CDA COLLEGE ACC101: INTRODUCTION TO ACCOUNTING Lecture 9 Lecture 9 Lecturer: Kleanthis Zisimos

Chapter Review In Today’s Lecture we Examine the characteristics of promissory notes and the nature of interest Examine the characteristics of promissory notes and the nature of interest

Notes Receivables A promissory note is a written promise to pay a specific amount of money either on demand or at a definite future rate. A promissory note is a written promise to pay a specific amount of money either on demand or at a definite future rate. Promissory notes are used in many transactions, including paying for products and services, and lending and borrowing money Promissory notes are used in many transactions, including paying for products and services, and lending and borrowing money Sellers sometimes ask for a note to replace an account receivable when a customer requests additional time to pay a past – due amount. Sellers sometimes ask for a note to replace an account receivable when a customer requests additional time to pay a past – due amount. For legal reasons, sellers generally prefer to receive notes when the credit period is long and when the receivable is for a large amount. For legal reasons, sellers generally prefer to receive notes when the credit period is long and when the receivable is for a large amount.

Notes Receivables (continued) Maturity Date and Period. The maturity date of a note is the day the note must be paid. The period of a note is the time from the note’s (contract) date to its maturity date. Maturity Date and Period. The maturity date of a note is the day the note must be paid. The period of a note is the time from the note’s (contract) date to its maturity date. Many notes mature in less than a full year, and the period they cover is often expressed in days. When the time of a note is expressed in days, its maturity date is the specified number of days after the note’s date. Many notes mature in less than a full year, and the period they cover is often expressed in days. When the time of a note is expressed in days, its maturity date is the specified number of days after the note’s date.

Notes Receivables (continued) Interest Computation. Interest is the cost of borrowing money for the borrower or, alternatively, the profit from lending money for the lender. Unless otherwise stated, the rate of interest of a note is the rate charged for the use of the principal for one year. Interest Computation. Interest is the cost of borrowing money for the borrower or, alternatively, the profit from lending money for the lender. Unless otherwise stated, the rate of interest of a note is the rate charged for the use of the principal for one year. Formula: interest=Principal of the note x Annual interest rate x time expressed in years Interest Rate in years Formula: interest=Principal of the note x Annual interest rate x time expressed in years Interest Rate in years Example. Find the interest rate of a 90 days note 1000 euro, 12% Interest= 1000x12%x90/360= 30 euro

Notes Receivables (continued) Accounting treatment of a note receivable Note receivable Dr Sales Cr Sales Cr Recording a note paid in maturity (honored note) Cash Dr Notes receivable Cr Notes receivable Cr interest revenue Cr interest revenue Cr Recording a note not paid in maturity (dishonored n.) Accounts receivables Dr interest revenue Cr interest revenue Cr notes receivables Cr notes receivables Cr

Notes Receivables (continued) Converting receivables to cash before maturity Converting receivables to cash before maturity Sometimes companies convert receivables to cash before they are due. Reasons for this include the need for cash and the desire not to be involved in collecting activities. Converting receivables is usually done either by 1) Selling them 2) Using them as a security for a loan

Notes Receivables (continued) Selling Receivables. A company can sell all or a portion of its receivables to a finance company or bank. The buyer, called a factor, charges the seller a factoring fee and the buyer takes ownership of the receivables and receives cash when they come due. By incurring a factoring fee, the seller receives cash earlier and can pass the risk of bad debts to the factor. Selling Receivables. A company can sell all or a portion of its receivables to a finance company or bank. The buyer, called a factor, charges the seller a factoring fee and the buyer takes ownership of the receivables and receives cash when they come due. By incurring a factoring fee, the seller receives cash earlier and can pass the risk of bad debts to the factor. Example. TechCom sells euro of its accounts receivables and is charged a 4% factoring fee Example. TechCom sells euro of its accounts receivables and is charged a 4% factoring fee Cash Factoring fee 800 Accounts receivables Accounts receivables 20000

Notes Receivables (continued) Pledging Receivables. A Company can raise cash by borrowing money and pledging its receivables as security for the loan. Pledging receivables does not transfer the risk of bad debts to the lender because the borrower retains ownership of the receivables. If the borrower defaults on the loan, the lender has a right to be paid from the cash receipts of the receivable when collected. Example. TechCom borrows euro and pledges its receivables as security. Cash Loan Loan 35000

Notes Receivables (continued) Discounting notes receivables. Notes can be converted to cash before their maturity if they are discounted in a financial institute Example. TechCom discounts a 3000, 90day, 10% note receivable at the Bank of Cyprus. TechCom has held the note for 50 days. The bank applies a 12% rate in discounting the note Cash 3034 interest received 34 interest received 34 notes receivable 3000 notes receivable 3000

Notes Receivables (continued) More exercises to be solved in the class from the book “Fundamental accounting principles” page