journal entry for account receivable

The Ins and Outs of Journal Entries for Accounts Receivable

Accounts receivable represent a significant asset on the balance sheet for many companies that sell products or services on credit. Recording journal entries for accounts receivable is a key step in the accounting process. This article will provide an in-depth look at accounts receivable journal entries, including common examples, accounting for bad debts, and key takeaways for business owners and accounting professionals.

What Are Accounts Receivable?

Accounts receivable (AR) refers to the amounts owed to a company by customers who have purchased goods or services on credit. It represents money that is expected to come in the door in the near future. Accounts receivable are a current asset on the balance sheet because the accounts are expected to be converted to cash within one year or one operating cycle.

When a company makes a credit sale it records an increase in accounts receivable representing money owed from the customer. The offsetting entry is a credit to sales revenue which increases with the sale. Once the customer pays off their credit, accounts receivable is decreased or debited, and cash is increased or credited.

Why Are Accounts Receivable Journal Entries Important?

Recording journal entries for accounts receivable is a critical piece of the accounting process. There are several key reasons why properly recording AR journal entries matters:

• Provides an accurate record of credit sales and money owed. Tracking accounts receivable entries allows a business to have visibility into how much income they have earned through credit sales that has not yet been collected. This helps with cash flow planning.

• Feed the financial statements. The accounts receivable balance flows into the balance sheet and income statement, so accurate AR entries are needed to ensure financial statements are correct.

• Supports revenue recognition principles. Revenue accounting rules state that revenue is recorded when it is earned, not necessarily when cash is received. Accounts receivable entries align with this accrual basis of accounting.

• Enables bad debt tracking. Accounts receivable entries also form the foundation for recording and tracking bad debt expenses or write-offs when customers do not pay.

Basic Journal Entries for Accounts Receivable

The most common accounts receivable journal entries are:

1. Recording Credit Sales of Goods and Services

This entry records a credit sale to a customer:

Debit: Accounts Receivable $100
Credit: Revenue $100

This increases AR and revenue to reflect the business earning $100 in sales revenue through a credit transaction.

1. Receiving Cash Payments on Account

When the customer pays off their credit, the business makes this entry:

Debit: Cash $100
Credit: Accounts Receivable $100

The cash and accounts receivable balances are increased and decreased by $100 accordingly.

1. Discounting for Early Repayment

If the company offers a cash discount for paying early, the entry is:

Debit: Cash $98
Debit: Discount Revenue $2
Credit: Accounts Receivable $100

This records a 2% discount taken on a $100 AR balance.

1. Writing Off Bad Debts

If a customer invoice is deemed uncollectible, it can be written off by removing it from AR:

Debit: Bad Debt Expense $100
Credit: Accounts Receivable $100

The $100 AR is written off to bad debt expense in the income statement.

These examples cover the most common scenarios for recording accounts receivable activities. Companies make these journal entries routinely as sales occur and customer payments come in.

Accounting Treatment for Bad Debts

Unfortunately, not all customers pay what they owe on their accounts. Some default on payments due to financial troubles, disputes, or other issues. These non-payments are called bad debts.

There are two methods for recording and tracking bad debt write-offs:

1. Direct Write-Off Method

The direct write-off approach involves waiting until the end of the period and writing off uncollectible accounts as follows:

Debit: Bad Debt Expense $1,000
Credit: Accounts Receivable $1,000

This directly reduces net income in the period of write-off. The downside is volatility, as the timing of write-offs can fluctuate widely.

1. Allowance Method

The second approach is the allowance method. With this method, companies estimate bad debts each period and make the following recurring entry:

Debit: Bad Debt Expense $100
Credit: Allowance for Doubtful Accounts $100

This sets aside an allowance contra account against accounts receivable to reflect estimated defaults. Then, as actual write-offs occur, the company debits the allowance and credits AR. The allowance method smooths out the impact of bad debt expenses over time. However, estimating future write-offs requires judgment.

Key Takeaways on Accounts Receivable Journal Entries

Key points to remember about recording journal entries for accounts receivable:

• Accounts receivable are increased with debit entries when credit sales are made. This records the earning of revenue prior to receipt of cash.

• Cash account payments decrease accounts receivable through credit entries. This brings cash into the business and settles the outstanding AR.

• Bad debts should be tracked and written off in a timely manner. The direct write-off or allowance method can be used based on company preferences.

• Accounts receivable entries require estimates of collectability. Understanding customer payment history and credit trends is important.

• Errors in recording accounts receivable could lead to larger issues in reported revenues and bad debt expenses.

Properly recording accounts receivable is an indispensable part of the accounting process for any business that offers credit terms to customers. Mastering the typical AR journal entries and bad debt methods presented here is crucial knowledge for accounting and finance professionals looking to advance their careers.