Why It Matters: Receivables and Revenue

What you’ll learn to do: Describe the accounting and reporting of receivables and revenue

NeatNiks is a small business, but Nick prides himself on his ability to accommodate his customers. He does a lot of his work at night and after regular business hours, so collecting cash or a check for the services he provides isn’t convenient. One way he accommodates his customers is by offering credit. He bills his customers after he has performed the service, and gives them 30 days to pay. Even though he hasn’t collected cash from those credit customers, he recognizes the revenue as earned when the service is provided, and then matches the associated expenses with the revenue in the proper period based on the matching principle and revenue recognition guidelines. As we’ve discussed previously, this gives him a more accurate picture of how his business is doing than just a cash-basis system.

A graphic of a graph with an arrow pointing up.By offering credit terms, NeatNiks operates in good faith that customers will pay their accounts in full. Sometimes this does not occur, and the bad debt from the receivable has to be written off. Because he follows GAAP (even though his company is publicly traded) Nick will use specific accounting principles that dictate the estimation and bad debt processes. In addition, he will have to carefully manage his receivables and bad debt in order to reach his financial goals. By extending credit, Nick can make more sales and grow his business, and someday maybe even turn it into a franchise or other mega-business organization.

But for now, we need to learn how exactly to recognize revenue, especially when it isn’t as clear as the examples we’ve been using, where Nick performs a service and then gets paid. What if Nick entered into a five-year $5,000 contract that included regular cleanings, semi-annual deep cleanings, a warranty provision, payments in advance, and an escalation clause? What if you are working for a company that manufactures luxury yachts to order, that take more than a year to complete, and include an annual service component?

In addition, when you are accounting for receivables, you will be managing a large amount of data that goes beyond just numbers. In this section, we’ll be discussing revenues, receivables, bad debts, and some of the disclosures that go with those. When you are done, you’ll have a working knowledge of the interplay between revenues and receivables.