Basics of Receivables Management



Activities to Manage Receivables

Accounts receivable represents money owed by entities to the firm on the sale of products or services on credit.

Learning Objectives

Summarize how a company manages its accounts receivable

Key Takeaways

Key Points

  • Collections and cashiering teams are part of the accounts receivable department. While the collection’s department seeks the debtor, the cashiering team applies the monies received.
  • An example of a common payment term is Net 30, which means that payment is due at the end of 30 days from the date of invoice.
  • The first method of bookkeeping is the allowance method. It establishes a contra- asset account, allowance for doubtful accounts, or bad debt provision, that has the effect of reducing the balance for accounts receivable.
  • The second method of bookkeeping is the direct write-off method. It is simpler than the allowance method in that it allows for one simple entry to reduce accounts receivable to its net realizable value (debiting a bad debt expense account and crediting the respective accounts receivable).

Key Terms

  • receivable: A debt owed, usually to a business, from the perspective of that business.
  • debtor: One who owes another anything, or is under obligation, arising from express agreement, implication of law, or principles of natural justice, to pay money or to fulfill some other obligation; in bankruptcy or similar proceedings, the person who is the subject of the proceeding.

Basics of Accounts Receivables

Accounts receivable (or debtors) represent money owed to a business by its clients (customers). It is shown on its balance sheet as an asset. It is one of a series of accounts dealing with the billing of a customer for goods and services that the customer has ordered.

Accounts receivable represents money owed by entities to the firm on the sale of products or services on credit. In most business entities, accounts receivable is typically executed by generating an invoice and either mailing or electronically delivering it to the customer, who, in turn, must pay it within an established time-frame, called credit terms or payment terms.

The accounts receivable departments use the sales ledger. This is because a sales ledger normally records:

  • The sales a business has made.
  • The amount of money received for goods or services.
  • The amount of money owed at the end of each month varies (debtors).

The accounts receivable team is in charge of receiving funds on behalf of a company and applying it towards their current pending balances.

Collections and cashiering teams are part of the accounts receivable department. While the collection’s department seeks the debtor, the cashiering team applies the monies received.

Payment Terms

An example of a common payment term is Net 30, which means that payment is due at the end of 30 days from the date of invoice. The debtor is free to pay before the due date. Businesses can offer a discount for early payment. Other common payment terms include Net 45, Net 60, and 30 days end of month.

Bookkeeping

Account receivables are classified as current assets assuming that they are due within one year. To record a journal entry for a sale on account, one must debit a receivable and credit a revenue account. When the customer pays off their accounts, one debits cash and credits the receivable in the journal entry. The ending balance on the trial balance sheet for accounts receivable is usually a debit.

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General Accounting Cycle: Figure shows the accounting cycle.

Two Methods

The first method is the allowance method, which establishes a contra-asset account, allowance for doubtful accounts, or bad debt provision, that has the effect of reducing the balance for accounts receivable. The amount of the bad debt provision can be computed in two ways, either (1) by reviewing each individual debt and deciding whether it is doubtful (a specific provision) or (2) by providing for a fixed percentage (e.g. 2%) of total debtors (a general provision). The change in the bad debt provision from year to year is posted to the bad debt expense account in the income statement.

The second method is the direct write-off method. It is simpler than the allowance method in that it allows for one simple entry to reduce accounts receivable to its net realizable value. The entry would consist of debiting a bad debt expense account and crediting the respective accounts receivable in the sales ledger.

Managing to Prevent Fraud

To help prevent fraudulent activities, management must implement internal controls/structure and know what situations to look for.

Learning Objectives

Explain how a company can prevent fraud by establishing internal controls

Key Takeaways

Key Points

  • Employees are more likely to commit fraud when under situational or financial pressure, and when the opportunity to commit fraud is present.
  • One of the main factors of an effective internal control system is segregation of duties. To segregate duties, a company can involve more than one person in the financial statement preparation process. For fraud to occur in this situation, two employees must collude to perpetrate the crime.
  • A strong control environment (top management control) involves enlisting management to demonstrate ethical behavior.
  • Outside parties performing annual examinations of financial statements can prevent management from committing fraud.

Key Terms

  • control: A security mechanism, policy, or procedure that can counter system attack, reduce risks, and resolve vulnerabilities, synonymous with safeguard and counter-measure.
  • fraud: Any act of deception carried out for the purpose of unfair, undeserved, and/or unlawful gain.
  • accounting: The development and use of a system for recording and analyzing the financial transactions and financial status of a business or other organization.

Failure to Prevent Fraud

Failure to implement adequate internal controls can result in financial statement fraud (purposely misstated financial statements) or embezzlement (theft). This is when the services of a forensic accountant may be necessary. Forensic accounting is the application of accounting methodology to legal issues. It is frequently associated with the investigation of civil or criminal white-collar crime such as fraud, embezzlement, and general abuse of funds issues. Typical tools used in forensic accounting are bank records, personal financial statements, interviews, and credit reports. The forensic accountant’s responsibility is to gather and analyze the evidence and deliver clear, accurate, and unbiased reports reflecting the results of the investigation.

Ways to Prevent Fraud

Educate Management

Financial statement fraud involves the intentional publishing of false information in any portion of a financial statement.

To help prevent fraudulent activities, management must implement internal controls/structure, and know what situations to look for. Employees are more likely to commit fraud when under situational or financial pressure, and when the opportunity to commit fraud is present.

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Occupy Wall Street – Fraud: Occupy Wall Street protester with a sign defining fraud.

Separate Accounting Functions

One of the main factors of an effective internal control system is segregation of duties. Management helps to prevent fraud by reducing the incentives of fraud.

One incentive, the opportunity to commit fraud, can be reduced when accounting functions are separated. The act of segregating duties separates the record-keeping, authorization, and review functions in the accounting process. To segregate duties, a company can involve more than one person in the financial statement preparation process. For fraud to occur in this situation, two employees must collude to perpetrate the crime.

Control Environment

A strong control environment (top management control) involves enlisting management to demonstrate ethical behavior. Whatever tone management sets will have a trickle-down effect to the employees. A strong tone is developed by establishing and complying with a written set of policies which are concise and include consequences when procedures are disobeyed. In addition, one of the easiest ways to establish a strong moral tone for an organization is to hire employees with strong ethics/morals.

External Controls

Outside parties performing annual examinations of financial statements can prevent management from committing fraud. To meet financial goals for the company managers may be tempted to “cook the books. ” To help prevent management from adjusting financial statements, an independent auditor should examine financial statements on an annual basis.