Accounts Receivable vs. Notes Receivable: Main Differences
Updated November 16, 2022
Published March 15, 2021
Dave Lee is a passionate writer and editor with 15-plus years of experience writing for print and online media in the United States and United Kingdom. His topical expertise includes finance, technology, sports, social media, start-ups, security, piracy and government policy.
Accounts receivable and notes receivable both show up on a company's balance sheet as assets. They're important financial components that allow accountants or other financial experts to understand the liquidity position of a company. If you have a finance role, understanding these essential tools can help you analyze business operations and make strategic financial decisions that benefit the company.
In this article, we define accounts receivable and notes receivable, discuss the differences between them, answer some common questions about them and provide an example of journal entries for these line items.
What are accounts receivable?
Accounts receivable are line items or a group of line items that appear as assets on an organization's balance sheet. It's the money a company's clients owe for services they've received by haven't paid for yet . For instance, when a customer purchases products or services on credit, the amount they owe gets added to the company's accounts receivable. It's a financial obligation a business transaction creates.
What are notes receivable?
Notes receivable are asset accounts for an underlying promissory note that details the terms of payment for a purchase between a company and a customer. Most often, notes receivable appear when a client needs more time to pay for a sale than the conventional billing terms. As a trade-off for agreeing to a slower payment, the company charges interest and requires a signed promissory note for legal purposes.
For example, a construction company that's providing services to a building owner may communicate the cost of the construction project totals $10,000. If the construction business wants to start work, even though the client isn't able to pay, it may attach a promissory note to the contract that the client signs that states they agree to pay the final total of the project, including accrued interest. The $10,000 total then appears under notes receivable on the balance sheet.
Accounts receivable vs. notes receivable
Although accounts receivable and notes receivable both appear on the company's balance sheet as assets and indicate unpaid debts that customers or clients owe to the company, there are some differences between the two statuses. Some of the most notable differences are:
Formality: The arrangement of paying accounts receivable debts often is more informal than notes receivable, which includes a promissory note that serves as a legal contract between the client or customer and the business. Both the customer and the company's representative sign the promissory note to make it legally binding.
Payment terms: Although accounts receivable may include some payment terms, it's more common in notes receivable because of the promissory note, which outlines what the customer owns, when the payment is due and any interest that accrues.
Interest: Accounts receivable items don't include interest payments, while notes receivable items may include interest at the discretion of the company. The details about the client's interest rate appear in the promissory note with the debt.
Length: Notes receivable often take longer to balance out and receive payment from clients because notes receivable often appear when a client isn't able to pay their normal bill and agrees to other payment terms. In contrast, the business typically receives accounts receivable balances in less than one year.
Negotiability: Notes receivables, compared to accounts receivable, are negotiable, which means a company can transfer the note to sell its ownership of it to another party. The new owner of the note can claim it the same way as the original payee.
Current asset vs. noncurrent asset: Accounts receivable items are assets because the assumption is the customer pays the debt within the year or accounting period. In contrast, notes receivable can be a current or noncurrent asset, depending on when the customer pays their promissory note.
Conversion: Sometimes, businesses convert an accounts receivable line item to notes receivable if the customer or clients expresses they may struggle to repay the debt during a shorter period. This benefits the company and the debtor because the company receives income for interest accrued, and the debtor has more time to pay the debt.
FAQs about accounts receivable and notes receivable
Here are some common questions with answers about these line items:
What do large accounts receivable amounts indicate?
A large accounts receivable balance can be positive or negative, depending on business operations and the ability of the individuals or companies to pay their debt. It can mean the company sells a lot of products and services. Otherwise, the balance may not exist in the first place unless the business is cash-only.
A large accounts receivable balance correlates with a higher chance the company won't receive payment for these debts. A company might be more likely to write off the debts or convert them to notes receivable with an attached promissory note as accounts receivable age. A high accounts receivable balance also can put the company at risk of losing more money and failing to meet its goals.
What's the difference between notes receivable and notes payable?
Some companies have notes receivable and notes payable sections within their financial statements. Notes receivable refers to the amounts that customers owe a business. In contrast, notes payable are the amount of money a business owes to another company, such as a supplier or vendor.
What are the benefits of a customer using notes receivable?
Businesses may use notes receivable for customers because the organization can receive more money if it attaches interest terms to the promissory note. Notes receivable also is a way for the client to acknowledge their debts and enter an agreement with the company. This agreement can help assure the organization's leadership they're likely to receive the payments they're owed.
Example of journal entries for accounts receivable and notes receivable
Here are examples of journal entries for accounts receivable and notes receivable:
Andrew manages a tree service company, and he bills his customer, Jane, $600 for removing a tree on Nov. 24, but Jane doesn't pay immediately. Here's the journal entry to record the sale in the company's general ledger:
QuickTree Co. General Ledger
Revenue: Tree removal
When Jane pays the invoice on Dec. 24, Andrew's tree service company posts this journal entry:
QuickTree Co. General Ledger
Last month, Alice sold $10,000 of merchandise on account to Mark. Mark requested more time to pay, and Alice agreed to give him a formal two-month bearing interest of 12% per year, which results in $200 in accrued interest over those two months. The entry to record the conversion of the account receivable to a formal note would look like this:
To record the conversion of an account receivable to a note receivable
After two months, Alice's entry to record her collection of the maturity value appears as:
To record the collection of notes receivable, including accrued interest of $200
This article is for informational purposes only and does not constitute financial advice. Consult with a licensed financial professional for any issues you may be experiencing.
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