Definition and Importance of Notes Receivable

Notes Receivable are written and legal instruments containing an explicit commitment from the debtor (maker) to pay a specified amount of money to the creditor (payee) on a certain date or on demand. They are considered negotiable credit instruments that are transferable, containing essential elements such as amount, maturity date, party names, and signature. Classified accounting-wise as current assets and subject to commercial paper laws.

Importance:

• Legal documentation of debts
• Negotiable and transferable
• Can be discounted at banks for liquidity
• Usually bear interest
• Stronger guarantee than regular accounts receivable
• Facilitate short-term financing

Types of Notes Receivable

• Promissory Notes issued by customers containing written commitment to pay a specified amount on an agreed date, most common in commercial transactions

• Bills of Exchange drawn on customers ordering payment of a certain amount to the company on a predetermined maturity date

• Post-dated Checks issued by customers with future dates as payment guarantee, especially in credit sales

• Payment Orders Due from suppliers or other parties resulting from returns or various financial claims

Accounting Treatment and Debit/Credit Nature

Nature: Debit (current asset) - classified as current assets if maturity is within one year. Valued at face value with allowance for doubtful notes.

Notes receivable go through accounting stages starting with receipt where they're recorded from Notes Receivable account to Sales or Accounts Receivable account. Upon collection, entries are made from Cash account to Notes Receivable account. In case of bank discount, entries are made from Cash account and Discount Expense on Notes Receivable account to Notes Receivable account. They appear in the balance sheet under current assets.

Example: Promissory note 20,000 riyals:

• Receipt: Dr. Notes Receivable 20,000 Cr. Accounts Receivable 20,000
• Collection: Dr. Cash 20,000 Cr. Notes Receivable 20,000

Difference Between Notes Receivable and Accounts Receivable

Definition: Notes receivable are formal legal documents like promissory notes and bills of exchange proving customers' payment obligations on specific dates, while accounts receivable are debit amounts recorded in books from ordinary credit sales without formal documentation.

Legal Nature: Notes receivable are signed documents negotiable and endorsable with strong legal protection under Saudi commercial paper law, while accounts receivable are merely accounting entries based on invoices and commercial contracts.

Maturity Terms: Notes receivable have fixed and predetermined maturity dates that cannot be changed, while accounts receivable have flexible payment terms that can be extended by agreement.

Negotiability: Notes receivable can be discounted at banks or transferred to others, while accounts receivable are not directly negotiable or transferable.

Risks and Guarantees: Notes receivable provide stronger legal guarantee with simplified collection procedures, while accounts receivable carry higher collection risks with longer legal procedures.

Practical Use: Notes receivable are used in large and important transactions requiring additional guarantees, while accounts receivable are for ordinary daily sales and customer relationship management.

Discount Allowance and Special Treatments for Notes Receivable

Discount Allowance is an estimated amount the company reserves to meet potential discounts it may grant to customers or pre-agreed commercial discounts. Calculated as a percentage of total notes receivable value according to company policy and historical experience. Recorded by debiting Discount Allowance Expense account and crediting Notes Receivable Discount Allowance account.

Special Treatments:

• Dishonored Notes: Dr. Accounts Receivable Dr. Return Fees Cr. Cash
• Doubtful Notes: Dr. Bad Debt Expense Cr. Allowance for Doubtful Notes Receivable
• In Balance Sheet: Notes Receivable - Discount Allowance = Net Notes Receivable