FA22 - Accounts Receivable Explained

Summary

This financial accounting module delves into receivables, exploring why businesses extend credit and the complexities of collecting payments. It highlights the challenges of dealing with both good and bad credit customers, emphasizing the importance of estimating potential bad debts before year-end financial statements. The module also illustrates the accounting process for recognizing bad debts, emphasizing the need for educated estimates rather than waiting for debts to be confirmed as uncollectible.

Takeaways

• 😕 Receivables are a common current asset representing money owed to a company, which can be a mystery to beginners as to why they exist at all.
• 💼 Cash customers are straightforward, involving a single transaction where revenue is credited and cash is debited immediately upon payment.
• 📈 Credit customers require more work, with two journal entries: one for the initial sale and another when payment is received.
• 👍 Most customers are good credit customers who pay on time, but not all, and dealing with those who don't is a significant part of accounting for receivables.
• 🕵️‍♂️ A bad credit customer is one who doesn't pay, which can create challenges for a company and its accounts receivable function.
• 📊 The process of collecting payments from customers can be laborious, involving accounts receivables clerks and potentially a lot of chasing.
• 📆 The timing of when to recognize bad debts is crucial; accountants must estimate and record bad debt expenses in the same period as the revenue was earned.
• 💡 The matching principle in accounting requires that revenues and related expenses be recorded in the same fiscal period, even if the bad debt is only discovered later.
• 🔢 Estimating bad debts involves making an educated guess about the percentage of customers who won't pay, which is a key skill in accounting for receivables.
• 📝 Adjusting entries for receivables are necessary to account for bad debts before the financial statements are issued, even if the actual non-payment is discovered after the fiscal year-end.
• 🏦 Companies sometimes have to write off bad debts when collection efforts fail, which can be a painful decision, especially if legal action is costly or impractical.

Q & A

What is a receivable in the context of financial accounting?

A receivable is a current asset that represents money owed to a company by its customers for goods or services that have been delivered but not yet paid for.

Why do companies have receivables when they could just require cash payments?

Companies offer credit to customers to increase sales, improve customer relationships, and remain competitive. However, this introduces the complexity of managing accounts receivable and the risk of non-payment.

What is the difference between a cash customer and a credit customer in terms of accounting entries?

A cash customer transaction requires one journal entry: debiting cash and crediting sales revenue. A credit customer involves two entries: first, debiting accounts receivable and crediting sales revenue, and second, when payment is received, debiting cash and crediting accounts receivable.

What is the primary challenge for accountants in managing receivables?

The primary challenge is collecting payments from customers who owe the company money. This includes dealing with customers who may be slow to pay or who default on their payments entirely.

What percentage of customers are typically considered good credit customers according to the script?

The script suggests that approximately 90% of customers are good credit customers who pay on time, while 10% may require chasing for payment.

What is the process for an accountant to deal with a bad credit customer who does not pay?

The accountant must first attempt to collect the debt through various means, such as phone calls and resending invoices. If the customer refuses to pay or cannot be reached, the accountant may have to write off the debt as a bad debt expense.

Why can't an accountant record a bad debt expense after they know the debt has gone bad?

Accountants must adhere to the matching principle, which requires that revenues and the expenses related to those revenues be recorded in the same accounting period. Therefore, they must estimate bad debts before the end of the fiscal year, even if they do not yet know which specific debts will not be collected.

How does a company estimate bad debts that will not be collected?

Companies make an educated guess based on historical data and the percentage of customers who typically do not pay. This estimate is recorded as a bad debt expense to match the revenue recognized in the same period.

What is the impact of not being able to collect on receivables on a company's financial statements?

If a company is unable to collect on receivables, it will have to record a bad debt expense, which will reduce its net income. Additionally, the accounts receivable balance will be reduced, reflecting the loss of this asset.

What is the role of an accounts receivables clerk in a large organization?

An accounts receivables clerk is responsible for managing the company's receivables, including sending invoices, following up on overdue payments, and maintaining records of customer accounts.

Why might a company decide not to pursue legal action against a customer who refuses to pay a debt?

A company may decide against legal action if the cost of pursuing the debt, such as legal fees and the time involved, outweighs the potential recovery of the debt, especially if the debtor has moved to another country where legal recourse may be more difficult.