 In this presentation, we will take a look at notes receivable. We're first going to consider the components of the notes receivable, and then we'll take a look at the calculation of maturity and some interest calculations. When we look at the notes receivable, it's important to remember that there are two components to people, two parties at least, to the note. That seems obvious, and in practice, it's pretty clear who the two people are and what the note is and what the two people involved in the note are doing. However, when we're writing the note or just looking at the note as a third party that's considering the note that has been documented, or if we're taking a look at a book problem, it's a little bit more confusing to know which of the two parties are we talking about, who's making the note, who is going to be paid at the end of the note time period. We're considering a note receivable here, meaning we're considering ourselves to be the business who is going to be receiving money at the end of the time period, meaning the customer is making a promise. The customer is, in essence, we're thinking of making a note in order to generate that promise that will then be a promise to pay us in the future. So, in essence, you can think of a note as a type of promise. We are the business in this case. We're providing a service, and therefore, the customer is making a promise in order to pay us at some point in the future. We're asking for a bit more commitment of the promise than we would typically have under an accounts receivable situation, and typically the reasons for that would be that the amount of the sale was greater, possibly, so it's a bigger dollar amount that we want a formal documented promise to pay us, and or we're going to charge interest on the loan that we're making here. Now remember that although we're thinking of it as a promise from the customer, it's probably the case that we as the business who deal with these type of documentations and promises all the time are probably the one that are going to generate and print out the formal type of documentation as part of our business that the customer can then sign as the promise to pay in the future. But from a conceptual standpoint, we can think of it as the customer basically documenting or making this, filling out this promise in order to pay us in the future, a couple critical components that will typically be in any note receivable, even a fairly simple note receivable, which we will typically have documentation for and have a formal written document when it's a larger dollar amount, and we're charging interest, there's a larger or longer time frame involved than the normal 30 days or 60 days possibly of an accounts receivable. So we're typically going to have the amount, we're going to have the amount of the note. That would be if we sold something as the business, then we maybe had a sticker price of whatever we sold of $1,000 and therefore our, our owed $1,000. There's going to be a promise by the customer to pay us for what they purchased. Then we're going to have the date of the note, typically the date that the transaction happened, purchase happened. Then we're going to have the due date. And oftentimes the due date is going to be written something like this, 90 days after date of note, I promise to pay to the order of, and then we'll have the name of the payee. And that's for a couple of different reasons. Note that this isn't just, doesn't just have a date at some point in the future. Typically a lot of times the note will be written in wording such as this. And part of that could be that it, it makes it easier for us if we're the business who are generating this note for the customer to sell and we do this often. Then it could be a pretty standard way for us to just say 90 days from any point of the date of the note. And that makes it easy for us to make like a template to make the note. But for any, in any case that the terminology will opt to be like 90 days, 30 days, 120 days for the note. We're going to be dealing with notes here typically shorter terms meaning less than a year when we're considering the notes that we'll be working with. Now it's important to keep straight that the payee, as you can see from the wording of the note is who we are promising to pay. So that's in essence us, that's the business. That's who we're going to get paid at the end of the time period. The principal amount plus the interest. So the other component then will be the interest. We're going to pay $1,000 for value received with interest at the annual rate of 10%. So that's how much is going to be paid. Note how much is going to be paid then in terms of two components. One, the principal component. This is kind of like the loan that we gave. We didn't give them a loan in dollars. We didn't loan out the dollar amount, but we sold something with a sticker price of 1,000 didn't get paid yet at the point of sale. And therefore are in essence, loaning this money, renting the money out to the customer. And we're going to get paid that money at the end of the loan term 90 days, typically greater than a normal account receivable term. And we're going to get paid interest on top of the loan. Note what's not being said here is we don't have an official end date. We have 90 days from the due date. So we'll have to figure out when that will be, when is this actually due. And we don't have the actual amount that we're going to get. We know we're going to get $1,000, that's the sticker price. And then we got to figure out the 10%. This is typical in many notes. So if you read a note, oftentimes it's not going to give you like an amortization schedule or an interest type of calculation. It's not required to have that in the note because you can figure it out. And so oftentimes it's not included. But you're probably going to want to figure that out and we'll take a look at that and we'll need to know that in order to make the payment at the end of the time period. And then we've got the maker of the note to remember that is going to be, in our case, the customer. We're imagining the customer is the one that's making this promise. So that's the thing that's often confusing when we think about these notes. Who's who? It seems obvious, but it can be a little bit confusing in terms of who's the payee and who's the maker. Although we, as a customer, when we go and finance something, don't think of ourselves as writing out this little promise. But you can think of it as making this promise, as if we're writing this out. We're saying, hey, give me a piece of paper. I don't have the time right now. I don't have the money right now. But my word is good. Give me a piece of paper and I'll write out to you a little promise, a little formal promise here, right? Here's the date, here's the amount. I promised to pay it within 90 days. I promised to pay you not only the principal, but 10% interest for giving me the service of loaning me this money for a certain time period. And then the person making the promise, the customer in this case, the maker signs the note. Of course, in practice, the person who has this document made, formally made, would probably be the business, them being the person who is used to making this documentation, then allowing the customer to read it and go through it and sign it as well. So if we look at the components, remember that the principal is up here. We're going to break out these two components of the payment of the note at the end of the time period in two components. One, the principal, the amount of the original loan, two, the interest. Then we're going to have the due date, which is here, 90 days, from the date of the note, which we'll have to figure out. Well, when will that actually be? Then we've got the payee, who's going to be paid at the end of the time period. It's going to be paid the 1,000 plus the interest, who's going to get that payment at the end. We have the interest rate, in this case being 10%, and the maker of the note, the person who signed the note, the person who made the promise for the note. Okay, so then we're going to figure out the maturity date. This can be a little bit more confusing than you would think, because if we're saying it's a 90 day note, and we're saying the due date was 115, well, we really got to think, well now, I mean, each month has a different number of days in it, so it's actually a little bit confusing to go through and figure out when the actual date of maturity is, and this is actually a common problem. Of course, a computer can help us out when we generate this, and they'll typically give us the due date because it can be computer generated. But note that when you're working problems, and when you're figuring this stuff out, and when you're trying to just say, what's 90 days from this due date, it's a little bit more confusing than you might think. And you want to have a system if you're doing a test question to be able to figure that out, and if you're in a system where you're figuring this out all the time, have some computerized system, or just note that it might be a little bit more confusing than you would think at first. So we can think about that by saying that, okay, we're going to count up 90 days, there's about 30 days in each month, but it's starting on January 15th. So we can start off with a kind of a little subtraction problem. We can say, well, there's 31 days in January. And we know that the note date is as of the 15th. So 31 minus 15 means there's 16 days left. Now be careful because it depends on whether or not we're going to be counting the day of the note term, like this 15th day. So the question is, does that count in the term of the note? And you're going to have to be kind of careful on that. So if you're off by basically a day of a problem, of a computer problem, or something like that, or a multiple choice problem that may consider the fact that, well, is this 15 day included or not? If it is, then we'd have to add to that one more for this day for the 15th. We're taking the difference between the two, 31 minus the 15, which would start at the 16th. You can count it on your fingers, right, 16, 17, 18, up to 31, 16 days. Then we can count up from there. We're doing around three months because it's 90 days. So we're going to say the days in February, we're going to say it's 28 in this year. And then we're going to say the days in March are 31. And then we're going to consider, well, we need to be at 90 days. So we can just figure out where are we going to lie then at the end of this. We're going to say, well, 16 days that are left in January, plus 28 days plus 31 days, that gives us 75. We need to get up to 90. That's not going to complete a full another month. So how many days then are we going to need in April? It's going to be 75 minus the 90 or 15 more days. So this last piece, we're going to say days in April or the due date, is going to be April 15th. So in other words, if we calculate this one more time, we're going to say we have 16 days in January, plus 28 days in February, plus 31 days in March, plus the 15 days in April. And that gives us our 90 days. So that means the due date is going to be here on April 15th. So just be aware that due date calculation can be a little bit tricky. Okay, so when we record the note, it's a pretty easy thing to do to record the note, but often very confusing for people. When you see this note, you see this note and you say, oh man, there's a principal amount, there's an interest rate of 15%. There's the 90 days of the due date. And so you would think that when I record the note, it's going to be fairly confusing. But really when we record the note, all we need is this 1,000. And so it's deceptively easy to record the note. The interest of the note and the due date doesn't come into play until time passes. We haven't earned any interest as of the day of the note. If we sold something for $1,000 and they gave us a note saying they will pay us in the future, then all we have to do is record the note at this time period. Interest accumulates as we basically rent them money. It's rent on the money. So we have no rent on the money when we just gave the note. So to record the note, if we sold something for $1,000, we would just record the sale of $1,000. And then we debit instead of accounts receivable, notes receivable. So note, it doesn't matter. All this other stuff, I don't need any of this stuff. All I need to know is that there's a note for $1,000. I don't need to know the interest rate. I don't need to know the terms. I don't need to know any of that in order to record the note. So just be aware that can be really confusing because of too much information to put the note on the books. Now, of course, if we made a sale and we sold inventory, we would have the other side of that cost of goods sold and the inventory going down. But so this is the same transaction that should look familiar for us making a sale on account. Instead of having accounts receivable, we're now having notes receivable, typically because the amount of the note is a larger dollar amount. We want to charge interest on the note, typically the term of the note being longer term and therefore having a formal written document. We then will be tracking it not in the subsidiary ledger for accounts receivable, but in a separate notes receivable and tracking both the principal and the interest. So same transaction, just replacing accounts receivable with notes receivable and pretty straightforward transaction. Then when we're going to calculate the interest, we're going to have to figure this out so that we know how much is going to be paid to us or due to us at the end of the time period. So note at the beginning of the time period, there's only $1,000 due us. And that's it. There is no interest yet. There's no interest until time passes. After time passes, then they're going to owe us the interest because we rented them money and they have to pay us rent on the money. They have to pay us interest on the money. So how much are they going to have to pay us because of the rent on the money? We'll figure that out now. We got $1,000. The interest rate is 10%. So 1,000 times 10%. And remember, if it's in a calculator, we're going to say 1,000 times 0.1 or 10% 0.1. If you move the decimal over two places, it's 10%. That's $100. So that gives us the $100. And then I typically think about it this way. Remember that this interest, and we'll go over this in more depth later, we'll figure out different ways to calculate the interest. But interest is for a year. So it says it here an annual rate, even if it doesn't say annually. Whenever we think about interest, we think about it in terms of a year. So just we have to understand that whenever we talk about interest, we talk about in terms of a year, even though the note term is rarely for one year. It's often for a series of months. And we'll have to then break out this interest amount, which would be for a year if the note was out for a year into some monthly amount. So in order to do that, one way to do that is we can take the days in a year, or 360, and we can take that $100 divided by 360 days. Or it doesn't come out even, and we'll have to deal with this, 0.2777, right? And so that's going to be the amount. Now where did we get the 360? There's 365 days in a year, typically. We're going to use a rounding a number to make this an easy calculation for simple interest. Meaning we're just going to take 12 months times an average of 30 days in each month, or 360 days. And that'll give us a nice even way to calculate this simple interest that we'll be calculating. So once again, we have $100 divided by 360 days in a year. That's about 28 cents per day. If we round it, so 28 cents, we need to be careful about this rounding. We cannot get away from rounding. It's always going to be a situation. So we could make problems that come out perfect all the time, and they don't round out perfectly, but in real life, there's going to be this issue. So if you're off by a little bit, a couple dollars, it could be a rounding issue, and we always have to be aware of that. So then if we have the 28 cents per day, and the number of days of the note is 90 days, then we can multiply that out, and we get the 25 here. Again, if you do the math here, and you say 0.28 times 90, it's actually 25.2, and so that's a rounding issue there. And remember, this wasn't actually 28. It's 100 divided by 360 is actually 27.277 times 90 is 25. So just if we use Excel, and we'll take a look at Excel, we'll be able to know how to deal with these rounding issues and make it exact. So just note that those are always going to be something that we have to deal with. Things aren't going to be perfect in terms of dollars and pennies. We need to figure out how are we going to deal with these rounding issues. And when we're off by a dollar or so, we need to recognize that and say, it's okay, well, it's rounding. We'll figure it out. Okay, so then if we're going to say that the interest is 25 dollars that will be earned at the end, then when we get paid at the end of the time period, we're going to get paid, then what's our journal entry going to be? Well, cash is going to be received, and the note receivable is going to come off the books. Now, we'll see this was an example problem with a trial balance. It's a lot easier to see if you have a trial balance. But the note receivable we put on the books, remember, by debit of 1,000, it's kind of like a account receivable has a debit balance. We need to now take it off the books because we're going to get paid. We're going to get paid more than 1,000, 1,000 plus the 25, but we're going to take it off the books for the amount that's on the books, 1,000. That 25 is going to be interest revenue. So it's going to be revenue that we earned. We earned revenue based on not the sale when we earned the thousand dollars when we sold it. This is revenue that we earned for renting money, in essence. And it's going to increase revenue, increasing an income statement account, a revenue income statement account, which will increase net income. And then the cash we get will be the 1,025. So remember, we made the note for 1,000. When we put it on the books, we only put it on for 1,000. Then we had to take it off the books, taking that thousand dollars off. But at this point in time, we had earned $25 throughout the term of the note. And therefore, we're recording more revenue than we had recorded at the beginning of the note. Because we recorded revenue for whatever we sold at the beginning. Now we're recording revenue due to the fact that we loaned out money. We made interest on the money. We rented money. That's how we earned this 25 increasing net income by the 25. And then we got, then, 1,000 principal back plus 25 interest. That's how much is going to be paid to us at the end of the note. Now if the note is dishonored, we have the same kind of problem that what happens if they don't pay the note. Then we still had earned the 25 and we're going to have to revert it to some other components. But due date of the note, we still need to do something. Meaning we need to take the note off the books. It's passed to due. And then we're going to record the interest. We still earned the interest for renting the money. And we're going to have to debit something. We can't debit cash. So we could put it back into accounts receivable. Tracking it back into accounts receivable so that we can track in our subsidiary ledger, this customer, this individual that owes us money and track that they still owe us that money somewhere. So we're going to still record the fact that we earned interest revenue. We still need to take the note off the books because the term of the note had ended. And then we can put it back into accounts receivable as a holding accounts to let us know that we still have this dishonored note and we still want to try to collect on it and go through the collection process for it. There's also a case that we might have an adjusting entry at the end of the note time period. And that'll happen because remember that we make financial statements as of the end of the month or the end of the year. And the note term in this case is 90 days. So what that means is that, for example, here we have the note term. It happened on January 15th. If we're going to make financial statements as of January 31st, then we're going to have some days that fell in this month where we earned revenue. We rented money out kind of like we rented a house out. We earned revenue, but we're not going to collect the rent until next month after the end of the close here. That means that there's there's rental money that was earned, which we should recognize as earned it. We earned it because we loaned out what we loaned out. Not a house in this case, but money. And so we should recognize it in this time period, even though we have not received the cash. That's going to be an adjusting entry. So to do that, we're going to have to figure out, well, how much did we earn as of the end of the month? So it's a 90 day note, but how much did we earn in January? We have to figure out, well, that depends on how many days it was outstanding and the interest rate. So we'll do a similar type of an interest calculation. We got the principal. We've got the interest rate is 10%. 10% times $1,000 is $100. Then we've got the days in a year. This would be $100 per year, remember. 360 days, which we're saying 12 months times 30 days to make it even. $100 per year times 360 days is 0.2828 cents per day. Again, that's rounded. It's really 0.277. This is the same calculation we had prior. Now we're just going to make a slight difference. We're not going to multiply times the term of the note the 90 days, but by only the amount of days that are remaining in the note, which is 16. So if we did this in a calculator, remember what we're saying is there's 31 days in January minus 15. That means there's 16 days left. And you have to be careful in terms of are we going to count the day of the note or not. So if you're off by a little bit, that might be the difference if we're counting the 15th day the note was created or not. The difference when we calculate it here at 31 minus 15 is not calculated, meaning if we counted it up on our fingers, we would count starting with 16, 16, 17, 18 up to 31 would be 16 days. So if we do this calculation, then we're going to say we had $100 of interest divided by 360. That gives us 0.2777 and that's about 0.28 times 16 days. And that gives us 4.44. Again, it's not perfect, but it's about $4.44. Now this amount seems minor and it is, so in this Adjusting Entry. But if we had a lot of these Adjusting Entries or if the dollar amount was larger, this could be a material Adjusting Entry that we would want to make sure that we record in order to represent the financial statements correctly as of the date we make them, the end of the month, the end of the year. So to record the Adjusting Entry, we'd have to say that we have interest receivable of this $4.44. In other words, at this point in time, we have the notes receivable already on the books when we first recorded this at $1,000. And we're not going to record this amount in the receivable itself. We're not going to say the receivable is $4,400. What we're going to do is make another account called Interest Receivable and that's where we're going to accumulate the interest which is related to this note. It's an asset, asset F debit balances. The receivable is going to go up by doing the same thing to it, another debit. Then we're going to record the interest revenue that we earned. We didn't get paid yet. We haven't gotten cash yet. But we did record interest and remember that's just the rent on the money that we loaned out. Interest is a revenue account or interest revenue is a revenue account has a credit balance as all revenue accounts do. We're going to make it go up by doing the same thing to it another credit increasing both the revenue account and therefore net income.