Discounting Notes Receivable Just as accounts receivable can be factored, notes can be converted into cash by sellin sel ling g the them m to a fin financ ancial ial institut institution ion at a dis discou count. nt. Not Notes es are usu usuall ally y sol sold d (discounted) with recourse, which means the company discounting the note agrees to pay the financial financial institution institution if the maker dishonors the note. hen note notess receivable are sold with recourse, the company has a contingent liability that must be disclosed ni the notes accompanying the financial statements. A contingent liability is an obligation to pay an amount in the future, if and when an uncertain event occurs. !he discount rate is the annual percentage rate that the financial institution charges for buying a note and collecting the debt. !he discount period is the length of time between a note"s sale and its due date. !he discount , which is the fee that the financial institution charges, is found by multiplying the note"s maturity value by the discount rate and the discount period.
#uppose a company accepts a $% ‐day, $&, ',%%% note, which has a maturity value (principal interest) of ',**%.$+. n this e-ample, precise calculations are made by using a +‐day year and by rounding results to the nearest penny.
f the company immediately discounts with recourse the note to a bank that offers a *& discount rate, the bank"s discount is '*/$.%0
!he bank subtracts the discount from the note"s matur maturity ity value and pays the company '0,$1*.$1 for the note.
2aturity 3alue
',**%.$+
Discount
(*/$.%0)
Discounted 3alue of Note
'0,$1*.$1
!he company determines the interest e-pense associated with this transaction by subtracting the discounted value of the note from the note"s face value plus any interest inte rest revenue the company has earn earned ed from the note. #ince the company discounts the note before earning any interest revenue, interest e-pense is '4/.%/ ('%%%.%% ‐ '0,$1*.$1). !he company records this transaction by debiting cash for '0,$1*.$1, debiting interest e-pense for '4/.%/, and crediting notes receivable for ',%%%.%%.
#uppose the company holds the note for +% days before discounting it. 5fter +% days, the company has earned interest revenue of '4.$4.
#ince the note"s due date is % days away, the bank"s discount is '+.%*. !he bank subtracts the discount from the note"s maturity value and pays the company ',%04.$ for the note.
2aturity 3alue
',**%.$+
Discount
(+.%*)
Discounted 3alue of Note
',%04.$
Discounted 3alue of Note
(,%04.$)
nterest 8-pense
' 1+.%1
!he company records this transaction by debiting cash for ',%04.$, debiting interest e-pense for '1+.%1, crediting notes receivable for ',%%%.%%, and crediting interest revenue for '4.$4.
Derecognition !he company subtracts the discounted value of the note from the note"s face value plus the interest revenue the company has earned from the note to determine the interest e-pense, if any, associated with discounting the note. n this e-ample, the interest e-pense e6uals '1+.%1.
Note"s 7ace 3alue nterest Revenue 8arned
',%4.$4
Definition9 Derecognition is the removal of a previously recogni:ed financial asset or liability from an entity"s balance sheet. 5 financial asset should be derecogni:ed if either the entity"s contractual rights to the asset"s cash flows have e-pired or the asset has been transferred to a third party (along with the risks and rewards of ownership). f the risks and rewards of ownership have not passed to the buyer, then the selling entity must still recogni:e the entire financial asset and treat any consideration received as a liability.
;art of the year
