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The Fundamental Accounting Equation
A Simple Balance Sheet and Income Statement
Debits and Credit Transaction Posting Rules
8b. Another Cash Transaction Posting Example
Accounts Payable and Wage Withholding
Prepaid Expenses and Deferred Revenue
Inventory and Cost of Goods Sold
The Lower of Cost or Market Rule
Financial Statement Preparation
16. The Reliability of Financial Statements
Relative Measures of Economic Performance
This article describes Accounts Receivable.
In accrual accounting, revenue is recorded when earned, and expenses recorded when incurred. A customer’s obligation to pay for goods and services provided is called accounts receivable(A/R). From the firm’s point of view, A/R are assets.
When a business extends credit to customers, it assumes a certain risk that it may not be able to collect what it is owed. Why would a business be willing to let customers wait to pay for goods and services they have already received? Perhaps you have seen the sign over a business counter that says, ” In God we trust…all others pay cash”. Indeed, it would seem like a more prudent business practice to insist on cash payment as soon as goods or services are delivered. Or, even better why not get paid before goods and services are delivered?
Generally, firms extend credit to customers and clients because they have to. If a business refuses to extend credit it may lose customers to competitors who do. Many managers conclude that the additional revenue made by extending credit outweigh the costs of non-collection of receivables.
When a business extends credit to its customers, it records a revenue transaction at the time it provides its customer with goods or services. The transaction results in a revenue account increase and an increase in an asset account. Since no cash is received, the asset account that is increased is A/R.
When Joint Ventures made its December delivery the Columbian Grower’s Co-op did not pay the balance owed until January. When the delivery was completed the Co-op had an obligation to pay Joint Ventures for its services. Joint Ventures completed the $50,000 delivery on December 20. Assume that the Co-op had already paid $5,000 on the delivery, so on December 20 the following journal entry would be made:
A/R is an asset account. Notice that no cash account was involved in the transaction, because no cash changed hands. An asset account was increased and equity (revenue) was increased. If on January 5 the Co-op paid the $45,000 owed, the transaction would be recorded in this way:
Notice that no revenue account was affected by the January payment. This is because the revenue was recorded in December 2018, when Joint Ventures actually earned it. In January, all that happened was that one asset account, Cash, increased, while another asset account, A/R, decreased.
If a business only has credit sales (i.e., it never receives cash when the sale is made), all cash collections from customers can be deemed to be credits to Accounts Receivable. Conversely, if a business has no credit sales (i.e., it never extends credit and receives cash whenever a sale is made), all cash received from customers can be credited directly to a revenue account.
A good number of businesses fall between these extremes. Sometimes they extend credit and sometimes they receive cash immediately. To avoid accounting confusion and accurately track accounts receivable, a business that extends credit to customers must maintain a special set of accounting records called subsidiary ledgers. An A/R subsidiary ledger consists of the revenue and payment history of each customer to which a business extends credit.
Assume that the Columbian Growers Co-op contracts with Joint Ventures for three deliveries and makes two payments in 2018. The accounts receivable subsidiary ledger on Joint Ventures would look like this:
In a manual accounting system, a business like Joint Ventures has to record all deliveries and payments twice: once in the general journal, and once again in the subsidiary ledger. Because two postings are required for each delivery and payment, transcription errors may cause the ending balance of the accounts receivable to disagree with the cumulative ending balances in the subsidiary ledgers. Finding such discrepancies can be a time consuming and expensive process.
When using computerized accounting software, all payments and deliveries are posted simultaneously to the subsidiary ledger and the general ledger accounts receivable account. In fact, in a computerized software system, even a cash sale is recorded in the general ledger and subsidiary ledger as if it were a credit transaction. In this case, the service or product delivery date is the same as the payment date.
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