Account receivable is the amount the company owes from the customer for selling its goods or services. The journal entry to record such credit sales of goods and services is passed by debiting the accounts receivable account with the corresponding credit to the Sales account.
Overview of Accounts Receivable Journal
Accounts receivables are the money owed to the company by the customers. The accrual accounting system allows such credit salesCredit SalesCredit Sales is a transaction type in which the customers/buyers are allowed to pay up for the bought item later on instead of paying at the exact time of purchase. It gives them the required time to collect money & make the payment. read more transactions by opening a new account called accounts receivable journal entry.
Accounts receivablesAccounts ReceivablesAccounts receivables is the money owed to a business by clients for which the business has given services or delivered a product but has not yet collected payment. They are categorized as current assets on the balance sheet as the payments expected within a year. read more can be considered an investment made by the business that includes both risks and returns. Returns in the form of easily acquiring new customers and risk in the form of non-payments called bad debts.
- Accounts Receivables are asset accounts in the seller’s books because the customer owes him an amount of money to pay against the goods and services already delivered by the seller. Conversely, it creates a liability accountLiability AccountLiability is a financial obligation as a result of any past event which is a legal binding. Settling of a liability requires an outflow of an economic resource mostly money, and these are shown in the balance of the company.read more in the books of customers called Accounts Payables.
- The Balance Sheet categorizes Account Receivables as a current assetCurrent AssetCurrent assets refer to those short-term assets which can be efficiently utilized for business operations, sold for immediate cash or liquidated within a year. It comprises inventory, cash, cash equivalents, marketable securities, accounts receivable, etc.read more because sales made on credit are expected to get paid soon per the credit terms mentioned in the invoice issued by the seller.
- Generally, financial statementsFinancial StatementsFinancial statements are written reports prepared by a company's management to present the company's financial affairs over a given period (quarter, six monthly or yearly). These statements, which include the Balance Sheet, Income Statement, Cash Flows, and Shareholders Equity Statement, must be prepared in accordance with prescribed and standardized accounting standards to ensure uniformity in reporting at all levels.read more are prepared using the accrual accounting methodAccrual Accounting MethodAccrual Accounting is an accounting method that instantly records revenues & expenditures after a transaction occurs, irrespective of when the payment is received or made. read more made mandatory by both GAAP & IFRS. Accrual accounting requires recording the revenues as for and when they are earned, whether payments in cash are received or not.
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Key Takeaways
- The “accounts receivable” refers to the money customers owe a company in exchange for goods or services sold. To record these sales, the company debits the accounts receivable account and credits the Sales account.
- It is an investment the business makes that includes risks and returns. Returns as quickly acquiring new customers and stakes in non-payments are called bad debts.
- When a customer buys from a seller and doesn’t pay immediately, it becomes an asset and a liability for the customer. It is recorded in accounts receivable and accounts payable, respectively.
Journal Entries for Accounting Receivable
E.g., The Indian Auto Parts (IAP) Ltd sold some truck parts to Mr. Unreal on credit. Since IAP has already incurred various expenses called the cost of goods soldCost Of Goods SoldThe Cost of Goods Sold (COGS) is the cumulative total of direct costs incurred for the goods or services sold, including direct expenses like raw material, direct labour cost and other direct costs. However, it excludes all the indirect expenses incurred by the company. read more (COGS) for his sales but has not been paid.
When Mr. Unreal Pays off his billing amount, the accounts-receivable account gets written off against payment received in cash. However, if payment is not received or is not expected to be received shortly, considering it to be losses, the seller can charge it as expenses against bad debts.
Let’s elaborate above example of Indian Auto Parts (IAP) Ltd and journalize the related transactions step by step:
- On Jan 1, 2019, IAP ltd sold some truck parts to Mr. Unreal on credit. The calculated amount of the invoice, including all expenses and taxes, was $10000, to be paid on or before Jan 31, 2019. Mr. Unreal made a full payment of $10000 on Jan 28, 2019.
- Recording credit sales if IAP provides credit terms to its customers. Consider credit terms as 2/10 net 302/10 Net 30The term 2/10 net 30 means that the supplier or seller will give the purchaser an additional 2% discount if the purchaser pays the due amount within 10 days of the date of purchase of goods rather than taking the full credit period of 30 days.read morei.e., if paid within ten days, a discount of 2% is offered; otherwise, payment must be made within 30 days without any discount.
Mr. Unreal pays his billing amount on Jan 8, 2019, and avails the discount.
Accounting for Bad Debts
While making sales on credit, the company is well aware that not all of its debtorsIts DebtorsA debtor is a borrower who is liable to pay a certain sum to a credit supplier such as a bank, credit card company or goods supplier. The borrower could be an individual like a home loan seeker or a corporate body borrowing funds for business expansion. read more will pay in full, and the company has to encounter some losses called bad debts. Bad debts expensesBad Debts ExpensesBad Debts can be described as unforeseen loss incurred by a business organization on account of non-fulfillment of agreed terms and conditions on account of sale of goods or services or repayment of any loan or other obligation.read more can be recorded using two methods viz. 1.) Direct write-off methodDirect Write-off MethodThe Direct Write-off method is a process of booking the unrecoverable receivables that are no longer collectable by removing them from the books of accounts without prior booking for the provisions of bad-debts expenses.read more and 2.) Allowance method.
#1 – Direct Write-Off Method
Bad debts provisionBad Debts ProvisionA bad debt provision refers to the reserve made by a company to set aside an amount computed as a specific percentage of overall doubtful or bad debts that has to be written off in the next year.read more is recorded as a direct loss from defaulters, writing off their accounts and transferring in full amount to the P&L account, thus lowering your net profit.
E.g. Mr. Unreal passed away and will not be able to make any payment.
#2 – Allowance Method
Charge the reverse value of accounts receivables for doubtful customers to a contra account called allowance for doubtful accountAllowance For Doubtful AccountAllowance for doubtful accounts primarily means creating an allowance for the estimated part that may be uncollectible and may become bad debt and is shown as a contra asset account that reduces the gross receivables on the balance sheet to reflect the net amount expected to be paid.read more. It keeps the P&L account unaffected from bad debts, and reporting the direct loss against revenues can be avoided. However, writing off the account at a future date is possible. For example:-
a) Mr. Unreal incurred losses and cannot make payment at due dates.
b) Mr. Unreal goes bankrupted and will not pay at all.
c) Mr. Unreal has recovered from initial losses and wants to pay all its previous debts.
Frequently Asked Questions (FAQs)
The provision for doubtful accounts in the contra-asset account is deducted to write off bad debt. The likelihood that the firm will never receive payment for that loan will decrease the number of account receivables on the balance sheet.
Accounts receivable is an amount of money owed to a business by an individual or entity, recorded as a debit.
Building monthly financial statements, doing account reconciliations, producing invoices and account statements, and managing the billing system are some of the many tasks an accounts receivable department carries out.
Managing accounts receivable is crucial for maintaining healthy cash flow and ensuring the financial stability of a business. Efficient AR management helps to reduce the risk of bad debts, improves collection times, minimizes the need for borrowing, and provides funds for business operations and investments.
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This has been a guide to Account Receivable Journal Entries. Here we discuss the overview of Accounts Receivables, journal entries examples, and we will also discuss the Effects of credit sales on inventory and its balance. You can learn more about firms from the following articles –
