Question

The principal reason for converting a customer's account receivable to a note receivable is?

1) the note receivable earns interest and the account receivable does not.
2) the receivable is less likely to have to be written off as uncollectible.
3) working capital is immediately increased.
4) the customer is more likely to continue purchasing the company's products.

Answer 1

The primary reason for converting an account receivable to a note receivable is to earn interest on the amount owed, in contrast to a non-interest-bearing account receivable.

Step-by-step explanation:

The principal reason for converting a customer's account receivable to a note receivable is that the note receivable earns interest and the account receivable does not. A note receivable is a formal promissory note that provides a source of interest income and generally has more structured payment terms, making it a stronger claim than an ordinary account receivable. By converting, a company benefits from the interest revenue, which can help improve the company's financial performance.

In addition to earning interest, notes receivable can often be seen as more credible than accounts receivable. This is particularly true if a company has a history of significant revenues or profits, which reinforces its ability to fulfill its interest-bearing obligations. While banks and bonds are the main methods of borrowing for firms, holding notes receivable is a way for a company to act as a lender, earning interest rather than paying it.