What Is a Notes Receivable vs. Accounts Receivable?

Notes receivable represent a formal, written promise of payment, serving as an asset in a business’s financial dealings. These instruments provide a legally enforceable claim to a specific sum of money, often including interest, at a predetermined future date. Companies utilize notes receivable to formalize credit arrangements and secure repayment for various transactions.

Key Characteristics and Components

A notes receivable is a promissory note, a written agreement outlining the terms of a financial obligation. This document details the principal amount, which is the original sum of money borrowed or owed, excluding any interest. Promissory notes include a stated interest rate, the cost charged for the use of the money.

The maturity date specifies the future date when the principal and any accrued interest must be repaid to the note holder. The party who promises to pay is the maker (borrower), while the party who holds the note and is due to receive payment is the payee (lender).

Distinguishing from Accounts Receivable

Notes receivable and accounts receivable both represent amounts owed to a business, but they differ in their characteristics. Accounts receivable are informal, short-term amounts arising from routine sales on credit, typically without interest charges. Payment for accounts receivable is expected within 30 to 60 days from the invoice date.

Conversely, notes receivable are formal, written commitments backed by a promissory note. These notes include a specified interest rate, compensating the lender for the extended payment period. Notes receivable have longer repayment terms, often extending beyond a year, compared to accounts receivable.

Common Scenarios for Usage

Businesses utilize notes receivable in situations that require a structured payment agreement. One frequent scenario involves formal loans extended to customers or employees, where the notes clearly define repayment terms and interest. Notes receivable are also employed in sales of high-value assets, such as equipment, when extended payment terms become necessary. This allows the buyer more time to pay while securing the seller’s claim.

Another common use is the restructuring of overdue accounts receivable into a formal notes receivable. When a customer fails to pay an account receivable by its due date, converting it into a note provides the customer with additional time and formalizes the debt with interest. This conversion strengthens the business’s legal position for collection.

Recording and Management

Notes receivable are recorded as assets on a company’s balance sheet. If the note is due within one year, it is classified as a current asset; otherwise, it is a non-current asset. Upon issuance, the note is recorded at its face value, representing the principal amount.

Interest income on notes receivable is recognized over time as it accrues. This involves periodically recording accrued interest. At the maturity date, the business collects both the principal amount and the accrued interest. If the maker fails to pay by the maturity date, the note is considered dishonored, and the amount due, including interest, is typically reclassified to Accounts Receivable for collection.