In this lesson you will be able to account for receivables and short term investments and you will be able to:
- Distinguish between trade and non-trade receivables.
- Distinguish between the direct write off and allowance methods.
- Prepare entries for uncollectible accounts using the direct write off and allowance methods.
- Differentiate between the income statement and balance sheet approaches to estimating bad debts.
- Prepare entries used by a retailer to account for credit card sales.
- Accounts for notes receivable with interest and non-interest bearing notes.
The following video gives a definition and examples of receivables.
In previous units, you learned that most companies use the accrual basis of accounting since it better reflects the actual results of the operations of a business. Under the accrual basis, a merchandising company that extends credit records revenue when it makes a sale because at this time it has earned and realized the revenue. The company has earned the revenue because it has completed the seller’s part of the sales contract by delivering the goods. The company has realized the revenue because it has received the customer’s promise to pay in exchange for the goods. This promise to pay by the customer is an account receivable to the seller. Accounts receivable are amounts that customers owe a company for goods sold and services rendered on account.
The term trade receivables refers to any receivable generated by selling a product or providing a service to a customer. Trade receivables can be accounts or notes receivable.
A non-trade receivable would be when someone owes the company money not related to providing a service or selling a product. For example, the company loans an employee money for a travel advance or a company borrows money from another company.
When a company sells goods on account, customers do not sign formal, written promises to pay, but they agree to abide by the company’s customary credit terms. However, customers may sign a sales invoice to acknowledge purchase of goods. Payment terms for sales on account typically run from 30 to 60 days. Companies usually do not charge interest on amounts owed, except on some past-due amounts.
Companies will establish a subsidiary (think of as secondary or detail) ledger for accounts receivable to keep up with what is owed by each customer. The total amount owed according to the subsidiary ledger should always match the balance in the accounts receivable account.
A note (also called a promissory note) is an unconditional written promise by a borrower to pay a definite sum of money to the lender (payee) on demand or on a specific date and usually include a required interest amount. A customer may give a note to a business for an amount due on an account receivable or for the sale of a large item such as a refrigerator. Companies also have non-trade note receivables if they loan money to non-customers.
Companies usually do not establish a subsidiary ledger for notes. Instead, they maintain a file of the actual notes receivable and copies of notes payable.