A note receivable occurs when a company lends money to another business or individual. A note receivable can also occur when a customer requests an extension on an existing accounts receivable account. A company extends a promissory note because of the interest revenue that will be generated from the loan. A note receivable can be due within one year, or the note can become due in more than one year, depending on the terms of the loan.
Notes receivable is an asset listed on a company’s balance sheet. The amount of the loan is called the principal amount of the note, and interest is charged according to the interest rate associated with the note. When a company extends an accounts receivable account, the accounts receivable balance must be transferred into a notes receivable account. Assume, for example, that a customer requests an extension on a $20,000 accounts receivable account. In this case, the company must debit notes receivable for $20,000 and credit accounts receivable for $20,000. This entry transfers the accounts receivable account balance to the notes receivable account.
Interest on a note receivable represents the amount of money gained as a result of extending a note to a customer. The terms of a note receivable can allow a company to collect interest payments on an annual, monthly, semiannual or quarterly basis. When a company receives interest payments on a note receivable, the payment must be documented in the general journal. The company must debit cash for the amount of money received, and credit interest revenue for the same amount. This entry shows the company’s assets and revenues increased.
Accrued Interest Earned
A company must recognize and record interest receivable earned, even when cash has not been paid. To record accrued interest receivable in the general journal, the company must debit interest receivable for the amount of interest earned and credit interest revenue for the same amount. For example, a company that accrues $300 in interest on a notes receivable for the accounting period must debit interest receivable for $300, and credit interest revenue for $300. This transaction illustrates the interest has been earned, but the company has yet to receive a cash payment. The entry increases the company’s revenue and assets.
When a company receives an interest receivable payment, the company’s assets remain unchanged. The company takes the interest receivable off the books by crediting interest receivable for the amount of cash paid and debiting cash for the same amount. In this transaction, the company’s cash account increases, while the less liquid interest receivable account decreases because of the interest payment.