Honor of Note Receivable
Overview
Note receivable is honored when the payer makes the full payment including both principal and interest at the maturity date. Likewise, the company needs to make the journal entry for the honor of note receivable in order to remove the note receivable and its related interest receivable (if any) from the balance sheet.
Honor of note receivable journal entry
No accrued interest receivable
When the company receives the full payment including principal and interest at the end of the note maturity, it can make the journal entry for the honor of note receivable by debiting the cash account and crediting the notes receivable account and interest revenue account.
| Account | Debit | Credit |
|---|---|---|
| Cash | $$$ | |
| Notes receivable | $$$ | |
| Interest revenue | $$$ |
This journal entry is usually made when the note maturity does not cross more than one account period or the accrued interest receivable is too insignificant to record at the period adjusting entry.
With accrued interest receivable
Otherwise, under the accrual basis of accounting, the company needs to record the interest revenue that is earned regardless of the time of payment received. Likewise, when the maturity of note passes the current accounting period, the company needs to account for the accrued interest at the period end adjusting entry as below:
| Account | Debit | Credit |
|---|---|---|
| Interest receivable | $$$ | |
| Interest revenue | $$$ |
In this case, when the note is honored, the journal entry will also include the credit of the interest receivable that the company has recorded as a debit in the prior period adjusting entry.
| Account | Debit | Credit |
|---|---|---|
| Cash | $$$ | |
| Notes receivable | $$$ | |
| Interest receivable | $$$ | |
| Interest revenue | $$$ |
Honor of note receivable example
For example, the company ABC receives a $5,000 promissory note from one of its customers for the goods it sold. The note has a 6 months maturity with the interest at the annual rate of 8 percent.
In this case, the company ABC can present the promissory note to the customer or the customer’s agent (e.g. bank) to collect the amount due at the end of 6 months maturity.
The amount due at the end of 6 months including the principal of $5,000 and the interest of $200 (5,000 x 8% x 6/12 ). Hence, the amount due at the end of the note maturity is $5,200 (5,000 + 200).
Likewise, the company can make the journal entry for the honor of note receivable after it receives the $5,200 payment at the end of 6 months as below:
| Account | Debit | Credit |
|---|---|---|
| Cash | 5,200 | |
| Notes receivable | 5,000 | |
| Interest revenue | 200 |
Example 2:
Assuming that the current accounting period of company ABC ends at the 5th month of the note maturity.
In this case, the company ABC needs to account for accrued interest of $167 (5,000 x 8% x 5/12) at the period end adjusting as below:
| Account | Debit | Credit |
|---|---|---|
| Interest receivable | 167 | |
| Interest revenue | 167 |
Then, when the company receives the full payment at the end of the note maturity, it can make the honor of note receivable journal entry as below:
| Account | Debit | Credit |
|---|---|---|
| Cash | 5,200 | |
| Notes receivable | 5,000 | |
| Interest receivable | 167 | |
| Interest revenue | 33 |
The $33 of interest revenue is the one-month portion of the interest that the company earns in this period while the other 5 months of interest have already been earned in the prior period.
