The Accounting Tabloid: Receivables, Simply Explained

by Othneil Hall

Overview

It is easy to be confused by different methods of accounting, and one of the hardest concepts to understand is receivables. In this guide, author Othneil Hall, a longtime accounting professional, examines accounts receivable in easy-to-understand language in this handbook for students, of?ce managers, bookkeepers, receivables specialists, and everyone else interested in mastering the basics of this critical feature of accounting. 

 

You will learn almost everything on receivables, including how to

 

understand the various types of receivables accounting; record receivables in the most ef?cient manner; convert accounts receivable into notes receivable; and make adjustments for bad debts.

 

This guide also provides advice on how to change your approach based on whether you work for a service-oriented company or one that revolves around merchandise inventory. Some of the transactions are similar between the two types of companies, while some are not.

 

Whether you are seeking to understand financial terms, get a job in the financial services ?eld, improve your organization’s collection of accounts receivable, or boost your general knowledge of accounting, The Accounting Tabloid can help.

Product Details

ISBN-13:	9781458214348
Publisher:	Abbott Press
Publication date:	12/05/2017
Sold by:	Barnes & Noble
Format:	eBook
Pages:	164
File size:	576 KB

Read an Excerpt

CHAPTER 1

Some important things to remember

• Accounting transactions are about making double entries of debits and credits.

• You must be able to analyze each transaction before journalizing them. That is determining how each transaction affects the asset, liability or equity account.

• All accounting transactions must be journalized first. Although with modern computer software, once you have entered a transaction based on a document such as an invoice via the computer, the software skillfully handles everything behind the scene.

• A journal is the book of original entry that the transactions are recorded in by order of the date the transactions occurred. Most companies have separate journals for credit sales, credit purchases, cash receipts, cash disbursements and general journal entries. If they do not have a journal for each of these tasks, they will at least have a general journal for the recording of all transactions.

• For every debit entry, there has to be a corresponding credit entry, and for every credit entry, there has to be a corresponding debit entry.

• Total debits must equal total credits.

• Accounting equation: Assets = Liabilities + Equity. $2,200 = 650 + 1550

Illustration I

Assets are the value of things you own $2,200
What this means, is that, if the owner decides to sell the assets at this moment, he/she collects cash $2,200. Pays the liabilities of $650 and retains $1,550.

The Accounting Cycle

The accounting cycle refers to the sequence of steps that lead up to the preparation of the financial statements. This process starts with the analysis of transactions to mostly the preparation of the post- closing trial balance. The accounting cycle is vital to understand since it is the structure upon which accounting is designed.

The Explanation of the Accounting Cycle

1. Analyzing the source documents

This step is the first part of the process when the source documents such as invoices or checks are analyzed, to determine how they affect asset, liability or equity.

2. Recording the transactions in the Journal

The transactions are then recorded in the journal. For example, if the source documents are sales invoices; these invoices are recorded as debits to accounts receivable and credits to Sales or Service Revenue.

Note: If your accounting system is computerized, once you have entered the invoices to the system, the software automatically does the debit and credit entries in both the journal and the ledger behind the scene.

3. Posting the transactions to the ledger

After recording the transactions in the journal, post the entries to the respective accounts in the ledger (e.g., the record keeping of the customer accounts is the accounts receivable ledger). That is, an update to the individual customer account with each amount as a debit entry, and update to the sales account with the corresponding credit entry.

4. The preparation of the unadjusted trial balance

Each account balance in the ledger is used to produce the unadjusted trial balance.

5. Make the adjustments

At this stage, any adjusting entries necessary are now made. There are five categories of adjusting entries:

I. Prepaid expenses-adjusting for expired or used amounts.

II. Depreciation which systematically and rationally allocates the cost of assets over a given period.

III. Accrued expenses - Expenses incurred but not yet paid.

IV. Accrued revenue - Revenue earned, but the business has not yet collected the cash.

V. Unearned revenue - Cash collected in advance, but the business has not yet earned the revenue.

Note that, the making of an adjusting entry always affect an income statement revenue or expense account, and a balance sheet asset or liability account.

6. Prepare adjusted trial balance

After making the adjusting entries to the previous ledger balances, the adjusted trial balance is then prepared according to the new balances.

7. Prepare statements

The adjusted trial balance is now used to prepare the financial statements.

8. Closing Entries

Close temporary accounts by journalizing and posting.

9. Prepare post-closing trial balance

A post-closing trial balance is now prepared.

10. Reversal entries

This step is optional.

FOB (Free on Board) Shipping Point

The buyer is responsible for paying the shipping or transportation cost. Ownership of the merchandise inventory is passed from the seller to the buyer once the goods are loaded on an accepted means of transportation. That means, even though the goods are in transit, they are now part of the buyer's inventory and any risk associated with the goods while in transit are undertaken by the buyer.

Note that, under FOB shipping point arrangement, there are times when the seller pays the shipping cost, and the buyer has to reimburse the seller.

FOB (Free on Board) Destination Point

The seller is responsible for paying the shipping or transportation cost. Ownership of the merchandise inventory is not passed to the buyer until the goods arrive at the buyer's place of business. That means the seller undertakes the risk involved in transporting the goods and cannot record a sale until the goods reach the buyer (goods are part of the seller's inventory while they are in transit).

How Debits and Credits affect the three Main Types of Balance Sheet Accounts

Debit

Increase in asset accounts Decrease in liability accounts Decrease in equity accounts

Credit

Decrease in asset accounts Increase in liability accounts Increase in equity accounts

How Debits and Credits affect the two Main Types of Income Statement Accounts

Debit

Increase in expense accounts (Reduction to equity)

Decrease in revenue accounts (Reduction to equity)

Credit

Decrease in expense accounts (Addition to equity)

Increase in revenue accounts (Addition to equity)

The Normal Balances of Accounts

Accounts have normal balances on the side where the increases are recorded

• Asset accounts have normal balances on the debit side.

• Expense accounts have normal balances on the debit side.

• Liability accounts have normal balances on the credit side.

• Equity accounts have normal balances on the credit side.

• Revenue accounts have normal balances on the credit side.

Illustration II

A Simple Income Statement Presentation

Revenue $1,500
Illustration III

A Simple Balance Sheet presentation

Assets Current assets $1,000
Liabilities Current liabilities 150
Equity Preferred stocks 500
Receivables

Whenever a Company performs a financial transaction with individuals or other companies, and it plans to collect the cash at a future date, these impending cash collections are referred to as receivables.

Just for the purpose of this book, we look at a very simple definition of receivables as, "the name given for any claims to be collected in monetary value." Therefore, when we think of receivables, our focus should be on the money owed to a company by outsiders or even by employees that are capable of collecting. The receivables can be created by either trade or non-trade activities. If the company is using an accrual system of accounting, the trade receivables are the money the company would have recognized most times as revenue earned even though they have not collected the cash as yet.

As a result of the accrual system of accounting, these future collections (receivables) cannot go un-noticed. We must recognize these receivables on the books at the point in time they are created, and because the collection is at a future date, they are considered as economic items that provide future value to the company that plans to collect them.

The Financial Accounting Standards Board (FASB)-Codification 310 has simply referred to receivables as "that which may arise from credit sales, loans or other transactions." They may be in the form of loans, notes and other types of financial instruments and may be originated by an entity or purchased from another entity.

Under the United States Generally Accepted Accounting Principles (GAAP), the FASB Codification 310 has provided a guide as to how we should treat these receivables. The argument is simply that since these receivables have proven to have some future economic value and that they belong to the company; it is now easy to conclude that they are part of the family of assets. Since they are assets, it means that they are also a balance sheet item. The classification of these assets on the balance sheet can either be current assets or long term/non-current assets. If collections are expected to be within one year or the operating cycle, whichever is longer, the receivables are part of current assets. Otherwise, they are non-current or long-term assets.

Most companies tend to list on their balance sheet a single line item of their total receivables, with further explanation in the notes or as an appendix to the financial statements.

Illustration IV

The balance sheet extract below shows Ford Motor Company presentation of total net receivables (Gross receivables less allowance for doubtful accounts) on their balance sheet. (Source: Yahoo Finance)

Some examples of receivables and their sources

While the following list does not include all the possible descriptions and sources of receivables, we have provided you with a list of the most popular ones to date.

Accounts receivable or trade receivable Sales in foreign currency Notes receivable Rent receivable Lease receivable Interest and dividends receivable Cash advances to employees Tax refund receivable Insurance claims receivable Sales on installment Retainage Loans receivable Factoring arrangement Rebates Debt security Letter of credit Standby commitment to purchase loans

We will examine each of the above regarding the recording entries.

Accounts Receivable/Trade Receivables

This is the money owed to a particular company by customers for goods sold or services provided to them on credit. These customers promise to pay, for example within a 30-60 days' time frame, and since these payments are expected to be received by the company within one year, they are classified and reported as part of current assets on the balance sheet.

Even though "cash is king" and every company is aware of such, our major concern might be why do companies continue to sell on credit.

The selling of any goods or the provision of any services only on a cash basis may not help most businesses. Therefore, companies take the risk of extending credit to their customers in an attempt to increase their sales.

While the intention behind the idea is a good one, some challenges are involved with the issuing of credit. Nonetheless, having a management team that can implement an effective credit policy, some of these problems can be mitigated or minimized.

An Effective Accounts Receivable System

Remember that a poor cash flow can be disastrous for any business entity. Therefore, before a company gives credit to any new customer, credit checks of the customer are required so as to minimize any risk involved in the process. Companies that sell on credit need to have as best as possible, an effective and efficient accounts receivable system in place so as to facilitate the smooth collection of the cash from the hands of the customers.

Management should ensure that each section of their accounts receivable department runs as efficiently as possible so that it produces the desired result.

There are some things that a company can do to help their system of collection:

• The numbering of invoices: Invoices must have a numbering sequence for effective control.

• Dispatching of invoices: Companies must ensure that invoices are dispatched as early as possible so as to let the customers be aware of the seriousness about cash collection. If customers see that you have little or no care in sending out your invoices early, they too in return may display a lack of urgency in paying any money owed.

• The accuracy of invoices: There is an absolute need for the correctness of any invoice sent to a customer. The invoice must state accurately the amount owed, the due date for payment, discount allowed if any, the description of the items sold and any other pertinent information that needs to be conveyed. Owing customers most times take advantage of errors on the invoices by delaying payment of the invoices until they are contacted. The time required to effect the necessary correction is time lost in collecting and utilizing your cash.

• Credit card payment: Some companies implement a system of having their customers' credit card details on hand so that they can easily charge the amount due on the invoices against their accounts. While this type of arrangement is good, effective internal controls are needed so as to prevent mistakes and fraud.

• Store card: Some retail stores issue store cards to their customers, in this case, the amount owed by the customers at most times starts attracting interest from the date of the purchase. This type of arrangement can be a huge advantage for the retail stores because it allows them to escape the fees charged by credit card companies. Monthly statements are then sent out to these customers who have the option of making at least a minimum payment.

• Accounts receivable reconciliation: Whenever goods or services are sold or provided on credit to customers, it is advisable to try our utmost to keep an accurate record of all the accounts receivable and invoices outstanding. In order to have proper checks and balances, it is good for the company to keep a second set of records in Microsoft Excel as a support for the information in the journal and ledger. The comparison can be made to detect any discrepancy.

• Employee training: Companies must also ensure that their employees receive the necessary training to do the job. Not having adequately trained employees can result in the loss of money to companies. The employees must be taught the following:

- how to handle the collection of payments,

- how to make adjustments as it relates to disputes and write-offs concerning the customers' accounts,

- how to conduct follow-ups to ensure that the customers are satisfied,

- how to push aggressively for the collection of any cash outstanding without pushing the customer away since client retention is also an objective.

• Collection agency: There is a need to have an excellent collection agency in place should there be a need for one. They are required specifically to help in the collection of overdue accounts so as to avoid excessive writing off of bad debts.

• Periodic Audit: Management needs to have periodic audit of the accounts receivable system to ensure compliance. Therefore, the system and procedure need to be adequately documented.

• Open door policy: Having an open door policy so that staff members can feel free to communicate ideas or any other relevant inputs so as to improve the system.

(Continues…)

---

Excerpted from "The Accounting Tabloid"
by .
Copyright © 2017 Othneil Hall.
Excerpted by permission of Abbott Press.
All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.
Excerpts are provided by Dial-A-Book Inc. solely for the personal use of visitors to this web site.

---

Table of Contents

Some important things to remember, 1,
Receivables, 11,
Credit balance in accounts receivable, 25,
Lock Box Banking, 26,
Handling Discount, 27,
Analysis of Accounts Receivable, 34,
Sales Returns and Allowances, 39,
Transportation Cost, 45,
Valuing Accounts Receivable, 47,
Credit Card Payments, 67,
Sales in Foreign Currency, 69,
Notes Receivable, 72,
Valuation of Notes Receivable, 97,
Disposition (Selling) of Accounts Receivable, 100,
Pledging of receivables, 106,
Some important Ratios, 108,
Rent receivable, 110,
Lease Receivable, 111,
Interest receivable, 119,
Dividends Receivable, 120,
Cash advances to employees, 121,
Income Tax Receivable, 123,
Insurance Claims Receivable, 126,
Sales on Installment, 128,
Retainage, 130,
Loans Receivable, 132,
Factoring Arrangement, 133,
Rebates, 134,
Investment in Debt Securities, 135,
Investment in Equity Securities, 137,
Letter of Credit, 138,
Standby Commitment, 140,
Mini cases, 141,
Glossary, 145,
Index, 151,