Account receivable is the amount which the company owes from the customer for selling its goods or services and 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 and accrual accounting system allows such type of 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. transactions by opening a new account called accounts receivable journal entry.
Accounts receivablesAccounts ReceivablesAccounts receivables refer to the amount due on the customers for the credit sales of the products or services made by the company to them. It appears as a current asset in the corporate balance sheet. 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 goods and services already delivered by the seller. Conversely, it creates a liability account 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. 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 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. 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 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. (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 Jan 31, 2019. Mr. Unreal made 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 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 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 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 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. is 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 –