Overview of Receivables

What Is a Receivable?

A receivable is money owed to a business by its clients and shown on its balance sheet as an asset.

Learning Objectives

Identify a receivable

Key Takeaways

Key Points

  • Accounts receivable is typically executed by generating an invoice and either mailing or electronically delivering it to the customer.
  • A receivable represents money owed to the firm on the sale of products or services on credit.
  • Receivables must be paid within an established time frame, called credit terms or payment terms.

Key Terms

  • receivable: Represents money owed to a business for the sale of products or services on credit.
  • asset: Items of ownership convertible into cash; total resources of a person or business, as cash, notes and accounts receivable; securities and accounts receivable, securities, inventories, goodwill, fixtures, machinery, or real estate (as opposed to liabilities).
  • revenue: Income that a company receives from its normal business activities, usually from the sale of goods and services to customers.

What is a Receivable?

A receivable is money owed to a business by its clients and shown on its balance sheet as an asset. It is one of a series of accounting transactions dealing with the billing of a customer for goods and services that the customer has ordered. Accounts receivable is an asset which is the result of accrual accounting. In this case, the firm has delivered products or rendered services (hence, revenue has been recognized), but no cash has been received, as the firm is allowing the customer to pay at a later point in time.

Sales on Credit

Receivables represent 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. This is called credit terms or payment terms.

Use of Ledger

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 ).

Accounts Receivable Department

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.

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Money: Factoring makes it possible for a business to readily convert a substantial portion of its accounts receivable into cash.

Types of Receivables

Receivables can generally be classified as accounts receivables or notes receivable, though there are other types of receivables as well.

Learning Objectives

Differentiate between accounts receivable, notes receivable and other receivables

Key Takeaways

Key Points

  • Accounts receivable are amounts that customers owe the company for normal credit purchases.
  • Notes receivable are amounts owed to the company by customers or others who have signed formal promissory notes in acknowledgment of their debts.
  • Accounts receivable and notes receivable that result from company sales are called trade receivables, but there are other types of receivables as well.

Key Terms

  • accounts receivable: Amounts that customers owe the company for normal credit purchases.
  • Notes Receivable: Amounts owed to the company by customers or others who have signed formal promissory notes in acknowledgment of their debts.

Receivables can be classified as accounts receivables, notes receivable and other receivables ( loans, settlement amounts due for non- current asset sales, rent receivable, term deposits). Other receivables can be divided according to whether they are expected to be received within the current accounting period or 12 months (current receivables), or received greater than 12 months ( non-current receivables).

Accounts Receivable

Accounts receivable are amounts that customers owe the company for normal credit purchases. Since accounts receivable are generally collected within two months of the sale, they are considered a current asset. Accounts receivable usually appear on balance sheets below short-term investments and above inventory.

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Types of Receivables: Classifying receivables…

Notes Receivable

Notes receivable are amounts owed to the company by customers or others who have signed formal promissory notes in acknowledgment of their debts. Promissory notes strengthen a company’s legal claim against those who fail to pay as promised. The maturity date of a note determines whether it is placed with current assets or long-term assets on the balance sheet. Notes that are due in one year or less are considered current assets, while notes that are due in more than one year are considered long-term assets.

Other Receivables

Accounts receivable and notes receivable that result from company sales are called trade receivables, but there are other types of receivables as well. For example, interest revenue from notes or other interest-bearing assets is accrued at the end of each accounting period and placed in an account named interest receivable. Wage advances, formal loans to employees, or loans to other companies create other types of receivables. If significant, these nontrade receivables are usually listed in separate categories on the balance sheet because each type of nontrade receivable has distinct risk factors and liquidity characteristics.

Recognizing Accounts Receivable

If you are operating under the accrual basis, you record account receivable transactions irrespective of any changes in cash.

Learning Objectives

Describe the journal entry to record an accounts receivable transaction

Key Takeaways

Key Points

  • Since not all customer debts will be collected, businesses typically estimate the amount of debts to be paid and then record an allowance for doubtful accounts.
  • 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.
  • Account receivables are classified as current assets assuming that they are due within one year.

Key Terms

  • Allowance for Doubtful Accounts: An estimated amount of bad debts to be subtracted from a balance sheet’s accounts.
  • Payment Terms: Forms of trade credit which specify that the net amount (the total outstanding on the invoice) is expected to be payment received in full 10, 15, 30, or 60 days after the goods are dispatched by the seller, or 10, 15, 30 or 60 days after the service is completed. Net 30 or Net 60 terms are often coupled with a credit for early payment.
  • payment date: the day when the dividend checks will actually be mailed to the shareholders of a company or credited to brokerage accounts

Recognition of Accounts Receivables

If you are operating under the accrual basis, you record transactions irrespective of any changes in cash. This is the system under which you record an account receivable. In addition, there is a risk that the customer will not pay you. If so, you can either charge these losses to expense when they occur, known as the direct write-off method, or you can anticipate the amount of such losses and charge an estimated amount to expense, known as the allowance method.

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Using the Balance Sheet: The balance sheet is one of the financial reports included in a company’s annual report.

Booking a receivable is accomplished by a simple accounting transaction. However, the process of maintaining and collecting payments on the accounts receivable is more complex. Depending on the industry in practice, accounts receivable payments can be received up to 10 – 15 days after the due date has been reached. These types of payment practices are sometimes developed by industry standards, corporate policy, or because of the financial condition of the client.

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 always debit.

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.

Allowance for Doubtful Accounts

Since not all customer debts will be collected, businesses typically estimate the amount of and then record an allowance for doubtful accounts which appears on the balance sheet as a contra account that offsets total accounts receivable. Two methods are available to calculate the amount of bad debt expense and allowance of doubtful accounts at the end of an accounting period — percentage of accounts receivable or percentage of sales. When accounts receivables are not paid, some companies turn them over to third party collection agencies or collection attorneys who will attempt to recover the debt via negotiating payment plans, settlement offers or pursuing other legal action.

Examples of Allowance Calculation

An example of how to calculate the allowance for doubtful accounts using the percentage of receivables method — Assume Furniture Palace has an ending accounts receivable balance of USD 10,000 and estimates that 5% of receivables are doubtful. To adjust the allowance account for the new estimate, debit Bad Debt Expense for USD 500 (10,000 *0.05) and credit Allowance for Doubtful Accounts for USD 500.

To calculate the allowance for doubtful accounts using the percentage of total sales, estimate the percentage of sales that will be uncollectible. Furniture Palace estimates that 10% of the period’s USD 20,000 total sales may not be collected. To adjust the allowance account for the new period’s estimate, debit Bad Debt Expense for USD 2,000 (20,000 *0.10) and credit Allowance for Doubtful Accounts for USD 2,000.

Valuing Accounts Receivable

Receivables of all types are normally reported at their net realizable value, which is the amount the company expects to receive in cash.

Learning Objectives

Differentiate between the direct write-off method and the allowance method of accounts receivable valuation

Key Takeaways

Key Points

  • Uncollectible accounts are called bad debts.
  • Companies use two methods to account for bad debts: the direct write-off method and the allowance method.
  • Business owners know that some customers who receive credit will never pay their account balances.
  • GAAP requires companies to use the Allowance Method.

Key Terms

  • Allowance Method: An adjustment is made at the end of each accounting period to estimate bad debts based on the business activity from that accounting period.
  • Direct Write-Off: Bad debts are recognized only after the company is certain the debt will not be paid.
  • direct write-off method: a way of reducing accounts receivable to its net realizable value through a single entry
  • direct method: a way to construct the cash flow statement by reporting major classes of gross cash receipts and payments

Valuation

Receivables of all types are normally reported on the balance sheet at their net realizable value, which is the amount the company expects to receive in cash.

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Valuing Receivables: Receivables are recorded at net realizable value.

Business owners know that some customers who receive credit will never pay their account balances. These uncollectible accounts are called bad debts. Companies use two methods to account for bad debts: the direct write-off method and the allowance method.

Direct Write-Off Method

For tax purposes, companies must use the direct write-off method, under which bad debts are recognized only after the company is certain the debt will not be paid. Before determining that an account balance is not collectible, a company generally makes several attempts to collect the debt from the customer.

Recognizing the bad debt requires a journal entry that increases a bad debts expense account and decreases accounts receivable. If a customer named J. Smith fails to pay a $100 balance, for example, the company records the write-off by debiting bad debts expense and crediting accounts receivable from J. Smith.

Allowance Method

Under the allowance method, an adjustment is made at the end of each accounting period to estimate bad debts based on the business activity from that accounting period. Established companies rely on past experience to estimate unrealized bad debts, but new companies must rely on published industry averages until they have sufficient experience to make their own estimates.

The adjusting entry to estimate the expected value of bad debts does not reduce accounts receivable directly. Accounts receivable is a control account that must have the same balance as the combined balance of every individual account in the accounts receivable subsidiary ledger.

Since the specific customer accounts that will become uncollectible are not yet known when the adjusting entry is made, a contra-asset account named allowance for bad debts, which is sometimes called allowance for doubtful accounts, is subtracted from accounts receivable to show the net realizable value of accounts receivable on the balance sheet.