Accounting for documents receivable

Companies regularly extend credit to their clients by promising to pay the bill at a future date. This credit is made in two main ways: accounts receivable and documents receivable.

The receivables represent promises of payment from customers on a certain date, which occurs shortly after the purchase have been made, while receivables represent clients who owe money and have agreed to pay the long term.

The receivables are created when customers sign documents known as promissory notes and agree to pay the face value of the document, together with interest, at a certain date.

Record of documents receivable

When a company accepts a promise to pay note from a customer, it must record it in its books of account as documents receivable. Each promise to pay includes the face value of the document, or the amount due, the date of payment, and the interest rate.

The documents receivable account represents an asset and maintains a normal debit balance. When the company records a customer’s receivable, it debits that account and credits sales.

Record of payments of documents receivable

When a customer pays for the document, they also pay the accrued interest. The company calculates the interest generated by multiplying the face value of the promise to pay by the interest rate and by the elapsed time. The company calculates the time by dividing the number of days that a note has been pending collection by the number of days in the year, or 365.

The company records the payment received by debiting the cash account for the total amount, crediting to receivables the amount of the nominal value of the note, and crediting to interest income for the amount resulting from the calculation.

Record of discounts on documents receivable

On some occasions a company may need the cash before the customer pays for the document. In this case, the company can discount the note with a financial institution. The latter will pay the company in cash in exchange for the right to collect the document. Financial institutions charge a small discounted fee for this service.

In this sense, the company determines the value of the discount by multiplying the value at maturity, the nominal value plus interest, by the discount rate, by the time remaining before the maturity of the note. The company calculates the period of time by dividing the total number of missing numbers at the expiration of the document, by the number of days in the year.

The company records the discount of the note by charging to cash the value of the money received, crediting the receivables for the total value of the note, and crediting the difference to interest income.

Report of documents receivable

The time period for receivables varies from a few months to years. If a receivable is due in less than a year, it represents a current asset. If the account is to be collected after one year, it will represent a fixed asset.

All documents receivable are assets of a company, and are always reported on the balance sheet. Short-term receivables appear in the current assets section of the balance sheet, while long-term accounts appear in fixed assets.