When a company makes a sale on credit it records the amount due from the customer in

Credit sales may be used for retaining customers and attracting new ones, but they may also add complexities to record keeping. Compared with cash sales and their simple recording, credit sales need to record not only initial sales but also potential credit losses and eventual cash collections.

When credit sales to some customers become uncollectible, businesses making the sales incur a bad debt expense. Thus, businesses must evaluate the realizable value of their accounts receivable. Unlike a straight cash sale journal entry example, recording credit sales is not complete until businesses have actually made cash collections.

Recording Accounts Receivable and Sales Returns

Accurately recording accounts receivable and any sales returns is vital to good record keeping. According to Accounting Capital, at the time of the credit sales, a business' credit purchase journal entry records accounts receivable as a debit and sales as a credit in the amount of the sales revenue. Instead of receiving cash from the sales, companies agree to delayed payments by holding customers' accounts receivable. Because no cash changes hands, for any returned sales from customers, businesses debit sales returns to reduce earlier sales, and credit accounts receivable to arrive at the reduced outstanding balance.

Estimated Losses and Accounts Receivable

Businesses sometimes make credit sales knowing that some accounts may eventually become uncollectible. In the period when the credit sales occur, companies may estimate the amount of potential losses from the credit sales based on past experience and current customer credit evaluation. The estimated losses are recorded in "allowance for doubtful accounts," a negative account to accounts receivable. Businesses use the allowance account to ensure the proper carrying value of accounts receivable.

Recording Bad Debt Expenses

According to FreshBooks, to properly record credit sales, businesses must record the bad debt expense from uncollectible accounts receivable in the period when the credit sales occur. This is to match an expense with the revenue. The bad debt expense is debited as part of the overall cost of making the credit sales, and the allowance for doubtful accounts is credited as a reduction to the total amount of accounts receivable.

Recording Cash Collections

Businesses specify in the terms of credit sales when customers must make their cash payments. The terms may also allow customers to make early cash payments for a discount. To record regular, on-time cash collections, businesses debit the cash account and credit accounts receivable to remove collected customer accounts. To record early cash collections, businesses debit both the cash account and the account of sales discounts as an expense and credit accounts receivable to reduce the outstanding balance.

What Are Accounts Receivable (AR)?

Accounts receivable (AR) are the balance of money due to a firm for goods or services delivered or used but not yet paid for by customers. Accounts receivable are listed on the balance sheet as a current asset. Any amount of money owed by customers for purchases made on credit is AR.

Key Takeaways

• Accounts receivable (AR) are an asset account on the balance sheet that represents money due to a company in the short term.
• Accounts receivable are created when a company lets a buyer purchase their goods or services on credit.
• Accounts payable are similar to accounts receivable, but instead of money to be received, they are money owed. 
• The strength of a company’s AR can be analyzed with the accounts receivable turnover ratio or days sales outstanding. 
• A turnover ratio analysis can be completed to have an expectation of when the AR will actually be received.

Accounts Receivable

Understanding Accounts Receivable

Accounts receivable refer to the outstanding invoices that a company has or the money that clients owe the company. The phrase refers to accounts that a business has the right to receive because it has delivered a product or service. Accounts receivable, or receivables, represent a line of credit extended by a company and normally have terms that require payments due within a relatively short period. It typically ranges from a few days to a fiscal or calendar year.

Companies record accounts receivable as assets on their balance sheets because there is a legal obligation for the customer to pay the debt. They are considered a liquid asset, because they can be used as collateral to secure a loan to help meet short-term obligations. Receivables are part of a company’s working capital.

Furthermore, accounts receivable are current assets, meaning that the account balance is due from the debtor in one year or less. If a company has receivables, this means that it has made a sale on credit but has yet to collect the money from the purchaser. Essentially, the company has accepted a short-term IOU from its client.

Many businesses use accounts receivable aging schedules to keep tabs on the status and well-being of AR.

Accounts Receivable vs. Accounts Payable

When a company owes debts to its suppliers or other parties, these are accounts payable. Accounts payable are the opposite of accounts receivable. To illustrate, imagine Company A cleans Company B’s carpets and sends a bill for the services. Company B owes them money, so it records the invoice in its accounts payable column. Company A is waiting to receive the money, so it records the bill in its accounts receivable column.

Benefits of Accounts Receivable

Accounts receivable are an important aspect of a business’s fundamental analysis. Accounts receivable are a current asset, so it measures a company’s liquidity or ability to cover short-term obligations without additional cash flows. 

Fundamental analysts often evaluate accounts receivable in the context of turnover, also known as accounts receivable turnover ratio, which measures the number of times a company has collected on its accounts receivable balance during an accounting period. Further analysis would include assessing days sales outstanding (DSO), the average number of days that it takes to collect payment after a sale has been made.

Example of Accounts Receivable

An example of accounts receivable includes an electric company that bills its clients after the clients received the electricity. The electric company records an account receivable for unpaid invoices as it waits for its customers to pay their bills. 

Most companies operate by allowing a portion of their sales to be on credit. Sometimes, businesses offer this credit to frequent or special customers that receive periodic invoices. The practice allows customers to avoid the hassle of physically making payments as each transaction occurs. In other cases, businesses routinely offer all of their clients the ability to pay after receiving the service.

What are examples of receivables?

A receivable is created any time money is owed to a firm for services rendered or products provided that have not yet been paid. This can be from a sale to a customer on store credit, or a subscription or installment payment that is due after goods or services have been received.

Where do I find a company’s accounts receivable?

Accounts receivable are found on a firm’s balance sheet. Because they represent funds owed to the company, they are booked as an asset.

What happens if customers never pay what’s due?

When it becomes clear that an account receivable won’t get paid by a customer, it has to be written off as a bad debt expense or one-time charge.

How are accounts receivable different from accounts payable?

Accounts receivable represent funds owed to the firm for services rendered, and they are booked as an asset. Accounts payable, on the other hand, represent funds that the firm owes to others—for example, payments due to suppliers or creditors. Payables are booked as liabilities.

What are credit sales recorded as?

What happens when a company sells on credit?

When a sale is made to a customer on credit?

When a company makes a sale on credit What does the account receivable represent on its balance sheet?