Typically, you as a business usually sell goods on credit to your customers. That is, you deliver goods or render services now, send the invoice, and get paid for them at a later date.
Now, you record the money that your customers owe to you as Accounts Receivable in your books of accounts.
Accounts Receivables are one of the important current assets of your business. Typically, you sell goods or services on credit to attract customers and augment your sales.
Likewise, extending trade credit is helpful to your customers for it gives them time to pay for goods or services they purchase on credit.
However, there is an element of risk attached to accounts receivable. That is, you are yet to receive cash against such credit sales. Therefore, it is important that you manage your accounts receivable carefully.
In this article, we will learn what is accounts receivable, accounts receivable examples, and accounts payable vs accounts receivable.
Accounting 101 for small businessesSmall business owners need to understand the basics of accounting to make informed business decisions, manage cash flow, and ensure the long-term sucess of their business
Accounts Receivable refers to the amount that your customers owe to you for the goods or services sold to them on credit. Such credit sales are also known as trade receivables or extending trade credit to your customers.
In other words, you provide goods and services to your customers instantly. However, you receive payments for such goods and services after a few days.
The customers to whom you sell goods or services on credit are recorded as trade debtors or accounts receivable in your books of accounts. That is, you record accounts receivable in general ledger accounts under the account titled ‘Accounts Receivable’ or ‘Trade Debtors’.
So, the question that comes to mind is as follows: ‘Is Accounts Receivable an Asset’? Yes, because this is the outstanding balance that you are yet to receive from your customers. Accordingly, such unpaid balance in the accounts receivable account forms part of the current assets on your company’s balance sheet.
As a seller, you must be careful in extending trade credit to your customers. This is because there is a risk of non-payment attached to accounts receivables. The customers who may not pay for the goods sold to them are recorded as bad debts in the books of accounts.
Typically, businesses sell goods on credit only to creditworthy customers. Still, good accounting practice requires you to keep some amount for accounts receivable that may not be paid.
This amount is recorded in the provision for doubtful accounts. Thus, the Bad Debts Expense Account gets debited and the Allowance for Doubtful Accounts gets credited whenever you provide for bad debts.
So, the Allowance for doubtful accounts helps you to understand how much amount you need to collect from your debtors. In other words, the credit balance in the Allowance for doubtful accounts tells you the amount that is doubtful to be collected from your credit customers.
Does this section answer the question ‘Is Accounts Receivable an Asset’? Yes! As stated above, Accounts Receivable is an asset account recorded as current assets on your company’s balance sheet.
It is nothing but the amount that your customers owe to you in a short period of time for the goods or services they receive on credit.
Accounts receivable is recorded as the current asset on your balance sheet. This is because you are liable to receive cash against such receivables in less than one year.
However, if such a receivable takes more than one year to convert into cash, it is recorded as a long-term asset on your company’s balance sheet.
Further, as mentioned earlier, there is a risk of non-payment attached to some of your accounts receivable. Therefore, as per the Accrual Accounting System, your Accounts Receivable account is reduced by the amount set aside as Allowance for Doubtful Accounts.
The Allowance for Doubtful Accounts tells you about the estimated amount of bad debts associated with specific accounts receivable.
So, the following balance sheet of XYZ Enterprises shows accounts receivable as on the year ending December 31, 2019.
| Assets | Amount | Liabilities | Amount |
| Current Assets | Current Liabilities | ||
| Cash | $200,000 | Accounts Payable | $60,000 |
| Accounts Receivable | $80,000 | Notes Payable | $25,000 |
| Inventory | $25,000 | Accrued Expenses | $14,800 |
| Prepaid Expenses | $10,000 | Deferred Revenue | $5,000 |
| Investments | $20,000 | ||
| Total Current Assets | $335,000 | Total Current Liabilities | $104,800 |
| Property & Equipment | Long Term Debt | $330,000 | |
| Land | $30,000 | ||
| Building | $300,000 | Total Liabilities | $434,800 |
| Equipment | $50,000 | ||
| (-) Accumulated Depreciation | $5,000 | Shareholder’s Equity | |
| Total Property & Equipment | $375,000 | Common Stock | $50,000 |
| Additional Paid-In Capital | $30,000 | ||
| Other Assets | Retained Earnings | $200,000 | |
| Intangible Assets | $5,000 | Total Shareholder’s Equity | $280,000 |
| (-) Accumulated Amortization | $200 | ||
| Total Other Assets | $4,800 | ||
| Total Assets | $714,800 | Total Liabilities | $714,800 |
Let’s understand what is Accounts Receivable via an example. Lewis Publishers requires 10,000 tons of paper for publishing books at the rate of $20 per ton.
Now, Lewis Publishers purchases this quantity of paper on credit from Ace Paper Mill. In such a case, Ace Paper Mill invoices Lewis for $200,000 (10,000 tons x $20 per ton) and gives Lewis Publishers a Credit Period of 45 days to pay the amount.
Now, till the time Ace Paper Mill does not receive cash $200,000, it will record $200,000 as Accounts Receivable in its books of accounts. Thus, both accounts receivable and sales account would increase by $200,000.
When Lewis Publishers makes the payment of $200,000, Ace Paper Mill will increase the Cash Account by $200,000 and reduce Debtors or Accounts Receivable Account by $200,000.
It can also be the case that Lewis Publishers does not make the payment within 45 days. In such a case, Ace Paper Mill would either reach out to Lewis Publishers for payment or hire a collection agency for collecting Accounts Receivable.
Let’s consider the above example again to understand what is accounts receivable and the journal entry for accounts receivable.
As per the above example, Ace Paper Mill sold worth $200,000 paper to Lewis Publishers on a 45-day period credit. The journal entry at the time the invoice is raised would be as follows:
| Accounts Receivable A/c Dr | $200,000 |
| To Sales | $200,000 |
Thus, debiting Accounts Receivable with $200,000 means an increase in Accounts Receivable by the same amount.
Likewise, crediting the Sales Account by $200,000 means an increase in Sales by the same amount.
In the above example, Lewis Publishers $200,000 in cash to Ace Paper Mill within 45 days. The journal entry at the time cash is received for goods sold on credit would be as follows:
| Cash A/c Dr | $200,000 |
| To Accounts Receivable | $200,000 |
As per the above journal entry, debiting the Cash Account by $200,000 means an increase in Cash Account by the same amount.
Likewise, crediting Accounts Receivable by $200,000 means a decrease in the Accounts Receivable by the same amount.
As a business owner, you undertake numerous transactions on credit. That is, you purchase as well as sell goods on credit. When you sell goods on credit, your customers owe money to you. That is, you act as a creditor to your customers. Such a credit sale is recorded as accounts receivable in your books of accounts.
