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9.7 Explain How Notes Receivable and Accounts Receivable Differ

Notes Receivable vs. Accounts Receivable​

Accounts Receivable:

  • Informal credit arrangement
  • Usually short-term (30-60 days)
  • No written promise to pay
  • No interest typically
  • Based on invoice

Notes Receivable:

  • Formal written promise to pay
  • Usually longer-term
  • Written promissory note
  • Usually includes interest
  • More legally enforceable

Notes Receivable​

What is a Note Receivable?

A note receivable is a written promise by a customer to pay a specific amount of money at a specific future date, usually with interest.

Components:

  • Principal: Amount borrowed
  • Interest Rate: Annual interest rate
  • Maturity Date: Date payment is due
  • Maker: Person/company who promises to pay
  • Payee: Person/company who will receive payment

Accounting for Notes Receivable​

Recording a Note:

Example:

  • Customer signs note for €5,000
  • Interest rate: 6% per year
  • Maturity: 90 days
  • Date: November 1

Journal Entry:

411000 Notes Receivable           €5,000
410000 Accounts Receivable                    €5,000
To convert account receivable to note receivable

PCN Account:

  • 411000: Notes Receivable (Class 4)

Interest Calculation​

Simple Interest Formula: Interest = Principal × Rate × Time

Time in Years:

  • 90 days = 90/365 = 0.2466 years

Example:

  • Principal: €5,000
  • Rate: 6%
  • Time: 90 days (0.2466 years)
  • Interest: €5,000 × 0.06 × 0.2466 = €73.98

Accruing Interest​

At End of Period (if note not yet due):

Example:

  • Note dated November 1
  • Year end: December 31
  • Interest accrued: 60 days

Calculation:

  • Interest: €5,000 × 0.06 × (60/365) = €49.32

Journal Entry:

423000 Interest Receivable        €49.32
730000 Interest Income                        €49.32
To accrue interest on note receivable

Collecting Note at Maturity​

When Note is Paid:

Example:

  • Note matures January 30
  • Principal: €5,000
  • Total Interest: €73.98
  • Total Received: €5,073.98

Journal Entry:

510000 Cash                        €5,073.98
411000 Notes Receivable                        €5,000
423000 Interest Receivable                      €49.32
730000 Interest Income                          €24.66
To record collection of note at maturity

Note: Interest Receivable had €49.32, remaining interest (€24.66) is recognized when collected.

Dishonored Notes​

If Note is Not Paid:

Example:

  • Note of €5,000 not paid at maturity

Journal Entry:

410000 Accounts Receivable        €5,073.98
411000 Notes Receivable                        €5,000
423000 Interest Receivable                      €49.32
730000 Interest Income                          €24.66
To record dishonored note

Note: Convert back to accounts receivable and continue collection efforts.

Luxembourg Considerations​

Notes Receivable:

  • Less common for SMEs
  • May be used for larger amounts
  • More formal than accounts receivable
  • Better legal protection
  • Interest income is taxable

Luxembourg Compliance Note​

Notes receivable in Luxembourg:

  • Must be properly classified (PCN Class 4)
  • Interest income is taxable
  • Must accrue interest properly
  • Must maintain proper documentation
  • Must comply with interest rate regulations

Think It Through​

When might a business prefer a note receivable over an account receivable? What are the advantages and disadvantages of each?