What Are the Treatments for Notes Receivable in Accounting?
A note receivable is a written promise a customer sends a company, vouching to remit a specified sum of money at a date that finance people often call "maturity date." There are various accounting treatments for notes receivable, and these include bookkeeping, interest accrual and payment, principal remittance and financial reporting.
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Initial Note Agreement
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When a supplier and a customer agree on the terms of a note receivable document, a corporate bookkeeper debits the note receivables account and credits the sales revenue account. A business may at times debit the customer receivables account, which is distinct from the notes receivables item, because accounts receivable -- the other name for customer receivables -- typically don't carry interest.
Interest Accrual
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In accounting terminology, accruing interest means accumulating and recording interest as long as a loan is outstanding -- meaning the borrower hasn't yet remitted the principal loan amount. Think of it as a credit card balance that generates interest expense as long as the cardholder doesn't remit the full account balance. To accrue interest on a note receivable, a bookkeeper debits the interest receivable account and credits the interest income account.
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Interest and Principal Remittance
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When a corporate customer remits the interest and principal note receivable amount, an accounting clerk -- who also goes by the names "bookkeeper" and "record-keeper" -- debits the cash account, crediting the interest receivable account and the note receivable account. Don't mistake an accounting debit for a banking debit. In financial terminology, debiting cash means increasing funds in a company's operating vaults. In the banking sector, debiting a customer's account means reducing cash in the account.
Bad Debt and Note Write-off
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Bad debt arises when a customer cannot settle a note receivable because of temporary financial tedium, bankruptcy or outright liquidation. To record bad debt, a record-keeper debits the bad debt expense account and credits the "allowance for doubtful items" account. A note receivable write-off comes into play when a business believes there's no glimmer of hope for recovery of that debt. In that case, the record-keeper debits the "loss on note receivable write-off" account and credits the note receivable account.
Financial Reporting
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Accounting treatments for notes receivable affect various financial statements -- the data synopses you review to learn more about how much a company made during a given period, as well as its debts and how much it had at the bank. The notes receivable account is integral to a balance sheet, similar to interest receivable. Interest income is part of a statement of profit and loss, as are bad debt expense and the loss on note receivable write-off.
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