Lecture Notes: Understanding Accounts Receivable

Introduction to Accounts Receivable

• Definition: Amounts owed by customers for goods or services sold on credit.
• Contrast with cash transactions:
  • In cash transactions, immediate payment is received.
  • Analyze transactions by asking:
    • What did we get?
    • What did we give away?
  • Use enhancing questions:
    • What did we earn?
    • What did we use or consume?
    • What do we owe?

Accounting for Cash Transactions

• Cash received: Considered an asset with future economic benefits.
• Goods/services given: Revenue earned.
• Impact on accounting equation:
  • Increase in assets (cash).
  • Increase in equity (through revenues).

Selling on Account (Credit)

• Description: Goods/services provided now, payment received later.
• Recording:
  • Record revenue: Service/goods delivered.
  • Record asset: Future cash collection right (accounts receivable).
• Accounts Receivable on Financial Statements:
  • Listed under current assets on the balance sheet.
  • Collected within one year or operating cycle.
  • Positioned by liquidity: Below cash/short-term investments; above inventory and prepaids.

Benefits of Selling on Account

• Competitive necessity: Attracts customers who prefer credit.
• Customer advantage:
  • Obtain product/service without immediate cash payment.
  • Delay cash payments while benefitting from goods/services.

Costs of Selling on Account

• Seller disadvantage: Delay in cash flow.
• Additional costs involved, such as potential non-payment.

Example Transactions

Example 1

• Date: August 28, 2014
• Transaction: $1,200 services sold on credit.
• Entries:
  • Increase in assets (Accounts Receivable).
  • Increase in equity (Revenues).
• Payment follow-up:
  • October 2: No transaction entry required.
  • October 18: Payment received, decrease accounts receivable, increase cash.

Example 2

• Date: November 1, 2014
• Transaction: $6,000 goods sold on credit (cost $2,500).
• Terms: Net 15
• Entries:
  • Sales entry: Increase assets (Accounts Receivable), increase equity (Sales).
  • Cost entry: Decrease inventory (Asset), increase cost of goods sold (Expense).
• Payment follow-up:
  • November 28: Partial payment of $4,000, reduce accounts receivable.
  • December 18: Remaining $2,000 paid, accounts receivable reduced to zero.

Example 3

• Date: November 1, 2014
• Transaction: $18,000 services sold on credit.
• Terms: 2/10 net 45
• Challenge: Customer may not pay.
• Consideration:
  • Accounts receivable may not represent full economic benefit.
  • Future economic benefit might be zero if the customer defaults.

Conclusion

• Accounts receivable involve the risk of non-payment.
• Valuation of accounts receivable at year-end to reflect true economic benefit is challenging.
• Next video will explore valuation methods for accounts receivable.