What Are Notes Receivable?

In the most basic terms, accounts receivable refers to any transaction where the customer has been granted payment terms for a product or service they have received. Notes receivable, while similar to accounts receivable, are typically extended to customers who are unable to pay for the product or service within the originally agreed-upon time frame. In these cases, the business issues a note receivable that extends the payment period, with interest.

One major difference between notes receivable and accounts receivable is that notes receivable are in effect a promissory note. The promissory note is a legally binding document that compels the customer to pay. It’s an additional level of commitment that is not normally applied to accounts receivable purchases.

A Closer Look at Notes Receivable

Notes receivable are not something a business takes lightly. After all, the customer had already agreed to pay for the product or service they received by a certain date and now they are saying they need more time. But if the business believes it is in their interest to extend the payment period, they will issue a note receivable. Notes receivable typically include the following information:

• The payee: the business that is owed the debt.
• The maker: the customer who has asked for additional time to repay the debt.
• The principle: the amount of the original debt that is still owed to the payee.
• The interest and interest rate: notes receivable always come with additional interest.

Are Notes Receivable the Same as Notes Payable?

While notes receivable and notes payable are related, they are not the same thing. They are two sides of the same debt notification. The note receivable represents the debt owed to the payee by the maker. Notes payable, on the other hand, indicate the monetary obligation the maker has to the payee.

How Are Notes Receivable Similar to Accounts Receivable?

Both notes receivable and accounts receivable represent unpaid balances owed by a customer to a business. Both notes receivable and accounts receivable are recorded as assets because they represent debts a company expects to be settled at some point in the future.

How Are Notes Receivable Different from Accounts Receivable?

With accounts receivable, a business extends non-interest bearing (informal) credit to a customer with a payment schedule and a set payoff date at some point in the near future. Accounts receivable are often expected to be paid in full in two months, sometimes less, but not more than 12 months.

Notes receivable are issued by a business to a customer who requires more time to pay off what was originally an accounts receivable debt. With notes receivable, the business issues a formal extension of the payment period by way of a promissory note that is legally enforceable. Notes receivable also involve the imposition of interest on the remaining principal and the payment schedule sometimes extends beyond one year from the date the note is issued.

Example of Notes Receivable

Company A sells a piece of machinery to Company Z for S200,000 with the understanding Company Z will make two payments of $100,000 at 30-day intervals. After 40 days (and one payment) Company Z informs Company A they will not be able to pay the remaining $100,000 on schedule and asks for more time to settle the debt.

Company A issues a note payable that stipulates the remaining $100,000 can be paid in four $25,000 increments (plus 10% interest) with payments due the last day of the next four months.

How Notes Receivable are Recorded

For accounting purposes, notes receivable are recorded under assets. That is because they represent money the business has every reason to believe they will collect. If they expect the debt to be fully repaid within 12 months, then the note receivable will be recorded as a short-term asset.

On the other hand, if it will be more than 12 months before the note receivable is paid in full, it will be recorded as a non-current asset, which is a type of long-term asset. In accordance with the fundamental accounting equation, notes receivable are listed first in the balance sheet alongside other assets.