Notes Receivable: Videos & Practice Problems

Notes receivable are formal agreements that include a principal amount and an interest rate, with a specified maturity date. Interest is calculated using the formula: $P^{1}rt$, where P is the principal, r is the interest rate, and t is the time factor. Adjusting entries for accrued interest ensure that revenue is recognized when earned, even if cash has not yet been received, impacting both assets and equity on the balance sheet.

Notes Receivable Definitions

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 contract, what we see is that the note receivable, different from AR, right? And another difference here is that they have a maturity date, so there's going to 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 going to be an interest rate and you're earning interest on this note receivable, you're going to be getting interest revenue. Okay, so we have 2 things, we've got principal, 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 principal 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 going to pay us interest for borrowing that money.

So when we calculate interest, we're going to use a very simple formula. We're going to have the face value of the note, the principal, right? This is the principal amount and we're going to multiply it by this interest rate. They're going to give us an interest rate in the question. So this is generally going to have to be given and we're also going 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 going to be current, they're going to be things like a note receivable that's for, you know, 90 days or 6 months, or maybe 1 year or 9 months, right? They are generally pretty short terms. So what happens is we're not going to earn in most cases a full year of interest, right? If it's a 90-day note receivable, well, we're only going to earn interest for 90 days, not a whole year. So we're going to have to multiply the interest rate which is usually given or which is pretty much always given as an annual amount and we have to multiply it to give it for 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 $1800 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 principal, 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 going to 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 going to calculate the total interest on that loan. Let's see what it is. $1800 times 0.12. 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. Alright? 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 $2000, 8%, but notice this time it's in months, not days, and not years. So we're still going to multiply the principal, $2000 times the interest rate 8% which is 0.08, but now we're going to multiply by the time factor. This time it's 9 months, right? We still don't get a whole year's worth, we get 9 months, months but we're talking in months. So we're not going to talk about 360 days anymore, we're going to talk about 12 months. So in this case, we're going to have it for 9 out of the 12 months, right? So let's see how much total interest will be earned in this case. Well, we've got $2000 times 0.08, so in a whole year, there would have been a $160 worth of interest, but we only get 9/12ths of it. Times 9 divided by 12 is $120, so there would be a $120 total interest in this case. Alright.

Last but not least, let's try this last one. $45100 times 4.5%, so don't get tripped up with the decimal there, 4.5%, 0.045. Right? 0.045 times, well, in this case, it's out for 1 year, right? So it would just be 1 times one over 1. It's out for 1 full year, so it would just be 1. That doesn't matter. Alright. So $45100 times 0.045 did I do that right? $45100 times 0.045. 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

So like I said, notes receivable have two distinct features that accounts receivable don't. There's the interest that we just learned how to calculate and the maturity date. There's going to be a specific date that it's due just like we saw. It's going to be due in 90 days. It's going to be due in 9 months, right? That is the due date. So how do we find that due date? Well, the maturity date, like I said, the date, the day the note is due and on that due date, they're going to pay the principal plus the interest. Everything gets paid on the due date. They don't pay the interest ahead of time generally. It all happens on the due date. Alright. So let's see how we find the maturity date of a note. Okay. They'll usually make you do this and you want to make sure that when you count days, you don't count the date 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, issued on July 17th. So on July 17th, we need to think of how many days are left in the month. So what we do is we're going to do July 31 minus seventeen, right? There are 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 going to include that, so that's going to 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 going to 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 going to be. It's going to be sometime in September. Right? And it's going to be how many days are left? There's 60 total minus 45. Well, it's 15 days into September, and that is going to be our answer. September 15th. 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

All right, a couple more details about notes receivable. Let's see what happens when we acquire notes receivable and dispose of them. So we're going to talk about 2 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 going to ask for a note, they're going to 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 percent 120 day note. Okay. So we got a lot of information, but what we'll notice is that previously remember that previously, 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. Alright? 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 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 what do we see? We see that AR in the first entry well, let's not even do the first entry. All we see is that we're having a swap from note 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 going to 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 30 day note. Alright. So how do you 30 day note. Alright. So how do we put this onto our books? Well, we received a note receivable, right? We gave them cash, We got a note receivable. So we're going to debit note receivable, for 12,000 and we're going to credit cash, right? We actually gave them cash in this situation. 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 going to pass and we'll earn some interest. Okay? So let's finish up this lesson here with 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 going to be the principal plus the interest that we earned. Okay? And that'll 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 30th, Quickcash paid the note back. Okay. So they paid the note back those 30 days later and what are they going to pay back? They're going to pay back the principal, the 12,000 plus interest. So let's see how much interest there's 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 annualization, 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 assume 360 rather than 3 65, especially when you're just learning the stuff right now. So 30 out 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 0.035 times 30 divided by 360. I = 12000 × 0.035 × 30 360 That comes out to $35 in interest. Okay? So when we get paid on April 30th, we're not just going to get $12,000, we're going to 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 going to be the debit of our entry, cash for 12,000 and $35. Alright? 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 going to 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. Alright, 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 12,000 035, 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 12.35 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 there. Revenue went up by $35, we're balanced. Cool? Alright. Let's go ahead and move on to the next video.

Notes Receivable:Interest Receivable Adjusting Entry

All right, 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. We're accruing for revenue that we've earned but not received yet. Accrued revenue, this is another accrued revenue and it's revenue earned before cash is received, okay? So we're thinking of it in terms of interest and notes receivable. Remember, a notes receivable, they get paid at the end of the maturity, and that's when we get the interest as well. So we're going to be earning interest over the life of the note. So, pop quiz real quick: interest receivable, what kind of account is it? Is it an expense, liability, asset, or revenue? Well, the keyword 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 are 2 important dates just like with all our adjusting entries, we've got 2 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 going to be earning interest revenue. The company earns interest revenue up 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 at 8% annual interest for 3 months, and this was on June 1st, so these dates are important. When preparing the June 30th 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 a 3-month loan and they've earned 1 of the 3 months, right? It was loaned on June 1st, and we're preparing June 30th financial statements. So it's been 1 month out of the 3 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 here. Yeah. Yeah. We'll do it right here. 16,000 is the principal amount times 8%, 0.08 times our annualization factor.

I = P × r × t T

This will tell us the total amount of interest that there is to be earned. So it was 3 months, right, 3 months out of a total of 12 months. So it's 3 divided by 12 and let's see what this gives us. 16,000 times 0.08 times 3 divided by 12, that comes out to $320 right there. So that's 320 total interest over the 3 months. Right? That's over the 3 months. So we're going to earn that 1 month at a time. We're going to earn ⅓ of that. So 320 divided by 3, what does that come out to? Well, doesn't come out to a pretty number, but we'll round it here to $107. Okay? It comes out to 107 approximately, so we'll leave it at that. So, now we've got this is the interest earned, right? They earned 1 month's worth of interest and if there were 3 months total and the $320, well, they earned 1/3 of that which is $107 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 going to 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 going to 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 cash receipt date. So this is the maturity date of the loan where we finally receive our principal balance and our interest. We're going to 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 got to 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 going to receive? Well, we're going to receive $16,000 plus the interest, which we calculated to be $320. So the cash we're going to receive is $16,320. Alright? So, let's go ahead. We know we're going to receive that in cash. Let's debit cash for $16,320. Right? Now what are we going to 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 accrued in the previous period, this $107 from the previous entry, well we're finally getting paid that amount. So I'm going to write this here, 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 interest revenue. Right? $213. So if you think of the $320 up here, the $320 minus $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 1, we earned $107 in interest, in year 2 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 2 years of $320. Okay. So you can imagine if all of this happened in 1 year, well, we would just have all the interest revenue in 1 year, but this is because we were splitting it up between the June 30th year-end, the 1st 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:

• A. Debit to Note Receivable for $50
• B. Debit to Interest Receivable for $50
• C. Credit to Interest Receivable for $50
• D. Credit to Note Receivable for $50

Answer: (B)

Here’s what students ask on this topic:

What is the difference between notes receivable and accounts receivable?

Notes receivable differ from accounts receivable in that they are supported by a formal written contract, which includes a principal amount, an interest rate, and a specified maturity date. Accounts receivable, on the other hand, are informal and do not typically include interest or a formal maturity date. Notes receivable earn interest over time, providing interest revenue, whereas accounts receivable do not.

How do you calculate interest on a note receivable?

Interest on a note receivable is calculated using the formula:

$I=Prt$

where $I$ is the interest, $P$ is the principal amount, $r$ is the annual interest rate, and $t$ is the time factor. The time factor is the fraction of the year the note is outstanding. For example, for a 90-day note, $t$ would be $\frac{90}{360}$.

What is the maturity date of a note receivable and how is it determined?

The maturity date of a note receivable is the specific date when the principal and interest are due to be paid. To determine the maturity date, you count the number of days or months from the issue date, excluding the issue date but including the maturity date. For example, for a 60-day note issued on July 17th, you would count 14 days in July (31-17), 31 days in August, and 15 days in September, making the maturity date September 15th.

How are notes receivable recorded in journal entries?

When a note receivable is acquired, it is recorded by debiting Notes Receivable and crediting either Accounts Receivable (if it replaces an account receivable) or Cash (if it is a new loan). For example, if a customer converts a $15,000 account receivable to a note receivable, the entry would be:

Debit: Notes Receivable $15,000
Credit: Accounts Receivable $15,000

When the note is paid, the entry would include debiting Cash for the principal plus interest, crediting Notes Receivable for the principal, and crediting Interest Revenue for the interest earned.

What are adjusting entries for accrued interest on notes receivable?

Adjusting entries for accrued interest on notes receivable recognize interest revenue that has been earned but not yet received. For example, if a $16,000 note with 8% annual interest is outstanding for one month, the interest earned would be:

$I=160000.08\frac{1}{12}$

This equals $107. The adjusting entry would be:

Debit: Interest Receivable $107
Credit: Interest Revenue $107

This ensures that the interest revenue is recognized in the correct accounting period.