Lesson 7-1: What is Accounts Receivable? An Accounts Receivable is money owed by customers to a company in exchange for goods or services that have already been delivered. For example, a customer has ordered 10,000 red roses from Joe’s Landscaping. After Joe’s Landscaping received the order, it shipped the roses to the customer. Included in the shipment is an invoice for the roses in the amount of $10,000. Since the customer has received goods from Joe’s Landscaping before they paid for it, Joe’s Landscaping has an account receivable from the customer for $10,000. This accounts receivable balance will stay open until the customer pays for the roses. In QuickBooks, an account receivable is created after an invoice has been created and saved.
Basic Principles of Accounts Receivables:
When a customer receives goods or services before paying for them, it has purchased the items on credit. This is very similar to when someone uses a credit card to purchase birthday presents; the presents are delivered to the customer, but the customer’s credit card bill does not arrive until later.
Establishing Credit With A Vendor
In order to establish credit with a vendor, a customer must qualify for credit according to the vendor’s terms and each vendor has its own set of terms. This is usually done by completing a credit application provided by the vendor. The vendor’s credit department will review the application and approve or decline the credit application. If the credit application is approved, a credit limit will be established, but that limit can be raised or lowered depending on the consistency of payments, or lack thereof, from the customer. Additionally, a time limit will be imposed as to when the payment is due. The limit can be 15 – 30 days or longer depending on how lenient a vendor is willing to be. When a company extends credit to its customers, it maintains a separate account receivable for each customer. The primary reason why a vendor would agree to extend credit to a customer is because the vendor has a reasonable expectation that the customer will make payments as agreed upon or otherwise negotiated.
What type of account is Accounts Receivable?
Accounts Receivable is an Asset account, and it is listed on the vendor’s balance sheet in the asset section until the customer pays the balance. During the initial setup of QuickBooks, there is a default Accounts Receivables account that will be automatically created for your company.
Bad Debt Expense
Let’s face it, when a company sells goods or services its customers on credit, there is no guarantee that every customer will pay the amount owed. The amount that a company will not collect from a customer is written-off using an account called Bad Debt Expense. For example, for the month of January 2014, Joe’s Landscaping sold a total of $1,000 worth of goods and services on credit to Huey Company and Curly Company. Huey Company owes $600 and Curly Company owes $400. Due to unforeseen events, Curly Company files for bankruptcy a few days later and is unable to pay their debt to Joe’s Landscaping. As a result, Joe’s Landscaping will have to write-off the debt using an account called Bad Debt Expense for the amount of $400. Joe’s Landscaping’s January 2014 income statement would resemble the following:
Sales $1,000
Bad Debt Expense -$400
Net Income $600
In this scenario, Joe’s Landscaping’s net income is lowered by $400 because of Curly Company’s inability to pay the amount it owed.
Who Benefits from Accounts Receivable:
From the customer’s perspective, having the ability to obtain goods or services before paying for it can be good because it allows a company to acquire the resources needed to continue its business operations. From the vendor’s perspective, allowing a customer to purchase items on credit can improve sales because some customers may not have the ability to pay in full at the time of the purchase. However, the vendor bears the risk of extending credit to its customer because of the possibility of non-payment. This chapter will focus on accounts receivables and keeping track of customer payments.