Recognizing Notes Receivable

• Definition - A written promise to pay a specified amount of money on demand or at a definite time

• If note is received to settle an outstanding account receivable:

• Notes are valued at net realizable value– Similar process to determine bad debt expense and

allowance as for accounts receivable

May 31 Notes Receivable - Higly 10,000 Accounts Receivable - Higly 10,000

To record acceptance of Higly note

Recording Interest• Formula for calculating interest:

– An annual rate of interest - to determine monthly interest, divide by twelve

• Separate interest receivable account is used (value of note is not altered)

• Example: $10,000 note at 6% due in 4 months

Principalof Note X X =

AnnualInterest

Rate

Time inTerms ofOne Year

Interest

J une 30 Interest Receivable 50 Interest Revenue ($10,000 x 6% x 1/12) 50

To accrue interest on Higly note

Disposing of Notes Receivable• A note is honoured when paid in full on its maturity

date• In our example, the $10,000 note is paid on time. We

need to record the principle and interest portions paid. We have accrued part of the interest already.

Sept. 30 Cash 10,200 Notes Receivable - Higly 10,000 Interest Revenue ($10,000 x 6% x 3/12) 150 Interest Receivable 50

To record collection of Higly note

Disposing of Notes Receivable - 2

• A note is dishonoured if not paid in full at maturity

• If collection is expected we debit the accounts receivable account

Sept. 30 Accounts Receivable - Higly 10,200 Notes Receivable - Higly 10,000 Interest Revenue 150 Interest Receivable 50

To record dishonouring of Highly note, collection expected

Accelerating Cash from Receivables

• Loans – using the receivables as collateral• Sale of receivables – sold to other companies

who specialize in collections• Factoring – sold to other company which collects

cash – if the company is still responsible it is sold with recourse

• Can also securitize your receivables – similar to sale, just usually better quality receivables, which gives you more cash for them

Management of ReceivablesReceivables turnover ratio:

= Net Credit Sales ÷ Average Receivables – Sometimes we don’t know credit sales, so we use total sales instead– Measures the number of times that receivables are collected in a

period– Higher the number, the more liquid are receivables

Collection period:= 365 ÷ Receivables Turnover Ratio– Calculates the average number of days that accounts receivable are

outstandingOperating Cycle:

= Days Sales in Inventory + Collection Period– Calculates the number of days to complete the operating cycle

• Purchase of inventory through collection of cash

Example

• P.426 – RIM’s Financial Statements for presentation

• Let’s Do BYP8-2 together

Class Work

• BE8-10,12,14,15

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