In this presentation we will take a look at receivables. The major two types of receivables and the ones we will be concentrating on here are accounts receivable and notes receivable. There are other types of receivables we may see on the financial statements or trial balance or Chart of Accounts, including receivables, such as rent receivable, and interest receivable. Anything that has a receivable, it basically means that someone owes us something in the future. We’re going to start off talking about accounts receivable that’s going to be the most common most familiar most used type of receivable and that means something someone, some person some company, some customer typically owes us money for a transaction happening in the past, typically some type of sales transaction. So if we record the sales transaction, that would typically be the way accounts receivable would start within the financial statements, meaning If we made a sale, we would credit the revenue account, we’ll call it sales. If we sell inventory, it would be called sales. If we sold something else, it might be called fees earned, or just revenue or just income, increasing income with a credit, and then the debit not going to cash. But going to accounts receivable.
This is a transaction that should be fairly familiar, there’s going to be a transaction that happens fairly often we made a sale on account. And of course, if we made that sale on account, and it was inventory, then under a perpetual system, we’d have the second component to that which would be cost of goods sold the expense related to the inventory we sold some amount less than the receivable and the inventory going down the assets going down. So we of course are focusing on here, this receivable amount, and talking about what that means for us what it means to the company. And are there some types of problems with receivables We will have to deal with and one major problem with receivables and one that many people see when we start to learn the accrual accounting, we start to say, Hey, we recorded a receivable here, we’re talking about balance sheet accounts. We say for example, we have cash, and we have total receivables of 45,000. Well, the cash is pretty concrete, we have that in the bank, and therefore, there’s not much question about the cash cash is cash.
However, the receivable many of us start to question in the accrual principle, especially when we start to first learn the accrual principle and say, Hey, is it really fair for us to record this receivable of 45,000? When we have not yet gotten the cash, we’re recording it as an asset, a current asset, almost equivalent to cash in some ways in the same section of the balance sheet as an asset when we don’t have the cash yet. What can we do something about that seems like we might overstepped state the financial statements and that’s the question here. Will we be able to collect on this is the question with the IRS. receivable the problem with the receivable just because we made the sale, just because we earned the revenue by doing the work completed in our case giving the merchandise in order to complete the sales process and earn the revenue and therefore be entitled to the receivable. It is the fact and the case that some symbols won’t be paid. And it’ll differ from industry to industry. So that’s what we’ll talk more about as we go through future presentations.
How can we value this? One way to do it is to have an allowance method and say, Hey, this is people that owe us money, how much is owed to us, we’re going to estimate how much of that is not going to be collectible. We cannot write down the receivable directly because we don’t know who’s not going to pay us yet. But it would be reasonable to tell our readers if someone’s reading the financial statements, they would want to know the receivables. We got to put it on the books, we can’t remove it. We can’t be that conservative in that in that we’re going to take it off the books and not recognize any assets at all 45,000 of what is owed to us is significant readers to financial statements want to know that number. However, in order to be as fair as possible on the balance sheet side, we would also want to say hey, we know that based on past history, that it’s likely that a certain amount of these receivables would not be collectible.
And therefore the net receivables is what we really think should be recorded as an asset. And so we cannot write down the receivable directly. We don’t know who’s not going to owe us but we can make this contra account. And that’s what we’ll talk about in the allowance method. There’s also a problem related to the receivables on the income statement side of things. And whenever we talked about receivables, we talked about the debit to accounts receivable and the other side of that is of course sales when we record the revenue and the receivable. And we have the same question or similar question on the revenue side. Did we really earn this money? Is this sales is this revenue that we recorded as earned when we made a sale on account for a certain time period is that Really sales that we can record. In other words, it’s not exactly a sale, even if we delivered the goods if we’re not going to get paid in the future.
And we need to question this on the income statement side, which again is another area where a lot of people when we learn accrual accounting, we start to really question this This question comes up a lot as to well, how can we record a sale aren’t we recording the sale that we may not actually actualize? And therefore be overstating sales. And the same thing is is the case here that we have to record the sales because the readers of the financial statements do want to know that we earned the revenue by completing the work and therefore earned the revenue However, we also need to tell our reader that hey, some of those sales possibly will not be collected on and therefore do a similar type of fashion on the income statement side, not only increase in the sales, but also decreasing it with the amount of those sales that we believe are going to be uncollectible something We typically called bad debt expense. So this would be dealing with the matching principle so that the net income effect here, we think should be something netted out between these two in order to be as fair as possible. Under the allowance method, this number here and this number here are just going to have to be estimates, which is another area of problem in and of itself.
Because estimates are estimates there’s a range and there’s there’s guesswork that we have to do there. But you can see why we would need to do these things because we need to record the receivable, we need to record the sale. Because those are important to the readers of the financial statement, we cannot eliminate it We can’t go to a cash basis and not record sales on account or accounts receivable. However, it would also be useful for us to try to look at past experience and give the actual number that we think is receivable on the on the balance sheet, and then we think was actually earned on the income statement and that will take a bit of guesswork. The other type of receivable we have is notes receivable. So a note receivable is going to be different from an accounts receivable in debt, it’s typically a bit longer term and timeframe usually has a larger dollar amount and therefore is often put in writing and often has interest then attribute a bit tributed to it.
So an accounts receivable may not have the formal note documentation to record the transaction and the note, whereas the note receivable, we’re typically going to have the formal notes transaction because of the longer time period, the bigger dollar amount and probably having the interest being charged on that. When we’re considering notes receivable, we’re gonna consider notes receivable of time periods that are typically shorter than a year when we’re talking about our receivables here, they could happen for a couple different reasons. We might make a sale and we might have to period a longer period and or more money and therefore want a more formal documentation and or charge interest and therefore make a note receivable rather than running it through accounts receivable. When we have a notes receivable, we’re not going to put it into accounts receivable and track it in the subsidiary ledger to accounts receivable, we are typically going to have possibly our own account on the trial balance for each note that we make for each individual customer. Or we’ll have a notes receivable account on the trial balance and then we’ll have the supporting documentation tracking the note receivable as well as the interest that will be generated from it. So note receivable document will have something like this we’ll have the amount of the note receivable on on the note receivable, the date of the note receivable, the date it was generated, so if we will have the due date, so the due date might be formatted such as 90 days after the date of the note, I promise to pay to the order of and then we have the payee.
So that’s going to give the terms of the Note which is going to be 90 days in effect of the due date of the note, and then it’s going to be paid to the order of the payee, then we’re going to have 1000. No sense dollars for value received with interest at the annual rate of 10%. So in other words, we’re typically going to have the principal amount that will be due in some time period, 90 days, in this case from the date of the note to the payee. And then we’re going to have the interest rate in this case being 10%. Then we’re going to have the maker of the notes signature here. So when we think of the note, remember that the maker is going to be the one that you can think of as creating this note, if we had a business transaction, say we that company sold something to a customer, then the customer would be the signer as the maker of the note.
Now of course, we would probably be the one as the business generating the note for the customer to Then sign in that circumstance. But note that this is in essence, a promise to pay. So you can think of this actually being written out by an individual making a promise. And that would be the person purchasing something would be writing out the note saying, You’re giving me something of value on purchasing something from your store, I’m going to write you a note here, saying that I’m going to pay you 90 days from this time period pay you the payee, the amount of 1000 plus 10% interest and then signing the note, as the customer then gives the note to the company or the store that is providing the goods or service. So if we go through the terminology of this one more time, we can see that the amount here is going to be the principal. So when we consider the amount of a note, we typically consider it two components of it. When we get paid at the end of the time period, we’re going to receive the original principle and that’s what we do. gave the customer in value. So if the customer purchased something for $1,000, the sticker price of what they purchased was 1000.
And they didn’t give us money, they gave us a note this note receivable. And therefore the principle of this notes receivable is the thousand, we’re going to get more than that, because we loaned them that money, we in essence rented them the money and therefore are going to also generate interest. So the final payment we will receive can be thought of as having two components of it. One, a principal component, and two an interest component. And then we’re going to have the due date. Now this is the date of the note up here. The due date is actually this item, which is the promise to pay within 90 days. And that does provide a bit of a complexity because when notes are worded this way, we do need to figure out when exactly that is when it’s 90 days up, and make sure that we get the correct due date on the note and then we’ve Got, of course, the payee, the payee is the person who’s going to get paid. And in our case, we’re going to say that that’s going to be the company where the company, making the sale, receiving the note from the customer.
Again, obviously, if you go in somewhere and you are, you purchase something on account that you’re going to get financed it and you go through the financing process, the company will typically help out with a financing process and be the one that generates the note but you can think about this note clearly being a promise from the purchaser, the purchaser, the customer, to the store the seller, in order to purchase something a promise to pay. And so that means that the payee is going to be the person paid the store providing the good or the service who is going to be paid the principal plus interest at the end of the note term. So this will of course, will be the interest amount, the interest amount being the 10%. Note what we have to do here with the note receivable, it’s saying what the principle is it’s saying with the interest rate is, but it doesn’t say specifically one, what the actual due date is it just says it’s 90 days, we’ll have to figure that out.
And that’s the case with many notes the way the note will be formatted and written. And that’s one for one reason, it makes it easier to form, formalize a note or make it a standard notes copy. If our standard note is 90 days, then it’s easy for us to just say 90 days from whatever date the signature happens, and therefore we can have just a template of the note for that type of sale and make it pretty easy to do. And the interest rate will be the same type of concept if we say that whatever the interest rate is typically 10%, then you know, whatever the dollar amount, we can basically have the interest rate there. What we’re not generating here is an is an amortization type table or a table to show us the calculation of interest that will be due at the term or the end of the note. And also note that we could have many different types of notes set up, this is going to be a very Simple type of note where we’re going to pay simple interest and the principal at the end of the term period at the end of the 90 days, we could make a note as complex as we want, we can make a note that pays monthly type of note we can have the compounding of interest be different. So note that the complexity of a type of note can differ greatly. But at the minimum, we’re going to need these components typically in a standard note, in order to create a standard note.
And oftentimes, when you look at the note, it doesn’t give the total amount that will be due at the end of the note term, it only gives you the interest rate, it gives you the principal, and it gives the timeframe for the note. And therefore we’re probably going to want to go through the process of figuring out what is actually going to be due at the end of the note which of course will be the principal amount, plus some type of interest. Now then, of course the maker of the note once again is going to be the person who is promising to pay So this is the person who is signing the note and therefore promising to pay for services rendered or goods rendered. So if we purchase goods and we’re the customer, we purchase goods, we got something of value of $1,000 in terms of goods and services or making this promise to pay back that amount, some point in the future.