 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 one 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 a thousand dollars and therefore our our owed a thousand dollars 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 the 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 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 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 $1000 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 a thousand 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 accounts 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 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 a thousand dollars 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 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 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 you know 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 promise to pay it within 90 days and I promise 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 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 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 to 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 1000 plus the interest who's going to get that payment at the end we have the interest rate in this case being 10 percent 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 that 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 bit 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 well when we generate this and they'll typically give us the due date because it could 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 you know 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 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 out on your fingers right 16 17 18 up to 31 16 days and then we can count up from there we're no 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 what 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 in gen 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 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 you say hmm oh man there's there's a principal amount there's an interest rate of 15 percent there's 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 1000 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 a thousand dollars 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 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 a thousand dollars we would just record the sale of a thousand dollars and then we debit instead of a counts receivable notes receivable so note it doesn't matter all this other stuff like I don't need any of this stuff all I need to know is there's a note for a thousand dollars 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 of that can be 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 this look this 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 a thousand dollars 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 a thousand dollars the interest rate is ten percent so a thousand times ten percent and remember if it's in a calculator we're going to say one thousand times point one or ten percent point one if you move the decimal over two places it's ten percent that's a hundred dollars so that gives us the hundred dollars 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 are 360 and we can take that a hundred dollars 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 will be calculating so once again we have a hundred dollars 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 and they round out perfectly but in real life there's going to be this issue so if you're off by a couple 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 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 2.77 0.277 times 90 is 25 so just be 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 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 uh 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 with 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 1000 it's kind of like accounts 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 a thousand a thousand plus the 25 but we're going to take it off the books for the amount that's on the books 1000 that's 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 1025 so uh remember we made the note for a thousand when we put it on the books we only put it on for a thousand then we had to take it off the books taking that thousand dollars off but at this point in time we had earned 25 dollars 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've 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 1000 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're still had earned the 25 and we're going to have to revert it to some other components but the 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 do 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 uh and 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 account 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 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 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 that 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 if 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 similar type of interest calculation we got the principal we've got the interest rate is 10 percent 10 percent times 1000 is a hundred dollars then we've got the days in a year this would be a hundred dollars per year remember 360 days which we're saying 12 months times 30 days to make it even 360 100 dollars per year times 360 days is 0.28 28 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 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 if you're off by a little bit that might be the the difference if we're counting the 15th the day the note was created or not the difference when we calculate it here it's 31 minus 15 is not calculating 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 a hundred dollars of interest divided by a 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 four dollars and 44 cents now this amount seems minor and it is so if 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 four dollars and 44 cents in other words at this point in time we have the notes receivable already on the books when we first recorded this at a thousand dollars and we're not going to record this amount in the receivable itself we're not going to say the receivable is four thousand four dollars and forty four cents 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 have debit balances so 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 revenues 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