Receivable Financing: Discounting of Notes Receivable
“Maria’s Paper Promise”
Maria owns a small shoe factory in Marikina. She makes nice school shoes.
A big department store buys P1,000,000 worth of shoes from Maria. The store does not pay cash. Instead, it gives Maria a promissory note. This is a paper that says, “We promise to pay Maria P1,000,000 plus interest in 180 days.”
Maria is happy, but she has a problem. She needs cash today to buy leather for her next big order. She cannot wait 180 days!
Maria runs to the bank. She shows the note to the bank manager. The manager says, “We will give you cash now, but you must sign the back of this paper.”
Maria picks up her pen. She has two ways to sign:
- Safe Signing (Without Recourse). Maria writes the words “without recourse” above her name. The bank gives her cash. Two months later, the department store goes broke and cannot pay the bank. The bank comes back to Maria. Maria points to her signature and says, “I wrote ‘without recourse.’ That means the risk is yours, not mine!” Maria walks away free. She has no more duty to pay.
- Risky Signing (With Recourse). Maria just signs her name without adding any extra words. The bank gives her cash. Two months later, the store goes broke. The bank comes back to Maria and shouts, “Pay us P1,060,000!” Maria must pay because she signed with recourse. On her accounting books, she must now record a contingent liability. That is a fancy term for a “hidden risk” that might cost her money later.
Now comes the tricky part for accountants. When Maria signs with recourse, is this a true sale or just a loan? The textbook gives the final answer: Because Maria signed the paper and handed it over, she lost control of it. The bank can sell it to anyone. Therefore, it is a Conditional Sale with a contingent liability.
Remember Maria’s pen. Without recourse = safe walkaway. With recourse = hidden risk.
Now, lock in that story, and drill these tables for the boards!
III: CONCEPTUAL DISTINCTIONS
| PRINCIPLE/TOPIC | THEORETICAL RULE | PRACTICAL EXAMPLE |
|---|---|---|
| Discounting Definition | “When a note is negotiable, the payee may obtain cash before maturity date by discounting the note at a bank or other financing company.” | ABC Realty receives P500,000 note due in 6 months. They need cash now for a land acquisition, so they discount the note at BPI Bank. |
| Endorsement with Recourse | “Endorsement may be with recourse which means that the endorser shall pay the endorsee if the maker dishonors the note. In accounting parlance, this is the contingent liability of the endorser.” | A retail store endorses a customer’s note to the bank. If the customer defaults, the store must pay the bank. This is a contingent liability on the store’s books. |
| Endorsement without Recourse | “Endorsement may be without recourse which means that the endorser avoids future liability even if the maker refuses to pay the endorsee on the date of maturity.” | A manufacturing company sells a note to the bank with “without recourse” notation. If the customer fails to pay, the bank cannot demand payment from the manufacturer. |
| Default Assumption | “In the absence of any evidence to the contrary, endorsement is assumed to be with recourse.” | A distributor discounts a note and does not indicate “without recourse.” The bank can hold the distributor liable if the customer defaults. |
II: KEY TERMS AND COMPUTATIONS
| PRINCIPLE/TOPIC | THEORETICAL RULE | PRACTICAL EXAMPLE |
|---|---|---|
| Maturity Value | “Maturity value is the amount due on the note at the date of maturity. Principal plus interest equals the maturity value.” | P1,000,000 note × 12% × 180/360 = P60,000 interest. Maturity value = P1,060,000. |
| Discount | “Discount is equal to maturity value times discount rate times discount period.” | P1,060,000 × 15% × 120/360 = P53,000 discount. |
| Net Proceeds | “Net proceeds refer to the discounted value of the note received by the endorser from the endorsee. Net proceeds = Maturity value minus Discount.” | Net proceeds = P1,060,000 – P53,000 = P1,007,000 (cash received from bank). |
| Discount Period | “Discount period equals term of the note minus the expired portion up to the date of discounting.” | 180-day note discounted after 60 days: Discount period = 180 – 60 = 120 days. |
| Carrying Amount | “Principal + Accrued interest receivable” (interest earned from note date to discounting date). | P1,000,000 + (P1,000,000 × 12% × 60/360) = P1,020,000. |
| Gain/Loss | “The difference between the net proceeds from discounting and the carrying amount of the note receivable is recognized as gain or loss.” | Net proceeds (P1,007,000) – Carrying |
III: DISCOUNTING WITHOUT RECOURSE
| PRINCIPLE/TOPIC | THEORETICAL RULE | PRACTICAL EXAMPLE |
|---|---|---|
| Nature of Transaction | “If the discounting is without recourse, the sale of the note receivable is absolute and therefore there is no contingent liability.” | A Cebu-based furniture maker sells a customer’s note to the bank without recourse. The sale is final—no future liability. |
| Journal Entry | Cash (net proceeds) / Loss on discounting / Note receivable (credit) / Interest income (credit). | Cash P1,007,000; Loss P13,000; Note receivable P1,000,000 (credit); Interest income P20,000 (credit). |
| Key Distinction | “The note receivable account is credited directly because the sale of the note receivable is without recourse or absolute.” | The note is fully removed from books—no contingent liability recorded. |
IV: DISCOUNTING WITH RECOURSE – CONDITIONAL SALE
| PRINCIPLE/TOPIC | THEORETICAL RULE | PRACTICAL EXAMPLE |
|---|---|---|
| Nature of Transaction | “If the discounting is treated as a conditional sale of note receivable, a contingent liability is recognized.” | A Manila-based retailer discounts a P2,400,000 note with recourse. They record a contingent liability for potential default. |
| Journal Entry (Initial) | Cash / Loss on discounting / Note receivable discounted (credit) / Interest income (credit). | Cash P2,385,000; Loss P39,000; Note receivable discounted P2,400,000 (credit); Interest income P24,000 (credit). |
| Presentation | “The note receivable discounted account is deducted from the total notes receivable when preparing the statement of financial position with disclosure of the contingent liability.” | In the balance sheet, Notes Receivable P2,400,000 minus Note Receivable Discounted P2,400,000 = P0 net, with contingent liability disclosure. |
| If Maker Pays | “The note is paid by the maker to the First Bank. The contingent liability is simply extinguished.” | Entry: Note receivable discounted P2,400,000 / Note receivable P2,400,000. |
| If Maker Defaults | “The note is dishonored by the maker, and the entity paid the bank the maturity value plus protest fee. The total payment is charged to accounts receivable.” | Entry: Accounts receivable P2,550,000 / Cash P2,550,000; Note receivable discounted P2,400,000 / Note receivable P2,400,000. |
V: DISCOUNTING WITH RECOURSE – SECURED BORROWING
| PRINCIPLE/TOPIC | THEORETICAL RULE | PRACTICAL EXAMPLE |
|---|---|---|
| Nature of Transaction | “If the discounting is treated as a secured borrowing, the note receivable is not derecognized but instead an accounting liability is recorded at an amount equal to the face amount of the note receivable discounted.” | A manufacturing firm treats discounted note as a loan, keeping the note on the books. |
| Journal Entry (Initial) | Cash / Interest expense / Liability for note receivable discounted (credit) / Interest income (credit). | Cash P2,385,000; Interest expense P39,000; Liability P2,400,000 (credit); Interest income P24,000 (credit). |
| Key Distinction | “There is no gain or loss on discounting if the note receivable discounting is accounted for as secured borrowing.” | No P39,000 loss is recognized—instead, P39,000 interest expense is recorded. |
| If Maker Pays | “If the note is paid by the maker to the bank, the liability for note receivable discounted and note receivable are derecognized.” | Entry: Liability P2,400,000 / Note receivable P2,400,000. |
| If Maker Defaults | “The note is dishonored by the maker, and the entity paid the bank the maturity value plus protest fee. The total payment is charged to accounts receivable.” | Entry: Accounts receivable P2,550,000 / Cash P2,550,000; Liability P2,400,000 / Note receivable P2,400,000. |
VI: COMPARISON & RECOMMENDATION
| PRINCIPLE/TOPIC | THEORETICAL RULE | PRACTICAL EXAMPLE |
|---|---|---|
| Conditional Sale vs. Secured Borrowing | “It is believed that the discounting of note receivable with recourse is to be accounted for as a conditional sale with recognition of a contingent liability.” | For CPALE, prefer Conditional Sale approach with contingent liability recognition. |
| Justification | “Upon discounting or endorsement of the note receivable, whether with or without recourse, the transferor or endorser has lost control over the note receivable. Accordingly, the transferee has complete control over the note receivable.” | The bank can sell the note to another party without restrictions—transferor no longer controls the asset. |
EXAM TIPS
Commonly Confused Distinctions:
| CONFUSION POINT | CLARIFICATION |
|---|---|
| Interest Rate vs. Discount Rate | “The discount rate should not be confused with the interest rate. The discount rate and interest rate are different from each other.” |
| Without Recourse (Absolute Sale) | Credited directly to Note Receivable; No contingent liability; Recognize gain/loss. |
| With Recourse – Conditional Sale | Credited to Note Receivable Discounted; Recognize contingent liability; Recognize gain/loss. |
| With Recourse – Secured Borrowing | Credit Liability for Note Receivable Discounted; No gain/loss; Recognize interest expense. |
| Counting Days | “Exclude the first day but include the last day.” For months, “counting is by months regardless of the number of days in a month.” |
Journal Entry Quick Reference:
| SCENARIO | DEBIT | CREDIT |
|---|---|---|
| Without Recourse | Cash; Loss (if any) | Note Receivable; Interest Income |
| With Recourse (Conditional Sale) | Cash; Loss (if any) | Note Receivable Discounted; Interest Income |
| With Recourse (Secured Borrowing) | Cash; Interest Expense | Liability for NR Discounted; Interest Income |
A Quick Note
I try my best to make sure all the information and answers in my articles are correct and accurate. I double-check everything against the official references. But if you find any errors or anything that does not look right, please feel free to let me know. Your feedback helps me improve and helps everyone learn better. Thank you!
© 2026 The Rooted CPA. All rights reserved. No part of this content may be reproduced without permission.