What are Accounts Receivable?

The word “account receivable” means the payment is yet to be made for the work that is already done. Generally, each and every business sells its goods and services either in cash or in credit. So, when the goods are sold on credit account receivable arise which means the company is going to get the payment from its customer to whom the goods are sold on credit. Usually, the credit period may be for a very short period of time and in some rare cases it takes a year.

For example, on April 1, 2016, ABC Ltd. sold goods worth $10,000 to Mr. A with a credit period of 30 days. Company ABC Ltd. will treat this account receivable against Mr. A’s account. If Mr. A makes a payment of $5,000 on April 15, 2016, to ABC Ltd., then this amount will be reduced from Mr. A’s account.  So, after adjustment, account receivable will be $5000. Similarly, all the sales on credit will be added to the receivable account and reduced when the payment is received from the respective debtors.

How Does Accounts Receivable Work?

Here is the quick guide on how to do accounting related to this account.

1. First, a business has to prepare the invoices of all the services that is performed by the company and most importantly the invoices must contain the following information:
   • Correct date at which the service is performed
   • Customer information
   • Types of service provided
   • Due amount
   • Due date
   • Relevant purchase order info
   • Contact data of business
   • Payment terms
2. Proper debit and credit should be done in the books of accounts.
   • Debit receivable account for the due amount.
   • Credit sales with the same amount.
3. After that, the business has to collect the payment from their respective debtors or customers.
4. Proper debit and credit should be done in the books of accounts to show the payment receive from the customers.
   • Debit cash because the business receives cash from the customer.
   • Credit account receivable to reduce the amount that is due by the customer.

Tips for Collecting Accounts Receivable

Company may use various tricks and techniques to collect due receivable from their customer in a short period of time:

• Business may provide some discount to that customer who pays quickly.
• Business may charge some late fine on due amount.

Must have an efficient follow-up process for this account.

Payment Terms

Here is the explanation of the payment terms of accounts receivable:

• Suppose its 2/10, here 2 implies the discount percentage which the customer will receive if the due amount is paid within 10 days.
• Net 30 or n/30 implies that within 30 days the amount should be fully paid.

Example:

On 1^st July 2015, ABC Ltd. Sold a $10,000 product on credit to Mr. A. The terms were 4/10 and n/30.

Solution:

Following are the journal entries

• When the credit sale is made

• When the payment is received from Mr. A within 30 days.

• When Mr. A avails the discount by making the payment within 10 days.

• When Mr. X is unable to join

Allowances for Uncollectible Accounts

Allowances for Doubtful Debt Account

Allowances for doubtful account is a contra asset account which means it has either credit balance or zero balance. The allowances for doubtful account are created only when some customers are failing in paying money that they owe. Due to this, the bad debt expense account increases and written off as uncollectible.

Allowances for doubtful account is a contra asset due to which amount of receivable gets decrease that why it is recorded under asset in balance sheet. In case, if these doubtful debts become bad debt, then it is recorded in the income statement because after that it is an expense for the firm.

Treatment in Balance Sheet

It is shown on the asset side of the balance sheet and is treated as current asset because it is convertible in cash in near future and within a short period of time.

Example is shown in the balance sheet:

In current asset, the items are listed according to their liquidity. Here, the accounts receivable is listed below cash and short-term investment because they are more liquid. Likewise, the accounts receivable is listed above inventory because comparatively, it is more liquid.

Cycle

• First, when the customer makes a purchase, an invoice is created. It shows the quantity, price and other details.
• Secondly, the invoice is sent to the customer
• Third, the discount is applied or an interest fee is charged. Discount is applicable in case of early payments made by the customers and interest fee is charged in case the customer doesn’t pay within the specified period.
• Finally, the company receives the invoice/ payment.

Accounts Receivable Turnover Ratio

Accounts receivable turnover ratio depicts the number of times a business collects its average account receivable. Accounts receivable turnover ratio is used by analysts to see how efficient a company is in collecting account receivable from its due customer. Account receivable is calculated by dividing the net credit sales to average account receivable for the same accounting period and it gives us an idea of how efficiently the debt owned are collected with respect to the credit extended. The higher the ratio, the higher are the chances that customer pay their debt quickly or within short span of time. Also, since the company receives the payment for debts, it increases their cash flow and enables them to pay off the company’s debt more quickly. The formula for calculating accounts receivable turnover ratio is.

$\text{Account receivable turnover ratio}=\frac{\text{Net credit sales}}{\text{Average account receivable}}$

Where

$\text{Net credit sales = Total number of sales – Sales return for a given period – Sales allowances}$

$\text{Average account receivable = }\frac{\left(\begin{array}{l}\text{Opening balance of account receivable + }\\ \text{Closing balance of account receivable}\end{array}\right)}{\text{2}}$

Example: Company A has a starting accounts receivable of $1, 00,000 and an ending accounts receivable of $2, 00,000. Net credit sale is $9, 00,000.

Solution: According to the formula given:

Average accounts receivable= $1,50,000

Therefore,

Net Credit Sales= $\frac{\$9,00,000}{\$1,50,000}$= $6

So, the Accounts receivable turnover of Company A is $6.

Context and Applications  

This topic is significant in the professional exams for both undergraduate and graduate courses, especially for

• B.com
• M.com