Discounts on Notes Receivable
The financial accounting term discounts on notes receivable is used to describe a contra asset account that holds unearned interest that was included in notes receivable.
A promissory note is an unconditional promise to repay a pre-defined sum of money at a future point in time or on demand. The maker of the note (borrower) is charged interest for the use of that money.
A note receivable is an asset and is recorded on the company’s books at face value; even if the note charges the borrower interest. When this note is repaid, the borrower will pay both the face value of the note (notes payable) as well as interest due (interest revenue).
A company may decide to sell their promissory notes to a financial institution or a bank. Depending on the prevailing interest rates and the rate charged the borrower, the company may receive more or less than the face value of the note. The contra asset account, discounts on notes receivable, is used to correct for the difference between the face value of the note receivable and the proceeds received from the sale of the note.