Accounting for Receivables

Receivables are amounts due to a company by its customers and others. Receivables include all such assets which arise as a consequence of the company’s main operations and which represent cash to be collected from other parties.

Receivables can be broadly classified into trade-receivables and non-trade receivables. Trade receivables are those receivables which originate from sales of goods and services by a business in the ordinary course of business. Non-trade receivables are the amounts due from third parties for transactions outside its primary course of business i.e. selling goods and services.

Receivables are normally current assets but some may have a non-current depending on their maturity.

Trade receivables include accounts receivable and notes receivable.

Accounts receivable

Accounts receivable are current assets which represent amounts to be collected from customers for goods sold and services provided. When a company sells goods or provides services, the customers rarely makes payment on spot. Instead, they are required to make payment within a certain time period, called credit period. The terms that determine the due date and the discount available if payment is made by a certain date are called credit terms.

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

Accounts receivableABC
SalesABC

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

Accounts receivableA
Less: allowance for doubtful accountsB
Net accounts receivableA - B

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

CashABC
Accounts receivableABC

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 receivableG
Sales/cash/accounts receivableG

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:

  1. Advances to employees
  2. Advance tax paid
  3. Deposits placed with other companies

Example

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
Sales200,000

Payment by JT on 15 May is journalized as follows:

Cash100,000
Accounts receivable100,000

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

Note receivable100,000
Accounts receivable100,000

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

Cash100,833
Note receivable100,000
Interest income833

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

Written by Irfanullah Jan