Accounting for Receivables

Receivables are amounts that a company is entitled to receive in cash/bank, with a receipt being due either at present or in future. Receivables may arise as a consequence of the company’s main operations i.e. the usual business or they may sometimes originate from other transactions.

Receivables are 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 the primary course of business. Another way receivables may be classified is whether interest is chargeable on the amount outstanding.

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

Trade receivables include:

  1. Accounts receivable
  2. Notes receivable

Accounts receivable

Accounts receivable are current assets which represent amounts to be collected from customers for goods sold or services provided. When a company sells goods or provides services, the customers usually do not make a payment on the 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 the 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 the customer, the accounts receivable balance on the balance sheet is reduced through the following journal entry:

CashABC
Accounts receivableABC

Many companies allow customers a certain percentage as cash discount when they make the payment quickly. The cash discount depends on the credit terms of the sale.

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 using the following journal entry:

Notes receivableG
Sales/cash/accounts receivableG

Interest on notes receivable is accrued as follows:

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

Non-trade receivables

None-trade receivables are receivables that arise from transactions other than those related to the company’s main course of business. Examples include:

  1. Advances to employees
  2. Advance tax paid
  3. Deposits placed with other companies (if advancing money is not the primary business)

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 above 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 a note receivable on 1 May is booked via the following journal entry:

Note receivable100,000
Accounts receivable100,000

The following journal entry is made to account for the receipt of note receivable principal and interest:

Cash100,833
Note receivable100,000
Interest income833

Whereas, the interest income is calculated as: $100,000 × 5% × 60/360

by Irfanullah Jan, ACCA and last modified on

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