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Notes Receivable

Notes receivable can be short-term or long-term and normally include both principal and interest. Principal is the amount borrowed or loaned, while interest is the amount earned. The interest rate is almost always stated as an annual rate. The maturity date is the date when the final payment will be due.

Example 1

To explain accounting for notes receivable, this lesson will use the following example.

On January 1, 2016, you loaned a customer $12,000 for one year at an annual rate of 5%. Below are the journal entries recorded on January 1, 2016, when you loaned the money, and on December 31, 2016, when you collect the money.

On December 31, 2016, your customer paid the $12,000 plus interest.

The interest calculation is $(\text{principal}\times \text{rate}\times \text{time})=(\; \$12,000\times 5\%\times 1\text{year}=\$600).$

Example 2

On June 1, 2016, you loaned a customer $12,000 for one year at an annual rate of 5%. Below are the journal entries recorded on June 1, 2016, when you loaned the money; on December 31, 2016, which requires an adjusting entry; and on May 31, 2017, when you collect the note receivable.

Since the note for Example 2 covers two fiscal periods (assuming year end is December 31), you will need to prepare an adjusting entry on December 31, 2016, to record interest revenue for 2016.

The interest calculation is  $(\text{principal}\times \text{rate}\times \text{time})=(\$ 12,000\times 5\%\times \text{(7/12)}\text{ ) }=350.$

Note that you need to express time as a fraction of the year (7 out of 12 months) since the interest rate is always expressed as an annual amount. Seven months’ worth of interest revenue ($350) was earned in 2016.

On May 31, 2017, your customer paid the $12,000 plus interest.

The interest calculation is $(\text{principal}\times \text{rate}\times \text{time})=(\; \$12,000\times 5\%\times \text{(5/12)}\text{ ) }=250.$

Seven months’ worth of interest revenue ($350) was earned in 2016, and five months’ worth of interest revenue ($250) was earned in 2017.