Accounts Receivable

Accounts Receivable

Key Things To Know

Revenue is “recognized” when:   

1) the good or service has been provided, and

2) the company expects to be paid 

Sell on “credit” –
provide them the good/service now and they pay you later.

When payment is due is based on the “terms” agreed upon

Example:  2/10, net30    means –
2% discount / if pay in 10 days, or full payment is due in 30 days

Example: net60
no discount offered and payment due in 60 days

Companies offer a discount in order to collect cash quicker when they need cash.
It is very costly to offer a discount, but necessary if the company is not able to borrow money at a lower interest rate

When a payment (cash) discount is taken it is called a sales discount
Sales discounts are reported on the income statement as:

     Sales
–   Sales Discount
=  Net Sales

Journal entries for sales on credit and payment received when a discount is offered:
Gross method of accounting for receivables

The sales and the accounts receivable are always for the full amount of the sale.
The cash is the amount actually received (sales x 1 – discount % if discount is taken)
The sales discount amount is:  sales $ x discount % offered

The balance sheet for accounts receivable will show:

The asset reported on the balance sheet, net accounts receivable, must be the amount you expect to be a future benefit.  There is no benefit to an uncollectible accounts receivable.

The accounts that are used to record accounts receivable transactions are:

Sales – represents the amount of goods or services provided

Accounts receivable – represents the amount the customer owes

Allowance for uncollectible accounts – represents the total amount you do not expect to collect – it is an estimate, you don’t know who won’t pay or how much

Bad debt expense – the current period estimate of what you won’t collect

There are 4 key transactions that must be recorded for accounts receivables:

1) Sales on credit, which creates the accounts receivable

2) Collect the accounts receivable when a customer pays

3) Estimate bad debt expense because you don’t know exactly how much won’t be collected from customers, but you know you won’t collect it all from past history.

You must estimate the expense at the end of the period to match with sales.

4) Write off an accounts receivable when you know who won’t pay you and exactly how much won’t be collected.   This occurs much later after the sale.

Journal entries for the 4 transactions are:

The accounts are changed by the following transactions:

Accounts Receivable:

Increases when a sale is made on credit

Decreases when the customer pays 

Decreases when an account is written off – you know who won’t pay and amount

Allowance for Uncollectible Accounts:

Increases when estimating bad debt expense using % sales method

Increases or decreases when estimating bad debt expense using % of accounts receivable (the up or down depends on how much is already in the account)

Decreases when an account is written off 

The allowance account represents the total estimate of what won’t be collected.  The company is not sure who won’t pay or exactly how much.  When they know who and how much won’t pay, they take it out of this account and take it off the accounts receivable list and out of the accounts receivable account.

Bad Debt Expense:

Changes ONLY when you estimate bad debt at the end of the period

If you overestimated in prior periods you can take some expense away when you are using the % of accounts receivable (aging) method.

The 4 transactions change the accounts:

Bad Debt Expense:  

Occurs when you do not get paid for a receivable.

The bad debt expense must be recorded in the same period the sale is made.

(This follows the matching principle: match revenues with all expenses)

Problem:   

You don’t know how much you won’t collect in the period of the sale.
You won’t know until much later when the customer doesn’t pay.

Solution:   

You must estimate, (based on past history) the amount you won’t collect and record this expense in the same period as the sale

Two ways to estimate the amount of bad debt expense for the current period:   

% of Sales Method:

      Sales
x   %  of sales the company historically doesn’t collect (given)
=   Bad debt expense

Record the bad debt expense amount you calculated

You are doing a direct match of the bad debt expense to sales.  This amount is also added to the account that accumulates the total amount of accounts receivable you do not expect to collect (the allowance account).

 % of Accounts Receivable (aging method):

       Accounts Receivable
x    % of accounts receivable the company historically does not collect (given)
=    The total amount of accounts receivable the company does not expect to collect

This amount must be the ending balance in the “allowance for uncollectible accounts account

Make your journal entry for the amount (plug) it takes to get the balance in the allowance account to be the amount you calculated above.

The ending balance must be the number you calculated above 

The journal entry for the amount of the “plug” amount will either be:

Allowance for uncollectible accounts
       Bad debt expense

or

Bad debt expense
       Allowance for uncollectible accounts

When you have an aging report which shows how old the accounts are and the % that is estimated to be uncollectible for each category, you must multiply the balance x the % given for each category and add them all up to get the total amount you do not expect to collect.  (See Practice As You Learn for an example).  When you have the total, follow the same procedures described above.

The difference between the two methods:  

% of Sales:

You are calculating the total bad debt expense for the period
You are estimating using this periods sales only

% of A/R:

You are calculating a cumulative amount that you do not expect to collect using the total amount that customers owe you from this period and all prior periods.

The expense for this period is the change in the cumulative amount you don’t expect to collect