Overview of Accounts Receivable Journal
Accounts receivables are the money owed to the company by the customers and accrual accounting system allows such type of credit sales transactions by opening a new account called accounts receivable journal entry
Accounts receivables can be considered as 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 books of the seller because the customer owes him an amount of money to pay against the good and services already delivered by the seller. Conversely, it creates a liability account in the books of customer called Accounts Payables.
- The Balance Sheet categorizes Account Receivables as a current asset because sales made on credit are expected to get paid soon as per the credit terms mentioned in the invoice issued by the seller.
- Generally, financial statements are prepared using the accrual accounting method that has been made mandatory by both GAAP & IFRS. Accrual accounting requires recording the revenues as for and when they are earned whether payments in cash is received or not.
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 cost of goods sold (COGS) for the sales he has made but not been paid.
Now 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 in the near future then 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 invoice including all expenses and taxes was $10000 to be paid on or before 31 Jan 2019. Mr. Unreal made full payment of $10000 on 28 Jan 2019.
- Recording credit sales if IAP provides credit terms to its customers. Consider credit terms as 2/10 net 30 i.e. if paid within 10 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 8 Jan 2019 and avails the discount.
Accounting for Bad Debts
While making sales on credit, the company is well aware that not all of its debtors will pay in full and the company has to encounter some losses called bad debts. Bad debts expenses can be recorded using two methods viz. 1.) Direct write-off method and 2.) Allowance method.
#1 – Direct Write-Off Method
Bad debts are recorded as a direct loss from defaulters, writing off their accounts and transferred in full amount to P&L account, thus lowers 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 account. This keeps the P&L account unaffected from bad debts and reporting of 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 is not able to 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 of its previous debts.
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 –