Lecture 3 - Accounting for Accounts Receivable

Accounting for Accounts Receivable

When the sale is made…
Debit A/R
Credit Sales

Then, when the payment comes in…
Debit Cash
Credit A/R

Managerial issues
Accounts Receivable Turnover
Ex: 12,000,000 in sales
Balance in A/R: 1,000,000
Turnover = sales/balance in AR

In our textbook, it says A/R Turnover = Sales/Avg AR balance, where avg AR balance is (starting A/R balance + ending A/R balance)/2

High A/R turnover generally means you’re collecting quickly and is generally good. Looking at turnover trends is also valuable. A problem with high turnover is that sometimes it indicates that the company is requiring customers to pay more quickly, which may make the customers less satisfied and lead to lost sales. Comparison to industry standards is also important.

Another measure of the efficiency of accounts receivable is the Days' Receivables = 365 / A/R Turnover. It indicates how many days it typically takes to collect the receivables.

Getting Cash from Receivables

There are a few ways to get cash from the receivables as quickly as possible.
1. Just wait until the person/firm pays.
2. Take a loan from a bank and use the receivables as collateral
3. Sell the receivables to a third party, called a factor.

The factored receivable may be sold either with or without recourse. Recourse means that if the factor can't collect the receivable, the seller is responsible for the debt. Selling receivables with recourse sells for more than without recourse, because the factor doesn't bear all the risk.

Another way to get cash is by securitizing the receivables in which they are packaged and then sold on the general market, not to a particular factor.

Accounts Receivable Entries

Direct write-off of uncollectible accounts is not allowed, due to the matching rule. You must use the allowance method which creates adjusting entries to estimate how many accounts will be uncollectible, even though you don't know which (or if) accounts will not be paid.

This is done by crediting the "Allowance for Uncollectible Accounts" account (a contra asset account, like accumulated depreciation) and debiting the uncollectible acounts expense account.

The amount that is creditted is done by estimating, usually based on industry standard or company history.

When, subsequently, an account does go bad, the write-off entry is done by crediting Accounts Receivable and debiting the Allowance for Uncollectible Accounts account.

If you eventually do collect the account, there are two steps:
First debit A/R and credit Allowance for Uncollectible Accounts.
Then, record the cash receipt by debiting Cash and crediting A/R.

Estimating Accounts Receivable Collectibility

First method is based on a percentage of all sales. This estimates the amount to debit to Uncollectible Accounts Expense.

The second method is to prepare an aged receivables schedule of each account and the amount that the account is 1-30 days, 31-60 days, 61-90 days and 90+ days overdue. For each category, assign a percentage that will be considered uncollectible. This estimates the amount to credit to the Allowance for Uncollectible Accounts account.