Definition: A note receivable is a written promise to receive a specific amount of money at a designated future date or on demand of the holder. In other words, a note receivable is lender’s contract with the borrower. It entitles the lender to receive principle and interest payments from the borrower in the future.
What Does Note Receivable Mean?
Basically, a receivable is the opposite side of the transaction from the payable. The lender records a note receivable as an asset on its balance sheet while the borrower records a note payable as a liabilityon its balance sheet.
This is how every bank loan and mortgage is recorded. The bank shows and asset while the borrower shows a liability. Let’s take a look at an example.
Example
Tim’s Tool Co. wants to expand into new territory, but it doesn’t have the capital to do it. Tim decides to get a bank note for $100,000 from First Bank to purchase the new equipment he needs. Tim signs the note as the maker and agrees to pay the bank back with monthly payments of $2,000 including $500 of monthly interest until the note is paid off.
Tim debits his cash account for $100,000 and credits his notes payable account for the loan balance. The bank credits its cash account and debits its notes receivable account for the same amount.
At the beginning of each month, Tim makes the $2,000 loan payment and debits the loan account for $1,500, debits interest expense for $500, and credits cash for $2,000. Again, the bank records the reverse side of the transaction. It debits cash for $2,000 and credits notes receivable for $1,500 and interest income for $500.
This set of journal entries happen every year until the note is completely paid off.
