Accounts receivable represents the amount of money a company has a right to receive from its clients based on goods delivered or services performed. Receivables can be classified as current assets if they mature in less than 12 months and noncurrent assets if they mature in more than 12 months.
Accounts receivable can also be classified as trade receivables and nontrade receivables. Trade receivables result from a business’s ordinary activity when goods or services are sold on credit. Common examples of nontrade receivables are loans granted to employees, wage advances, and tax refunds.
Under the accrual basis of accounting, a sale on credit leads to an increase in the Sales account and an increase in Accounts Receivable.
The sale on credit is recorded in the general journal by debiting Accounts Receivable and crediting the Sales account.
When cash is collected from a client, it is recorded in the general journal by debiting the Cash account and crediting Accounts Receivable.
Credit terms can offer some discounts for early payments. These are usually made to motivate customers to pay in advance and thereby reduce the length of the collecting period. For example, the credit term 1/10, net 30 entitles a customer to receive a 1% discount if the invoice will be paid within the first 10 days. If the customer fails to do this, the full amount should be paid.
If a customer pays within the discount period, two entries must be made. The first is recorded by debiting the Cash account and crediting Accounts Receivable by the amount of cash actually paid (net of discount). The second is recorded by debiting the Sales Discounts account and crediting Accounts Receivable by the amount of the discount.
These two journal entries can also be combined into one.
It can happen that a customer does not accept all goods shipped, for example, due to inappropriate quality. This should be recorded in the general journal by debiting Sales Returns and crediting Accounts Receivable by the value of goods returned by customer.
To illustrate accounts receivable accounting, assume that RetailX LTD has made the following transactions in the 4th financial quarter:
Assuming that all sales were made on credit terms 2/10, net 30, the journal entries to be made should be as follows:
Sale = 3,000 × $250 = $750,000
Cash collected = $575,000
Sale = 1,700 × $250 = $425,000
Since BMG LTD has paid the invoice within the discount period, it is entitled to receive a 2% discount.
Discount = $425,000 × 2% = $8,500
Cash collected = $425,000 - $8,500 = $416,500
Cash collected = 3,000 × $250 = $750,000
Sale = 2,500 × $260 = $650,000
Sales Returns = 150 × $260 = $39,000
Xander LDT has paid the invoice within the discount period, so it is entitled to receive a 2% discount. However, it returned some goods on November 22 in the amount of $39,000.
Net Sales = $650,000 - $39,000 = $611,000
Discount = $611,000 × 2% = $12,220
Cash collected = $611,000 - $12,220 = $598,780
Sale = 4,000 × $245 = $980,000
Sales Returns = 200 × $245 = $49,000
Sale = 1,500 × $250 = $375,000
Accounts receivable is a real asset account; thus, it increases by debiting and reduces by crediting. Let’s assume that its balance at the beginning of the 4th quarter was $625,000 and we transform general journal entries from the example above to a T-accounts format.