For accounting purposes, the term notes receivable refers to promissory notes, bills of exchange or trade acceptances. Notes receivable are distinguished by the fact that they are written contractual arrangements for the payment of a specific amount of money, generally plus interest, at a stated time. They are usually negotiable or transferable instruments which enable the holder to use them for cash generation in much the same way as is done with accounts receivable.
( A note is generally recorded at its face value.)
However, when no interest rate is specified, the face amount of a note is assumed to include some provision for interest. Such non-bearing notes are recorded at face value less an interest charge based on a percentage that is assumed to be reasonable.
The Discount on Notes Receivable is taken into income over the life of the note.
Discounting Notes Receivable
Notes receivable may be sold or discounted. When a note is sold to a bank or finance company without recourse, the seller assumes no future liability should the maker of the note default. Discounting, on the other hand, is usually done on a recourse basis (i.e., money is borrowed using the note as collateral and the borrower, who endorses the note, becomes contingently liable should the maker default).
The proceeds or cash received when a note is discounted may be computed in one of two ways:
- The interest or discount charged by the lender is deducted from the face value of the note
- The discount rate may be applied to the maturity value of the note.