Definition of Notes Payable and Notes Receivable
Notes payable and notes receivable are both associated with a written note that promises to repay the amount borrowed plus interest. A single promissory note is both of the following:
- It is a note payable for the borrower who reports the note on its balance sheet as a liability
- It is a note receivable for the lender who reports the note on its balance sheet as an asset
The interest promised in the note is reported as interest expense by the borrower, and as interest income by the lender.
If the note is due within one year of the balance sheet date, it is classified as current. If the note is due after one year of the balance sheet date, it is classified as noncurrent or long-term.
Example of Notes Payable and Notes Receivable
Assume that Local Retailer borrows $20,000 from its bank and signs a promissory note due in six months. Local Retailer records $20,000 as a credit to its current liability account Notes Payable (and debits its Cash account).
The bank records the $20,000 promissory note from Local Retailer in the bank’s current asset account Notes Receivable and it records the $20,000 as an increase in the customer’s checking account (which is part of the bank’s current liability account Customers’ Deposits).
Since the promissory note is a contract to pay interest, both parties must report the interest as follows:
- Local Retailer must report interest expense in each accounting period and report interest payable for any unpaid but incurred interest up to the end of the accounting period. Future interest is not recorded as a liability.
- The bank must report interest income (or revenue) in each accounting period in which it is earned, and report interest receivable for any interest that has been earned but not received as of the end of each accounting period