Financial Accounting: An Integrated Statements Approach, 2nd Edition

Chapter 8 Receivables 365

NOTES RECEIVABLE

A claim supported by a note has some advantages over a claim in the form of an ac-

count receivable. By signing a note, the debtor recognizes the debt and agrees to pay

it according to the terms listed. A note is thus a stronger legal claim.

Characteristics of Notes Receivable

A note receivable, or promissory note, is a written promise to pay a sum of money (face

amount) on demand or at a definite time. It can be payable either to an individual or

a business, or to the bearer or holder of the note. It is signed by the person or firm that

makes the promise. The one to whose order the note is payable is called the payee, and

the one making the promise is called the maker.

The date a note is to be paid is called the due dateormaturity date. The period of

time between the issuance date and the due date of a short-term note may be stated in

Receivables Fraud

Financial reporting frauds are often tied to accounts receiv-
able, because receivables allow companies to record revenue
before cash is received. Take, for example, the case of
entrepreneur Michael Weinstein, who acquired Coated
Sales, Inc.with the dream of growing the small specialty
company into a major corporation. To acquire funding that
would facilitate this growth, Weinstein had to artificially
boost the company’s sales. He accomplished this by adding
millions in false accounts receivable to existing customer
accounts.

The company’s auditors began to sense a problem when

they called one of the Company’s customers to confirm a large

order. When the customer denied placing the order, the audi-

tors began to investigate the company’s receivables more

closely. Their analysis revealed a fraud which overstated prof-

its by $55 million and forced the company into bankruptcy,

costing investors and creditors over $160 million.

Source:Joseph T. Wells, “Follow Fraud to the Likely Perpetrator,” The

Journal of Accountancy, March 2001.

INTEGRITY, OBJECTIVITY, AND ETHICS IN BUSINESS

Comparing the Direct Write-Off and Allowance Methods

Direct Write-Off Method Allowance Method

Amount of bad When the actual accounts Using estimate based on either (1) a

debt expense receivable determined percent of sales or (2) analysis of

recorded to be uncollectible receivables

Allowance No allowance account The allowance account is used

account is used

Primary users Small companies and companies Large companies and those with a

with relatively few receivables large amount of receivables

Describe the nature, char-
acteristics, and accounting
for notes receivable.

6

In contrast, the allowance method records an adjusting entry for estimated uncol-

lectible accounts of $42,500.

The primary differences between these two methods are summarized in the table

below.