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10 Best Examples of Accounts Receivable

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Define Accounts Receivable

Accounts receivable are also known as receivables refers to short-term amounts due from buyers to a seller who have purchased goods or services from the seller on credit. Credit is usually granted in order to gain sales or to respond to the granting of credit by competitors. Accounts receivable is listed as a current asset on the seller’s balance sheet.

The total amount of accounts receivable allowed to an individual customer is typically limited by a credit limit, which is set by the seller’s credit department, based on the finances of the buyer and its past payment history with the seller. Credit limits may be reduced during difficult financial conditions when the seller cannot afford to incur excessive bad debt losses.

What is Accounts Receivable

Accounts receivable are commonly paired with the allowance for doubtful accounts (a contra account), in which is stored a reserve for bad debts. The combined balances in the accounts receivable and allowance accounts represent the net carrying value of accounts receivable.

The seller may use its accounts receivable as collateral for a loan, or sell them off to a factor in exchange for immediate cash.

Accounts receivable may be further subdivided into trade receivables and non trade receivables, where trade receivables are from a company’s normal business partners, and non trade receivables are all other receivables, such as amounts due from employees.

When sales are made on credit, accounts receivable are created which are recorded through the following journal entry:

Accounts receivable ABC
Sales ABC

The accounts receivable balance is presented on balance sheet net of any allowance for doubtful accounts as follows.

Accounts receivable A
Less: allowance for doubtful accounts B
Net accounts receivable A - B

When cash is collected from customer, the accounts receivable balance on balance sheet is reduced through the following journal entry:

Cash ABC
Accounts receivable ABC

Many companies allow customers certain cash discount when they make payment quickly. The cash discount depends on the credit terms.

Notes receivable

Note receivable are receivables supported by a written statement by the debtor to pay a specified sum on a specified date. Like accounts receivable, notes receivable arise in the ordinary course of business; but unlike accounts receivable they are in written form. Notes receivable usually require the debtor to pay interest. They may be current and non-current.

When a company receives a note receivable it records it by the following journal entry:

Notes receivable G
Sales/cash/accounts receivable G

Interest on accounts receivable is accrued as follows:

Interest receivable (asset) H
Accrued interest (income) H

Non-trade receivables

None-trade receivables are receivables that arise from events that do not form the company’s main course of business. Examples include:

  • Advances to employees
  • Advance tax paid
  • Deposits placed with other companies

Best Examples of Account Receivable

Scarlet Systems, Inc. (SS) developed an ERP software for Johnson Tools, LLC (JT) for $200,000 due within 30 days of successful testing of the system. Testing was completed on 30 April and the software became operational. JT paid an amount of $100,000 on 15 May.

JT had to settle another large liability in April which resulted in it not being able to pay the remaining invoice amount (i.e. $100,000) by 30 May. On 1 June, JT CFO convinced SS finance team to accept a note receivable due within 60 days carrying interest rate of 5% per annum for the remaining outstanding balance. JT paid the interest and principal of the note receivable at its maturity.

Required: Journalize the transactions.

Solution

The sale of software and related services is recorded through the following journal entry:

Account receivable (JT) 200,000
Sales 200,000

Payment by JT on 15 May is journalized as follows:

Cash 100,000
Accounts receivable 100,000

Conversion of accounts receivable to note receivable on 1 May is booked via the following journal entry:

Note receivable 100,000
Accounts receivable 100,000

Following journal entry is made to account for receipt of note receivable principal amount and interest income:

Cash 100,833
Note receivable 100,000
Interest income 833

Where, interest income equals: $100,000 × 5% × 60/360

Steps to Collect Accounts Receivable

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What is Accounts Receivable?

Accounts receivable refers to the amount of money that a company is owed by its customers for goods or services that have been delivered or performed but have not yet been paid for. When a company sells goods or services on credit, it records the amount due from the customer as an account receivable. The company expects to receive payment in the future, typically within a certain number of days after the sale. Until the customer pays the amount due, the company records the amount as an account receivable on its balance sheet.

For example, if a retailer sells a product to a customer on credit and the customer is given 30 days to pay for the product, the retailer will record the amount due as an account receivable. If the customer pays the amount due within 30 days, the retailer will record the payment and the account receivable will be eliminated. If the customer does not pay the amount due within 30 days, the retailer will continue to record the amount as an account receivable until it is paid in full.

Accounts receivable is an important asset for companies, as it represents money that is expected to be received in the future. It is important for companies to carefully manage their accounts receivable to ensure that they are collecting payments from customers in a timely manner and to minimize the risk of bad debt.

It is essential to collect accounts receivable in a timely manner, thereby generating enough cash flow to support company operations. The rapid collection also improves the ability of a company to use its receivables as collateral for loans, since newer receivables qualify for treatment as collateral.

Collecting accounts receivable is not just the task of the collections department. Instead, it calls for a company-wide effort, because collections can be improved before an invoice is ever issued to customers. Consider the following steps for collecting accounts receivable:

Internal Problem Resolution

A fair proportion of all customer invoices are not paid because customers are dissatisfied with the goods or services they have received. This is not the fault of the collections department. Instead, the senior management team must be involved in following through on each issue pointed out by customers, such as failed products, inadequate services, damaged goods, incorrect items shipped, and so forth. In many cases, the internal processes that caused these problems will do so again until corrective action is taken.

In short, there must be an active feedback loop that sends customer complaints back to a core management group for ongoing problem resolution.

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Accounts Receivable Collections Management

Anyone involved in collections must be given the time and resources to engage in collections in an efficient manner. The following items can help to improve the efficiency of the department:

  • Posting. Immediate posting of cash, so the collections staff is not calling customers about invoices they have already paid.
  • Database. A computerized collections system that tracks customer promises, auto-dials customers, automatically e-mail invoices, and so forth. This greatly increases the efficiency of the collections staff.
  • Staff support. Administrative staff that keeps all unnecessary distractions away from the collections staff.
  • Staff scheduling. Work scheduling keeps the collections staff from being involved in any activity other than collections during peak calling hours.

Steps Accounts Receivable Collection Techniques

There are a variety of standard techniques used to contact customers and extract payment promises from them. A sampling of the more common methods are:

  • Issue dunning letters or e-mails when it appears that customers need a mildly-worded reminder. Some companies use a series of these communications, each one with progressively more strident wording.
  • Divide the overdue accounts receivable into groups, with the highest-dollar invoices receiving the most continual attention. Doing so focuses attention on collecting those few invoices that comprise the bulk of the overdue receivables.
  • Involve the sales staff in the collection effort for larger or more difficult collection tasks, where their customer connections can be of assistance.
  • Offer to take back goods for which it is apparent that payment will not be received.
  • Involve a law firm in collections. Issuing notices on the letterhead of the law firm can convey the impression that the company is about to take legal action against the customer.
  • File a claim against the customer in small claims court.

Allowance for Uncollectible Accounts Explained With Examples

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Allowance for Uncollectible Accounts : Definition

Allowance for uncollectible accounts is a contra asset account on the balance sheet representing accounts receivable the company does not expect to collect. When customers buy products on credit and then don’t pay their bills, the selling company must write-off the unpaid bill as uncollectible. Allowance for uncollectible accounts is also referred to as allowance for doubtful accounts, and may be expensed as bad debt expense or uncollectible accounts expense.

Allowance for Doubtful Accounts: Calculation

Finding the proper amount for the allowance for doubtful accounts is not an instant process. More, it is developed over years of operations. To create a standard allowance, have those financial records that indicate how many accounts have not been collected. Then, compare these figures to historical measurements. Then create an average amount of money lost over the number of years measured. This creates historical averages. Once done, a company can compare these to the records of other companies or industry statistics. The company can use this information to attempt to bring this amount to an equal level, as compared to common industry best practices.

Allowance for Doubtful Accounts: Normal Balance

Because the allowance for doubtful accounts account is a contra asset account, the allowance for doubtful accounts normal balance is a credit balance. So for an allowance for doubtful accounts journal entry, credit entries increase the amount in this account and debits decrease the amount in this account. The allowance for doubtful accounts account is listed on the asset side of the balance sheet, but it has a normal credit balance because it is a contra asset account, not a normal asset account.

For more ways to add value to your company, download your free A/R Checklist to see how simple changes in your A/R process can free up a significant amount of cash.

Direct Write-Off and Allowance Methods in Account Receivable

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Direct Write-Off and Allowance Methods

Because customers do not always keep their promises to pay, companies must provide for these uncollectible accounts in their records. Companies use two methods for handling uncollectible accounts. The direct write-off method recognizes bad accounts as an expense at the point when judged to be uncollectible and is the required method for federal income tax purposes. The allowance method provides in advance for uncollectible accounts think of as setting aside money in a reserve account. The allowance method represents the accrual basis of accounting and is the accepted method to record uncollectible accounts for financial accounting purposes.

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Direct Write-off

The direct write-off method is used only when we decide a customer will not pay. We do not record any estimates or use the Allowance for Doubtful Accounts under the direct write-off method. We record Bad Debt Expense for the amount we determine will not be paid. This method violates the GAAP matching principle of revenues and expenses recorded in the same period.

When we write-off an account under this method, the entry would be:

Debit Credit

Bad Debt Expense X

Accounts Receivable X

The amount used will be the amount the customer owes that we will not be able to collect.

 

Allowance Method

The allowance method follows GAAP matching principle since we estimate uncollectible accounts at the end of the year. We use this estimate to record Bad Debt Expense and to setup a reserve account called Allowance for Doubtful Accounts (also called Allowance for Uncollectible Accounts) based on previous experience with past due accounts. We can calculate this estimates based on Sales (income statement approach) for the year or based on Accounts Receivable balance at the time of the estimate (balance sheet approach).

As a contra asset account to the Accounts Receivable account, the Allowance for Doubtful Accounts (also called Allowance for uncollectible accounts or Allowance for bad debts) reduces accounts receivable to their net realizable value. Net realizable value is the amount the company expects to collect from accounts receivable. When the firm makes the bad debts adjusting entry, it does not know which specific accounts will become uncollectible. Thus, the company cannot enter credits in either the Accounts Receivable control account or the customers’ accounts receivable subsidiary ledger accounts. If only one or the other were credited, the Accounts Receivable control account balance would not agree with the total of the balances in the accounts receivable subsidiary ledger. Without crediting the Accounts Receivable control account, the allowance account lets the company show that some of its accounts receivable are probably uncollectible.

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When we decide a customer will not pay the amount owed, we use the Allowance for Doubtful accounts to offset this loss instead of Bad Debt Expense.

At the end of each year, we ESTIMATE bad debts expense and make the following entry:

Debit Credit

Bad Debt Expense X

Allowance for Doubtful Accounts X

The amount used will be the ESTIMATED amount calculated using sales or accounts receivable.

 

When we write-off a customer account under the allowance method, the entry would be:

Debit Credit

Allowance for Doubtful Accounts X

Accounts Receivable X

Notice how we do not use bad debts expense in a write-off under the allowance method.

 

Accounting in the Headlines

Let’s try and make accounts receivable more relevant or understandable using an actual company.

What does Coca-Cola’s Form 10-k communicate about its accounts receivable?

Picture of a bottle of Coca-ColaThe Coca-Cola Company (KO), like other U.S. publicly-held companies, files its financial statements in an annual filing called a Form 10-K with the Securities & Exchange Commission (SEC).

Coca-Cola has several assets that are listed on its balance sheet. Let’s look at what is reported on Coca-Cola’s Form 10-K regarding its accounts receivable. A 10-K is another name for a company’s annual report. Additionally, a 10-Q is a company’s quarterly report.

See the following excerpts from Coca-Cola’s 2013 Form 10-K:

  1. Partial Consolidated Balance Sheets containing current assets (page 76);
  2. Trade Accounts Receivable note (page 89); and
  3. Partial Statements of Income (page 74).

Questions

  1. What is the total (gross) value of Coca-Cola’s accounts receivable (before deduction for its allowance for doubtful accounts) as of December 31, 2013? As of December 31, 2012?
  2. What is “net realizable value”?
  3. What factors does Coca-Cola use to determine the amount of its allowance for doubtful accounts?
  4. In what line item on the income statement would bad debt expense be included?

 

 

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How to Evaluating Accounts Receivable Method

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Evaluating Accounts Receivable

Business owners know that some customers who receive credit will never pay their account balances. These uncollectible accounts are also called bad debts. Companies use two methods to account for bad debts: the direct write‐off method and the allowance method.

Direct write‐off method. For tax purposes, companies must use the direct write‐off method, under which bad debts are recognized only after the company is certain the debt will not be paid. Before determining that an account balance is uncollectible, a company generally makes several attempts to collect the debt from the customer. Recognizing the bad debt requires a journal entry that increases a bad debts expense account and decreases accounts receivable. If a customer named J. Smith fails to pay a $225 balance, for example, the company records the write‐off by debiting bad debts expense and crediting accounts receivable from J. Smith.

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The Internal Revenue Service permits companies to take a tax deduction for bad debts only after specific uncollectible accounts have been identified. Unless a company’s uncollectible accounts represent an insignificant percentage of their sales, however, they may not use the direct write‐off method for financial reporting purposes. Since several months may pass between the time that a sale occurs and the time that a company realizes that a customer’s account is uncollectible, the matching principle, which requires that revenues and related expenses be matched in the same accounting period, would often be violated if the direct write‐off method were used. Therefore, most companies use the direct write‐off method on their tax returns but use the allowance method on financial statements.

Allowance method. Under the allowance method, an adjustment is made at the end of each accounting period to estimate bad debts based on the business activity from that accounting period. Established companies rely on past experience to estimate unrealized bad debts, but new companies must rely on published industry averages until they have sufficient experience to make their own estimates.

The adjusting entry to estimate the expected value of bad debts does not reduce accounts receivable directly. Accounts receivable is a control account that must have the same balance as the combined balance of every individual account in the accounts receivable subsidiary ledger. Since the specific customer accounts that will become uncollectible are not yet known when the adjusting entry is made, a contra‐asset account named allowance for bad debts, which is sometimes called allowance for doubtful accounts, is subtracted from accounts receivable to show the net realizable value of accounts receivable on the balance sheet.

If at the end of its first accounting period a company estimates that $5,000 in accounts receivable will become uncollectible, the necessary adjusting entry debits bad debts expense for $5,000 and credits allowance for bad debts for $5,000.

 

 

After the entry shown above is made, the 樂威壯
accounts receivable subsidiary ledger still shows the full amount each customer owes, the balance of the control account (accounts receivable) agrees with the total balance in the subsidiary ledger, the credit balance in the contra asset account (allowance for bad debts) can be subtracted from the debit balance in accounts receivable to show the net realizable value of accounts receivable, and a reasonable estimate of bad debts expense is recognized in the appropriate accounting period.

When a specific customer’s account is identified as uncollectible, it is written off against the balance in the allowance for bad debts account. For example, J. Smith’s uncollectible balance of $225 is removed from the books by debiting allowance for bad debts and crediting accounts receivable. Remember, general journal entries that affect a control account must be posted to both the control account and the specific account in the subsidiary ledger.

 

 

Under the allowance method, a write‐off does not change the net realizable value of accounts receivable. It simply reduces accounts receivable and allowance for bad debts by equivalent amounts.

Before writing off J. Smith’s account After writing off J. Smith’s account
Accounts Receivable $100,000 $99,775
Less: Allowance for Bad Debts (5.000) (4.775)
Net Realizable Value $95,000 $95,000

Customers whose accounts have already been written off as uncollectible will sometimes pay their debts. When this happens, two entries are needed to correct the company’s accounting records and show that the customer paid the outstanding balance. The first entry reinstates the customer’s accounts receivable balance by debiting accounts receivable and crediting allowance for bad debts. As in the previous example, the debit to accounts receivable must be posted to the general ledger control account and to the appropriate subsidiary ledger account.

 

 

The second entry records the customer’s payment by debiting cash and crediting accounts receivable. Most companies record cash receipts in a cash receipts journal. Since a special journal’s column totals are posted to the general ledger at the end of each accounting period, the posting to J. Smith’s account is the only one shown with the cash receipts journal entry in the illustration below.

 

 

In the future when management looks at J. Smith’s payment history, the account’s activity will show the eventual collection of the amount owed.

If you use the general journal for the entry shown in the immediately previous cash receipts journal, you post the entry directly to cash and accounts receivable in the general ledger and also to J. Smith’s account in the accounts receivable subsidiary ledger.