Chapter 7: Promissory Notes and Disposing of Receivables(Read pages 281-286)

Recording Honored Note:

The principal and interest of a note are due on its maturity date. The maker of the note usually honors the note and pays it in full. When J. Cook pays the note above on its due date, TechCom record it as follows. Interest Revenue (interest earned) is reported on the income statement.

liquidity of receivables

speed of the collection

Sellers prefer notes when?

the credit period is long and when the receivable is for a large amount. If a lawsuit is needed to collect from a customer, a note is the customer's written promise to pay the debt, its amount, and its term.

Selling Receivables

Can sell its receivables to a finance company or bank. The buyer, called a factor, acquires ownership of the receivables and receive cash when they come due. The seller is charged a factoring fee. --Seller gets cash earlier and can pass the risk of bad debts to the factor. --Seller avoids costs of billing and accounting for receivables.

Accounts Receivable Turnover

Helps assess quality and liquidity of receivables. Shows how well management is doing in granting credit to customers -High turnover suggests that management should consider using less strict credit terms to increase sales -A low turnover suggests management should consider more strict credit terms and more aggressive collection efforts to avoid having assets tied up in accounts receivable.

Interest computation

Interest is the cost of borrowing money for the borrower and the profit from lending money for the lender. The rate of interest on a note is the rate charged for the use of the principal for one year. Point: Maturity value of a note = Principal + Interest earned

Recording End-of-Period Interest Adjustment: Recording cash receipt

Interest revenue is on the income statement, and interest receivable is on the balance sheet as a current asset. Total interest on the 60-day note is $60 = ($3000 x 12% x 60/360). The $15 credit to interest receivable is the collection of interest accrued from December 31 entry. $45 interest revenue is from holding the note from January 1 to February 14.

Selling Receivables: If TechCom sells $20,000 of its account receivable and is charged a 4% factoring fee, it records this sale as follows

Point: A seller of receivables always receives less cash than amount of receivables sold due to factoring fees

On July 18, Jerry Pope signed a note when he borrowed $1,200 at 12 percent for 30 days from Second National Bank. In this situation:

Pope is the maker of the note

Quality of receivables

The likelihood of collection without loss.

A 60-day, 11 percent, promissory note dated June 10 matures on

The note term of 60 days less the 20 left in June (30 days in June) less the 31 in July leaves 9 days (or 60 − 20 − 31). As such, the note matures on August 9.

Louvers, Inc., accepted a $15,000, 180-day, 10 percent note from a customer on May 31. On June 30, Louvers prepared a period-end adjusting entry to accrue the $125 of interest owed on the note. The note is honored on November 27. Prepare the necessary November 27 entry for Louvers by selecting the account names from the drop-down menus and entering the dollar amounts in the debit or credit columns. If there are multiple debits or multiple credits, please enter the account titles in alphabetical order.

-Interest of $750 (computed as $15,000 × 10% × 180/360) is due at maturity. Between June 30 and November 27, a total of 150 days passed. -The November 27 entry has a debit to Cash for $15,750 (computed as $15,000 + $750), -a credit to Interest Revenue for $625 (computed as $15,000 × 10% × 150/360), -a credit to Interest Receivable for $125, and a credit to Notes Receivable for $15,000 (the principal).

Converting receivables to cash is done by

1) Selling them 2) Using them as security for a loan. convert receivables to cash before they are due if they need cash or do not want to deal with collecting receivables.

Charging a dishonored note to accounts receivable does two things

1) removes note from the Notes Receivable account and records the dishonored note in the maker's account 2) If maker of the dishonored note asks for credit in the future, his or her account will show the dishonored note.

Pledging receivables

A company can borrow by pledging its receivables as security for the loan. If the borrower defaults on (does not pay) the loan, the lender is paid from the cash receipts of the receivables The borrower discloses pledging receivables in financial statement footnotes. enables a company to raise cash. enables a company to retain ownership of its receivables. does not transfer risk of bad debts to the lender. should be disclosed in financial statements.

Recording Dishonored Note

When a Note's maker does not pay maturity date, it is dishonored. The Payee still tries to collect. The balance of the notes receivable account should only include notes that have not matured. --We remove the amount of this note from notes receivable and charge it back to an account receivable from its maker.

Recording Notes Receivable: Assume that TechCom agreed to accept $232 in cash along with $600

When a seller accepts a note from an overdue customer to grant a time extension on a past due account receivable, it often will collect part of the past-due balance in cash.

Recording End-of-Period Interest Adjustment: Assume on December 16 TechCom accepts a $3,000, 60-day, 12% note from a customer. When TechCom's accounting period end on December 31, $15 of interest has accrued on this note

When notes Receivable are outstanding at period-end, any accrued interest is recorded. ($3000 x 12% x 15/360). Following adjusting entry records this revenue.

Promissory Note

a written promise to pay a specified amount of money on demand or at a stated future date. Used in Paying for products, lending, and borrowing money. Sellers Sometimes ask for a note to replace account receivable when a customer request more time to pay past due account.

Recording End-of-Period Interest Adjustment: Louvers, Inc., accepted a $15,000, 180-day, 10 percent note from a customer on May 31. Louvers plans to prepare financial statements as of June 30, the end of its fiscal year.

computed as $15,000 × 10% × 30/360) and a credit to Interest Revenue for $125

Maturity date of a note

the day the note (principal and interest) must be repaid. Many notes in less than a full year, and period they cover is often expressed in days. Period of note is sometimes expressed in months or years. When months are used, note is payable in month of its maturity on same day of month as its original date. Point: When counting days, omit the day a note is issued, but count the due date.