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Accounts Receivable Accounting

By Yuriy Smirnov Ph.D.

Definition

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.

Journal entries

The sale on credit is recorded in the general journal by debiting Accounts Receivable and crediting the Sales account.

Sale on credit journal entry

When cash is collected from a client, it is recorded in the general journal by debiting the Cash account and crediting Accounts Receivable.

Cash collection journal entry

Sales Discounts

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.

Sales discounts journal entry

These two journal entries can also be combined into one.

Sales discounts combined journal entry

Sales Returns

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.

Sales returns combined journal entry

Example

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:

Accounts receivable accounting example

Oct 11

Sale = 3,000 × $250 = $750,000

Oct 17

Cash collected = $575,000

Oct 25

Sale = 1,700 × $250 = $425,000

Nov 3

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

Nov 9

Cash collected = 3,000 × $250 = $750,000

Nov 17

Sale = 2,500 × $260 = $650,000

Nov 22

Sales Returns = 150 × $260 = $39,000

Nov 26

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

Dec 7

Sale = 4,000 × $245 = $980,000

Dec 15

Sales Returns = 200 × $245 = $49,000

Dec 21

Sale = 1,500 × $250 = $375,000

T-accounts

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.

Accounts receivable accounting in T-accounts format