 Hello and welcome to this session. This is Professor Farhad and this session we're going to be looking at eliminating notes receivable and discounting notes receivable. This topic is covered in advanced accounting as well as the CPA exam far section. As always I would like to remind you my viewers to connect with me on LinkedIn so if you don't have a LinkedIn account I strongly suggest you create one and please connect with me. LinkedIn is very important for your professional network ability and professional image. YouTube is where you would need to subscribe. I have 1500 plus accounting, auditing, tax and CPA related lectures. You want to make sure you subscribe this way you will stay up to date. This is my Instagram account. Please follow me on Instagram as I'm trying to increase my following. This is my Facebook page and this is my website. So let's talk about notes receivable discounted. Now let's talk about discounting notes receivable. What is the idea of notes receivable and how does it work? Well let's assume a company make a sale. Make a sale to an outside party and as a result the other party promise to pay in the future plus interest. So for the sake of simplicity we're going to ignore the principle. We're going to ignore the interest components. Let's assume we make a sale. We debit notes receivable. Let's make it $100,000 and we're going to credit sales $100,000. So we made a sale but the party did not have cash to pay us so they signed the note and for the sake of illustration we're going to charge them 10% and the note is due in 180 days. So that's the deal. We're going to charge you 10% so you're going to pay us 100,000 plus 10% but that's 180 days from now. Now let's assume this is the note. Let's assume just for the sake of looking at the picture this is the note. So this is $100,000 right here. This is the $100,000. Now guess what? This $100,000 here okay? It's a piece of paper. It's a note. We're waiting to get our money plus interest but guess what? We really can't wait or we cannot afford to wait in a sense that we need the cash now. We need to make payroll. We need to pay our suppliers. We need to pay our debt. So what we do is we go to a factor someone who's interested in buying the note. What does it mean by buying the note? The person that's buying the note will say something like this. We'll say okay I will buy your note. In other words I will give you cash today. You want cash I'll give you cash today. But here's the thing. I'm gonna give you only this much. Only this much I'm gonna assume this is $5,000 off. So I will give you right now. I'll give you right now $95,000 cash. Now okay then this factor will use an interest rate that they want to earn and they will discount the note and they will pay you $95,000. You get your cash now they will have the note. Now their note is $100,000 so when they buy the note the note's still $100,000. They only paid me $95,000. So basically they clipped $5,000 out. They didn't really clip it. The note's still $100,000 but they paid me less. So I gave them the note. I took $5,000 less but I want my cash now. So this is basically the idea of discounting. Now I'm keeping the interest computation out of the picture to keep it simple. Now bear in mind if you want to learn about this topic go to my advanced accounting which is I'm sorry go to my intermediate accounting course and specifically chapter 7 I talk in details about notes receivable, how to factor notes receivable, how to discount notes receivable, so on and so forth. So this is an advanced accounting course so the assumption is you have some idea about notes receivable. But here we are dealing with intercompany. So a company may issue a note to an affiliate company then that affiliate company will discount the note to an outside party. So basically what we're saying is you have a parent company and you have a subsidiary. The parent company will issue a note to the subsidiary. Then the subsidiary will sell the note to a bank. So this is what we're going to be dealing with or a company holding a note receivable from an outside party may discount the note to an affiliate. Now you have a note from an outside party so you made a sale you have a note remember that $100,000 in the prior example. Now rather than discounting the note to an outside party you discounted the note to an affiliate to one of your sister companies or to your parent company okay to an affiliate. So that could be that could be the case as well. In either situation when we consolidate from a consolidation point of view a receivable held by one of the affiliate companies should be reported in the consolidated balance sheet only if the note is due from an outside party. So remember if I if I discounted the note to you well that's not really a notes receivable right for you because we are related parties all have a notes people you have a notes receivable they're gonna cancel each other out. So from a consolidated point of view we only have if we if we it's only counted when we kind of not kind of when we when we discounted on outside party when we discounted this to an outside party. Now the best way to illustrate this is to work an example to see how this all work. So assume P company the parent company issued a $100,000 note to its subsidiary S company for cash. So what does that mean it means we needed cash we told S company give us $100,000 cash so we debit cash $100,000 we credit note and this note is for S our subsidiary pretty straightforward. S company will say okay now I have a notes receivable from P and I gave them $100,000 they will credit cash $100,000. Now just look at this ignoring interest income and interest expense and interest revenue and interest expense what happened is this the P company and the S company basically they canceled each other out $100,000 $100,000 credit this is $100,000 notes payable notes receivable notice if that's all what happened at the end of the at the end of the period they will cancel each other out. Now assume S company now assume S company discounted the note to a non affiliate bank or to a non affiliate party it doesn't have to be a bank it could be another company it could be another person so they discounted it before maturity discounted it means they took this note that they have from the parent company then they're gonna sell it as I told you they want their cash they cannot wait for P company to pay them they want to be paid now so they went to this bank okay let's do this and let's assume for simplicity the bank gave them $100,000 just they will not do so just for the sake of illustration so as company there are two methods to recording this transaction they can debit cash credits notes receivable if that's the case they're gonna keep their life easy why because basically this notes receivable cancel this notes receivable this cash cancels this cash and if there's any interest any any interest expense any interest revenue they would cancel each other but we're keeping it simple this is if they use this method if they credited notes receivable the other method if they they would credit rather than notes receivable they would credit an account called it's a counter receivable notes receivable discounted $100,000 so if so if they do this method if they go with the second method we have some additional entries to make so if we use method one the credit to notes receivable would cancel the debit made to the notes receivable when the note was received as I told you this note this credit and this debit they will cancel each other out and the consolidated balance sheet would appropriately report the $100,000 note held by the bank and still reported on the books of the P company and the P company would still have the notes payable so we are still showing that we owe the bank 100,000 because P company has a liability of 100,000 if there's any disclosure we also have to put the disclosure okay so if method one is used it's pretty straightforward if method two is used and what I mean by method two is this is method two method two if method two is used the notes receivable and the notes discounted would have to be eliminated so why because if method two is used so just kind of ignore this now because this doesn't exist anymore just want to show you in a picture if method two is used then what we have we have the notes receivable and still on the books and notes payable and credit the notes receivable notes if notes receive the notes receivable and the notes receivable discounted would have to be eliminated because the consolidated group is not continually liable for the note but it's the primary maker of the note so the consolidated group is the maker of the note they promise to pay it back because there's no difference between P and S when it comes to consolidation well what do we have to do then we have to remove the notes receivable discounted and we have to remove the notes receivable because we cannot keep the notes receivable on the books because we don't really have a notes receivable because that's that's coming from P company and we really have a loan a liability therefore we have to input this entry enter this entry to complete the elimination entries let's look at let's assume P company discount with S company a note that has originally received from one of its customers now P company have a note and that note is from a customer so let's assume P company made a sale to a customer for 100 000 so they will debit notes receivable from the customer 100 000 that will credit sales 100 000 now they discounted this note to S company once again they have two methods they can either use they can either use method one and method one basically if we use method one everything our life is easy because the note is gone okay so we we have we credit the notes and the note is gone if we use method two then what happened we still have the notes receivable on the books okay and let's take a look at the entry for the S company S company they will debit notes receivable and they will credit cash so if we use method two so ignore method one for now if we use method two we still have the notes receivable on the parent company box let me use a different color we still have the notes receivable on the parent company box and now we have an additional notes receivable on the subsidiary box so basically we have two notes receivable one and two and that's not really true that's not really true what does that mean it means if we use method two we have to make an additional entry but let's assume that just no elimination entry is required if method if method one is used if method two is used both company would report the same notes receivable as an asset which is that's not true we don't have two assets we don't have two assets from a consolidation perspective we only have one asset and P company would have to show a contingent liability for a notes receivable discounted so they'll have to explain if there's any contingent liability when they discounted the note to an outside party in the consolidating working paper one notes receivable must be eliminated we cannot have two notes receivable okay along with the notes receivable discounted because because s company they discounted the note again they have notes receivable discounted okay so assume company assume s company discounted the note to an outside party again they have two method they could use this method and if they use this method it's easy if they use the notes receivable discounted now we have two let me use a different color two notes receivable discounted two of them then we have to eliminate them simply put simply put we cannot have two notes receivable and two notes receivable discounted so what happened is this p had the note and this is actually what happened p transferred the note to s the p transferred the note to s it's the same notes receivable but if we don't if we don't use method if we use method one you know this this this notes is gone now it's appearing here but if we use method two then we have a note here and a note here then s discounted the note again if when they discount the note if they remove the note then we have no problem because the note is gone if we don't remove the note then we have to do something we have to eliminate the note and the notes receivable discounted okay so remember we have one note but it went from p to s then s discounted the note just bear in mind from a consolidated point of view it's one company p and s are one company not two companies if you have any questions about this topic please email me if you happen to visit my website for additional lectures please consider donating now for the CPA exam it doesn't go that far in my opinion anyway on the CPA exam what happened is this what you need to know basically I should have talked about this earlier basically on the CPA exam this is as far as it goes basically you have a note between two related parties they might ask you to eliminate the the note and if there's any interest revenue or any interest expense they would eliminate so so this company p company will have an interest expense because they have to pay expense yeah p company will have interest expense and they have to pay it to s revenue s revenue will have interest revenue and those two they would cancel each other out so this is as far as the CPA exam would go in my opinion if you know that much but you want to know in case it was discounted on outside party and notes receivable discounted could be involved if they use this method it's just keep our life easy if they use notes receivable discounted then we have to eliminate the note because we did not eliminate the note when we discounted it again study hard for your exam and see you on the other side of success good luck