A note receivable is a loan which a company has extended via a formal written agreement.
Because a note receivable represents funds owed to the company, the note receivable is an asset. Notes receivable expected to be settled within one year are classified as current assets. Notes receivable which are not expected to be settled within one year are classified as non-current assets.
Notes receivable may be amortized or unamortized. An amortized note is structured so that the loan principal is paid down over time. When a note is amortized, the company accounts for principal and interest based on a loan amortization schedule. The loan amortization schedule shows the payment-by-payment breakdown of interest and principal. An unamortized loan is a loan which pays the principal and interest at maturity (the date when the loan is due in full). Alternatively, an unamortized loan may pay interest-only payments periodically and the full principal amount at maturity.
A company may create a note receivable to allow a customer additional time to pay an account receivable. When this occurs, the company replaces the customer’s account receivable with a note receivable.
Consider the following example. A company is owed $50,000 from a customer. The customer notifies the company that it will need additional time to pay the account. The company grants the customer a six-month note at a 10% annual interest rate. The note is to be paid with principal and interest at maturity. The interest on the note is (10% / 2) x $50,000 = $2,500.
To account for the note, the company decreases accounts receivable by $50,000 and increases notes receivable by $50,000. The company must recognize interest income each month, despite the interest not being received until maturity. At maturity, the company retires the notes receivable.
