Accounts Receivables

 Meaning of Accounts Receivables

Accounts 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.

Accounts Receivables Accounting

Let us take an account receivables example to see how it works. ToysforU sales and receipts from customers are shown below.

Please create the Income Statement, Balance Sheet and Cash FlowsCash FlowsCash Flow is the amount of cash or cash equivalent generated & consumed by a Company over a given period. It proves to be a prerequisite for analyzing the business’s strength, profitability, & scope for betterment. read more at the end of Year 1 and Year 2

Year 1

Income Statement for the 1st Year

Balance Sheet for the 1st Year

  • Receivables is an asset and is reported as $100
  • After accounting for the allowance for bad debt, Net Receivables becomes $90
accounts receivables example - 11

Cash flow for Year 1

There is no cash received in Year 1, Cash Flow = $0

Year 2

Income Statement for the 2nd Year

  • Sales will be booked due to the “Accrual Accounting” concept (introduced in 1st chapter Kartik’s case study)
  • COGS is $0 as given in the case study
  • Bad Debt Expense is 10% of the Sales = 10% of $150 = $50
  • Net Income Reported in 2nd Year is $135

Balance Sheet for the 2nd Year

accounts receivables example - 22

Cash flow for Year 2

The actual cash collection during the year was $90. Cash Flow = $90

Examples of Accounts Receivable

Accounts Receivable-Examples

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For eg:
Source: Accounts Receivables (wallstreetmojo.com)

#1 – Sale of Goods

A trader Mark Inc. dealing in FMCG products sells 20,000 pieces of soap, each having a market price of $20 (total value $4,00,000) to Henry Inc. Against this purchase, Henry Inc. paid $1,00,000 in cash and agreed to pay the balance after 6 months.

Solution:

Calculation of Accounts Receivable can be done as follows:

Example1

Here, Mark Inc. generated an asset in the form of accounts receivable as Henry Inc. Since, a customer had paid $1,00,000 in cash and has agreed to pay rest after 6 months, Mark Inc. will show Balance of $3,00,000 as accounts Receivable in its balance sheet.

Suppose, in the above example, Henry Inc becomes insolvent after 3 months, and it is estimated that the company can recover only $1,00,000. Then, It will be reduced to $1,00,000, and the remaining $2,00,000 will be charged to profit and loss A/c as bad debtsBad DebtsBad 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.

Note:

Similarly, all goods supply accounts receivable can be identified and accounted for.

#2 – Supply of Service

Tony Builders Inc. (Construction contractor) gives the following data regarding the construction agreement of flat. Determine account receivable as on 31st March 2019:

Solution:

It is the case of sale of service (Completion of under-construction property). To determine debtors, Mark Inc. needs to identify all expenses which can be recovered from Henry Inc.

Debtors standing in books of Tony Inc. as on 31/03/2019 will be calculated as follows:

debtors Example2
#3 – Money Lending Industry

Bank of America lent Mark Inc. $5,00,000 on 01st January 2017 for purchasing machinery to be used in business on the following conditions:

  • An interest rate of 12% p.a. will be charged,
  • The principle will be repaid in 5 equal annual installments,
  • Loan Processing fees paid as on 01/01/2017 $ 2,000

Determine accounts receivable at the end of the Year 2017, 2018, 2019, 2020, 2021.

Solution:

It is the case of the money lending service industry like Banks, NBFCs. The primary Income of such industry is generated by Interest (charge against the use of money for a particular period). To determine debtors at each year-end, we need to prepare a loan amortization tableAmortization TableThe amortization table reflects the schedule of periodic payments to be made regarding a loan undertaken, representing the principal amount and the interest amount payable in each regular installment. Thus, it is a detailed working of the loan repayment.read more for 5 years as follows:

Accounts Receivable Example 3
#4 – Deferred Revenue – Sale of Magazine

Mark Inc., sells a popular monthly magazine on a subscription basis on the following terms:

  • One Year Subscription fees – $10,000
  • Two Year Subscription Fees gets a discount of $2,000
  • Five Year Subscription Fees gets a discount of $4,000
  • All amounts are payable immediately

Louis, Denial, Henry opts for each option, respectively, on 01/01/2019. Identify accounts receivable for Mark Inc. as on 31/01/2019

Solution:

Selling of magazine on a fixed subscription basis becomes a case of deferred revenueDeferred RevenueDeferred Revenue, also known as Unearned Income, is the advance payment that a Company receives for goods or services that are to be provided in the future. The examples include subscription services & advance premium received by the Insurance Companies for prepaid Insurance policies etc. read more since the magazine will be supplied monthly, but consideration is received in advance.

Under this, the amount is received in advance for supplying goods, i.e., magazine over a period of time. Here, accounts receivable will be calculated as follows:

debtors Example 4

You can refer to the given above excel template for a detailed calculation of accounts receivable.

Gross vs Net Accounts Receivables?

Let us see an example of Colgate to understand the difference between the two.

Colgate Net Receivables

In Colgate, we note the following –

  • 2014 – Net receivables is $1,552 mn, allowance is $54 mn; This implies Gross Receivables are $1,552 + $54 = $1,606 mn
  • 2013 – Net receivables is $1,636 mn, allowance is $67 mn; This implies Gross Receivables are $1,636 + $67 = $1,703 mn

Below is the Colgate receivables policy suggests a shorter credit policy of less than 60 days

accounts receivables Colgate

Accounts Receivables by Industry

Let us now have a look at the industry average receivables.

RankIndustryReceivables (Days)
1Banks331.9
2Machinery109.93
3Construction107.88
4Metal Products103.36
5Chemicals98.27
6Glass & Ceramics Products97.9
7Precision Instruments97.8
8Electric Appliances96.46
9Rubber Products92.09
10Other Services89.74
11Pulp & Paper85.73
12Nonferrous Metals Products85.13
13Other Products83.87
14Iron & Steel81.3
15Wood & Wood products75.7
16Communication74.19
17Wholesale Trade73.78
18Transportation Equipment70.65
19Textiles & Apparels69.34
20Leather Products69.23
21Air Transportation68.22
22Publishing & Printing67.31
23Agriculture61.59
24Oil & Gas Mining60.29
25Other Transportation58.85
26Insurance56.89
27Foods55.44
28Oil & Coal Products54.99
29Forestry54.38
30Coal Mining48.24
31Fishery42.81
32Metal Mining41.66
33Gas36.26
34Movie33.49
35Road Transportation32.41
36Retail Trade28.23
37Hotel27.47
38Electric Power27.28
39Railway24.68
40Warehousing23.81
41Marine Transportation23.72
42Amusement18.78
43Real Estate10.64
44Securities6.86

source: ediunet

As you can see from above, industries like Banks have a very long receivables period (in excess of 300 days), however, for capital goods and heavy asset industries like machinery, construction, metals, etc., it is around 100 days.

Conclusion

Accounts receivables are the amount that is due to the company by its customers. It is important to consider the default probability of the customer and therefore look at the Net Receivables numbers. Each industry has a different set of credit policy and hence, account receivable days differ by wide measures.

Accounts Receivables Video

 

This has been a guide to Accounts Receivables and their meaning. Here we discuss accounting for Accounts Receivables along with Industry examples.   You may also have a look at these following articles to learn more about accounting.

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