Notes Receivable: Statement of Financial Position/Balance Sheet

Notes Receivable: Statement of Financial Position/Balance Sheet

Updated: Sep 2, 2019


The Notes Receivable account is an asset account shown on the Statement of Financial Position (IFRS)/ Balance Sheet (ASPE). Notes Receivable are similar to Accounts Receivable in that money is owed to the company by its debtors. Accounts Receivable is typically money owed to the entity by customers/clients based on invoices that have been issued to them.


On the other hand, Notes Receivable are contracts that are usually signed by both the entity and its debtor. These contracts specify the terms of payment, payment dates and interest rates. Notes receivable can have both current portions (due within a year of the financial statements) as well as non-current portions (due after a year of the financial statements). If a client is having trouble paying its Accounts Receivable, the client might enter into a Notes Receivable and pay the balance over a longer period of time, often at higher interest rates.


Notes Receivable are also considered Financial Assets. We discuss how to measure different financial assets in greater detail in a later article.


But for now, we will focus on what makes Notes Receivable a Financial Asset and how they are measured.


The ASPE and IFRS criteria for Notes Receivable are more or less the same, with only some small differences (which we talk about below). So we will just review the IFRS definitions.


IAS 32 (IFRS) defines a Financial Asset as either:

  • Cash, OR

  • An equity instrument from a different entity, OR

  • A contractual right to receive cash, OR

  • A contractual right to receive another financial asset from a different entity, OR

  • A contract that might be settled using the entity’s own equity instruments. (There are some additional requirements within this clause that deal with derivatives. For more information see IAS 32.11)

Notes Receivable are a contractual right to receive cash - making them Financial Assets.

Recognition


IAS 39.14 states that an entity should only recognize Notes Receivable when the contractual provisions are met. In other words - we cannot add an amount to the Notes Receivable balance unless we have signed the contract and provisions of the contract are met.

Initial Measurement


Notes Receivable should initially be measured at the Fair Value. Fair Value is the present value of the future cash flows, discounted using the market interest rate.


Note that this is different from the Face Value of the note. Face Value of the note is what is agreed upon in the contract. The Face Value is the amount that will be paid by the debtor. The debtor will also have to pay interest.


Subsequent Measurement


Notes Receivable are later recorded at amortized cost. Amortized cost is the initial value of the Notes Receivable (which were initially recorded at Fair Value) less any principal repayments and then adjusted for amortization of the premium and any impairment.


Vocabulary: If a Notes Receivable is issued at a premium, this means that the note is issued by the entity at more than the what the debtor will pay us back in the future (the Face Value). In other words - we lend the debtor more money than they will pay us back in the future, usually in return for a higher interest rate payment throughout the term. If a Notes Receivable is issued at a discount, then the note is issued at a lower value than the Face Value, meaning that we lend the debtor less upfront, than they owe us at the end of the term. This is usually balanced by lower interest rate payments throughout the term.


Amortized Cost = Initial Value - Principal Repayments +/- Amortization of Discount/Premium - Impairments.


Differences between the two frameworks:


IFRS: Requires premiums or discounts to be amortized into income using the effective interest method.


ASPE: The premium or discount can be amortized into income using either effective interest method or straight-line method.


Feeling Confused?


We have an awesome example of how to do the calculations and journal entries, using each of the different methods, in our next article "Notes Receivable Calculations and Journal Entries".


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