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| Corporate practice bd |
Accounts Receivable (AR): Definition, Examples(In balance sheet Items)
Accounts Receivable (AR) represents the money owed to a company by its customers for goods or services delivered but not yet paid for. It is considered a current asset on the balance sheet because it is typically expected to be collected within one year. Proper management of accounts receivable is crucial for maintaining the cash flow and financial health of a business.
Journal Entries for Accounts Receivable
Initial Sale on Credit
When a sale is made on credit, the following journal entry is recorded:
- Debit: Accounts Receivable (to increase the asset)
- Credit: Sales Revenue (to recognize the income)
Example:01.
ABC Corporation sells goods worth $5,000 on credit to XYZ Inc. on January 1, 2024. The payment terms are Net 30.
Journal Entry:
Date Account Debit Credit
2024-01-10
Accounts Receivable $5,000.00
Sales Revenue $5,000.00
Collection of Accounts Receivable
When the customer pays the amount owed, the following journal entry is recorded:
- Debit: Cash (to increase the cash balance)
- Credit: Accounts Receivable (to decrease the receivable)
Example:02.
XYZ Inc. pays the $5,000 owed on January 30, 2024.
Date Account Debit Credit
2024-01-30 Cash $5,000.00
Accounts Receivable $5,000.00
Recording a Bad Debt Expense
If it becomes clear that a customer will not pay the amount owed, the company needs to write off the bad debt:
- Debit: Bad Debt Expense (to recognize the expense)
- Credit: Accounts Receivable (to remove the un collectible amount)
Example:03.
ABC Corporation determines that $500 of the amount owed by XYZ Inc. is uncollectible.
Date Account Debit Credit
2024-02-28
Bad Debt Expense $500.00
Accounts Receivable $500.00
Examples 04.
Example 1: Sale on Credit
A furniture store sells a sofa worth $2,000 to a customer on credit. The customer agrees to pay within 60 days.
Journal Entry for Sale on Credit:
Date Account Debit Credit
2024-03-01
Accounts Receivable $2,000.00
Sales Revenue $2,000.00
Example 05: Writing Off a Bad Debt
The furniture store decides that another customer, who owes $300, will not be able to pay. They write off the debt.
Journal Entry for Writing Off Bad Debt:
Date Account Debit Credit
2024-04-15
Bad Debt Expense $300.00
Accounts Receivable $300.00
Example 06: Collection of Accounts Receivable
The customer pays the $2,000 owed after 30 days.
Date Account Debit Credit
2024-03-31
Cash $2,000.00
Accounts Receivable $2,000.00
Example 07: Collection of Accounts Receivable
The customer pays the $2,000 owed after 30 days.
Journal Entry for Collection:
Date Account Debit Credit
2024-03-31
Cash $2,000.00
Accounts Receivable $2,000.00
Importance of Accounts Receivable Management
- Cash Flow: Effective management ensures steady cash flow, crucial for daily operations.
- Credit Policies: Setting appropriate credit policies helps in minimizing bad debts.
- Customer Relationships: Timely and accurate invoicing and collection improve customer relationships.
- Financial Health: Accurate tracking of receivables provides a clear picture of the company's financial health.
Conclusion
Accounts receivable are a vital part of a company’s financial operations. Proper recording, management, and collection of receivables ensure that a company maintains a healthy cash flow and accurately reflects its financial position. Understanding and managing accounts receivable effectively can significantly impact the success and stability of a business.