times 30 divided by 3 60. That comes out to $35 in interest. Okay. So when we get paid on April 30, we're not just gonna get $12,000. We're gonna get $12,000 plus 35 in interest. So what's the total payment? Well, the total payment, it's going to be the 12,000 plus the 35 in interest. We're going to receive $12,035 in cash. So that's gonna be the debit of our entry cash for 12,000 And $35. Right. So what do we have to get rid of? Well the note receivable, we no longer have a note receivable. Right, we got paid that money. So we're gonna credit note receivable to get it off of our books For 12,000. Right. It was on our books for 12,000. The principal amount. Now. What about the extra $35 that interest? Well, that was revenue. We earned that interest as interest revenue By loaning out money. We loaned out money and we earned interest. So it's interest revenue for $35. All right, and there we go. Our entry is balanced. Right here. That is our journal entry right there and it's balanced. So we see that cash goes up 12,035 notes receivable and our notes receivable is going down by 12,000. So you see our assets went up by $35 in essence. Right? The cash went up 1235 and notes receivable went down 12. So the 35 is left over. And that was revenue, the interest revenue, which went up by 35 in our equity. So there we go. We are balanced there. That's behind me. Their revenue went up by $35 were balanced. Cool. Alright, let's go ahead and move on to the next video
Notes Receivable:Interest Receivable Adjusting Entry
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Alright. So let's discuss one more adjusting entry related to notes receivable. And this is for the interest receivable. So this is another adjusting entry that's an accrual were accruing for revenue that we've earned but not received yet. So revenue accrued revenue. This is another accrued revenue and its revenue earned before cash is received. Okay, So we're thinking of it in the terms of interest and notes receivable. Remember a notes receivable? They get paid at the end of the end of the maturity and that's when we get the interest as well. So we're gonna be earning interest over the life of the note. So pop quiz rick real quick interest receivable. What kind of account is it? Is it an expense liability asset or revenue? Well the key word here is receivable and anytime we have a receivable we know that it's an asset. Okay? Anything receivable is going to be an asset. So there's two important dates just like with all our adjusting entries, we've got two important days for accrued interest. The first is the period ending date and this is the date that we're doing the adjusting entry. So remember that the company is gonna be earning interest. Revenue. Company earns interest revenue up to the, to the adjustment date but it has not received cash right? It didn't receive the cash for that interest but it's owed to the company. So we have to create the asset on june 1st. Big money company loaned $16,000 to no cash on terms of 8% annual interest for three months. And this was on june 1st. So these dates are important When preparing the June 30 financial statement. Big money company would adjust for the interest earned up to that date. So how much interest have they earned? Well it's what a three month loan and they've earned one of the three months, right? It was loaned on june 1st and we're preparing june 30th financial statements. So it's been one month out of the three months. So let's go ahead and calculate our total interest and then let's think about how much of the total interest was earned. So let's do it over and we'll do it right here. 16,000 is the principal amount times 8% 0.8 Times are annual Ization factor. This will tell us the total amount of interest that there is to be earned. So it was three months right? Three months out of a total of 12 months. So it's three divided by 12. And let's see what this gives us. 16,000 times point oh eight times three divided by 12. That comes out to $320 right there. So that's 320 total interest over the three months. Right? That's over the three months. So we're gonna earn that one month at a time. We're gonna earn one third of that. So 320 divided by three. What does that come out to? Well, it doesn't come out to a pretty number but we'll round it here to $107. Okay it comes out to 107. so we'll leave it at that. So um now we've got this is the interest earned right? They earned one month's worth of interest and if there was three months total in the $320 well they earned one third of that which is 100 and $7 in interest. So now let's make our adjusting entry first. We need to debit interest receivable right because we've earned some interest and it's owed to us. So we're gonna receive it at some point in the future And that's $107 in interest. And then we're going to credit interest revenue right? We've earned this revenue during this period. So we're gonna take the revenue during this period for $107 notice, there was no cash received for that interest but we did earn it from the passing of time. So let's go on to the second one. The second entry is the cash receipt date. So this is the maturity date of the loan where we finally received our principal balance and our interest, we're gonna finally receive it. So the company receives cash, it earns any remaining interest revenue right up to this point. We've only received 107 of our interest revenue but there's 320 total interest. And then we gotta get rid of the interest receivable as well. So august 1st comes around and no cash pays the loan off pays us all the money. So how much money are we gonna receive? Well, we're gonna receive 16,000 plus the interest which we calculated to be 3 20. So the cash we're gonna receive is 16,320. All right, so let's go ahead. We know we're gonna receive that in cash. Let's debit cash for 16 3 20. Right Now, what are we gonna credit first? We have to credit notes receivable to get the note off of our book. Right 16,000. Next we have to get rid of the interest receivable. Right? We finally got that interest paid to us that we had a crew in the previous period. This 107 from the previous entry. Well, we're finally getting paid that amount. So I'm gonna write this here in for interest receivable. Okay, interest receivable. And that was the 107 from the previous entry. And now we just have to make this balance right? So let's go ahead and find out what credit would be what makes this balance. And that's the remaining uh interest revenue. Right? 213. So if you think of the 320 up here, the 320 -107 that was already earned. Well, that means there's 213 left to earn. And that is what we earned in this second period interest revenue. So notice this is interest revenue for 213. So notice what happened, this was just we had to make this entry because of our reporting date. So in year one we earned 107 in interest in year two, we earned 213 but our total interest was 320. Right. Regardless of how we broke it up, based on the year end, we still got the same total interest revenue between the two years of 320. Okay, so you can imagine if all of this happened in one year? Well, we would just have all the interest revenue in one year. But this is because we were splitting it up between the june 30th year and the first year before june 30th and then the new year after june 30th. Cool. Alright. Let's go ahead and pause here and then you guys can try a practice
On April 15, Holden Company received a 60-day, 12% note in the amount of $10,000 from a customer who was having difficulty paying his account. When preparing the April 30 financial statements, the necessary adjusting entry related to interest would include:
Debit to Note Receivable for $50
Debit to Interest Receivable for $50
Credit to Interest Receivable for $50
Credit to Note Receivable for $50