Accounting for Account Receivable | Trade Receivable
Learning Objectives
I. Cash and credit sales
II. Accounting for irrecoverable debts
III. Allowance for receivables
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I. Cash and credit sales
Cash Sales
If a sale is for cash, the customer pays for the goods/services at the point of sale. The double entry for cash sales is:
Dr Cash……………..xx
Cr Sales revenue…………xx
Credit Sales
When sales are made on credit, the revenue is recorded with a corresponding asset that represents the customer’s commitment to pay. The asset is referred to as a ‘receivable.
The double entry is recorded as follows:
Dr Receivables……..xx
Cr Sales revenue……………xx
When the customer eventually settles the debt the double entry will be:
Dr Cash account …..xx
Cr Receivables …………….xx
This then clears out the balance on the customer’s account.
II. Accounting for irrecoverable debts
An irrecoverable debt is a debt which is, or is considered to be, uncollectable.
There is a possible situation where a debt is written off as irrecoverable in one accounting period, perhaps because the customer has been declared bankrupt, and the money, or part of the money, due is then unexpectedly received in a subsequent accounting period.
When a debt is written of the double entry is:
Dr Irrecoverable debts expense……………………………………xx
Cr Receivables (removing the debt from the accounts)……..xx
When an irrecoverable debt is recovered, Instead the accounting entry is:
Dr Cash………………………………………….xx
Cr Irrecoverable debts expense…………..xx
Example
Araf & Co have total accounts receivable at the end of their accounting period of $45,000. Of these it is discovered that one, Mr Xiun who owes $790, has been declared bankrupt, and another who gave his name as Mr. Jones has totally disappeared owing Araf & Co $1240.
Required
Make journal entry
Solution
Dr Irrecoverable debts expense……2,030
Cr Receivables, Mr.Xiun……………..……………….790
Cr Receivables, Mr.Jones………………….……..1,240
So net receivables in balance sheet are $42,970($45,000-$2,023) and Irrecoverable debts expense in income statement is $2,030.
Example
Celia Jones had receivables of $3,655 at 31 December 20X7. At that date she wrote off a debt from Lenny Smith of $699. During the year to 31 December 20X8 Celia made credit sales of $17,832 and received cash from her customers totaling $16,936. She also received the $699 from Lenny Smith that had already been written off in 20X7.
Required
1. Make journal entry for 20X7 and 20X8
2. What is the final balance on the receivables account at 31 December 20X7 and 20X8?
Solution
Year 20X7
Dr Irrecoverable debts expense……699
Cr Receivables, Lenny Smith ………………….……..699
So net receivables in balance sheet are $2,956 ($3,655 -$699) and Irrecoverable debts expense in income statement is $699.
Year 20X8
Credit Sale
Dr Receivables……………………..17,832
Cr Sales revenue………………………………..17,832
When the customer eventually settles the debt the double entry will be:
Dr Cash account …………………16,936
Cr Receivables ………………………………….16,936
When an irrecoverable debt in 20X7 is recovered, the accounting entry is:
Dr Cash………………………………….699
Cr Irrecoverable debts expense………699
So net receivables in balance sheet are $3,852 ($2,956 +17,832 -$16,936) and Irrecoverable debts expense as negative (it means it is income) in income statement is $699, and sales revenue is $17,832.
III. Allowance for receivables
There may be some debts in the accounts where there is come cause for concern but they are not yet definitely irrecoverable. It is prudent to recognize the possible expense of not collecting the debt in the statement of profit or loss.
The allowance should consist only of specific amounts where, for example, the customer is known to be in financial difficulty, or is disputing the invoice, or payment is already overdue, or is refusing to pay for some other reason (e.g. a faulty product), and therefore the amount owing may not be recovered. Therefore, an allowance can only be established where there is some objective evidence that a particular receivable may not be recovered in part or in full.
An allowance for receivables is set up with the following journal:
Dr Irrecoverable debts expense………xx
Cr Allowance for receivables………………..xx
If there is already an allowance for receivables in the accounts (opening allowance), only the movement in the allowance is charged to the statement of profit or loss (closing allowance less opening allowance).
As the allowance can increase or decrease, there may be a debit or a credit in the irrecoverable debts account so the above journal may be reversed.
Example
On 31 December 20X1 Jake Williams had receivables of $10,000. At that date, Jake estimated that there was evidence that amounts totaling 300$ may not be recovered as those receivables were already overdue and he therefore wanted to make a specific allowance for this amount.
During 20X2, Jake made sales on credit totaling $100,000 and received cash from his customers of $94,000. At 31 December 20X2, Jake now considered that there was doubt regarding the recoverability of amounts totaling $700 which were overdue and which may not be recovered. The allowance for receivables should therefore be increased from $300 to $700.
During 20X3 Jake made sales on credit of $95,000 and collected $96,000 from his receivables. At 31 December 20X3 Jake now considered that amounts totaling only $600 required an allowance for being overdue at that date. The allowance for receivables should therefore be adjusted from $700 to 600$.
Calculate the allowance for receivables and the irrecoverable debt expense as well as the closing balance of receivables for each of the years 20X1, 20X2, 20X3. You may make journal entry.
Solution
Year 20X1
An allowance for receivables is set up with the following journal:
Dr Irrecoverable debts expense………300
Cr Allowance for receivables………………..300
Statement of financial position
Receivables……………………………….10,000
Less: Allowance for receivables…..(300)
————————————————-9,700
Year 20X2
Credit Sale
Dr Receivables……………………..100,000
Cr Sales revenue………………………………..100,000
When the customer eventually settles the debt the double entry will be:
Dr Cash account …………………94,000
Cr Receivables ………………………………….94,000
An allowance for receivables is set up with the following journal:
Dr Irrecoverable debts expense………400*
Cr Allowance for receivables………………..400
*400=700-300
Statement of Financial Position
Receivables……………………………16,000**
Less: allowance for receivables…(700)
———————————————–15,300
**16,000 = 10,000 + 100,000-94,000=$16,000
Year 20X3
Credit Sale
Dr Receivables……………………..95,000
Cr Sales revenue………………………………..95,000
When the customer eventually settles the debt the double entry will be:
Dr Cash account …………………96,000
Cr Receivables ………………………………….96,000
An allowance for receivables is set up with the following journal:
Cr Allowance for receivables….100
Dr Irrecoverable debts expense………100***
***100=600-700
Statement of Financial Position
Receivables……………………………15,000****
Less: allowance for receivables…..(600)
———————————————–14,400
****15,000 = 16,000+ 95,000-96,000
Source: ACCA, F3 by KAPLAN