Notes Receivable

• Notes receivable


  Claims supported by formal promises to pay, usually in the form of notes
• Negotiable promissory note


  An unconditional promise in writing made by one person to another, signed by the maker, engaging to pay on demand or at a fixed determinable future time a sum certain in money to order or to bearer
• Notes receivable


  Represents only claims arising from sale of merchandise or service in the ordinary course of business
• Dishonored notes


  A promissory note matures and is not paid
• Handling dishonored notes receivable


  1. Theoretically, dishonored notes receivable should be removed from the notes receivable account and transferred to accounts receivable

  2. The amount debited to accounts receivable should include the face amount, interest and other charges
• Initial measurement of notes receivable

  • Conceptually, notes receivable shall be measured initially at present value
  • The present value is the sum of all future cash flows discounted using the prevailing market rate of interest for similar notes
  • The prevailing market rate if interest is actually the effective interest rate
  • Short-term notes receivable shall be measured at face value

  
• Initial measurement of notes receivable

  • In general (conceptual): at present value
  • Short term notes: at face value
  • Long term notes (interest bearing): at present value
  • Long term notes (non-interest bearing): at present value

  
• Subsequent measurement of notes receivable

  • Short term notes: at face value
  • Long term notes (interest bearing): at amortized cost using the effective interest method
  • Long term notes (non-interest bearing): at amortized cost using the effective interest method
• Amortized cost


  The amount at which the note receivable is measured initially, minus principal repayment, plus or minus cumulative amortization of any difference between the initial carrying amount and the principal maturity amount, minus reduction for impairment or uncollectibility

  
• Amortized cost for long-term noninterest-bearing notes receivable


  The present value plus amortization of the discount, or the face value minus the unamortized unearned interest income
• The term "noninterest-bearing" is a misnomer because all notes implicitly contain interest
• Time value of money


  The concept that money available at the present time is worth more than the same amount in the future due to its potential earning capacity
• Calculating simple interest vs. compounding interest

  1. Simple interest: Principal amount x Interest rate x Time period

  2. Compounding interest: Principal amount x (1 + Interest rate)^Time period
• Calculating present value (PV) and future value (FV)

  1. PV = FV x (1 + r)^(-n)

  2. FV = PV x (1 + r)^n