OCW041: Reporting and Analyzing Receivables

Classifying Receivables

Receivables can be classified as accounts receivables, trade debtors, bills receivable, and other receivables.

Learning Objectives

Distinguish between accounts receivable, trade debtors, bills receivables and other receivables

Key Takeaways

Key Points

  • Accounts receivable is the money owed to that company by entities outside of the company. Trade debtors are the receivables owed by the company’s customers.
  • Other receivables can be divided according to whether they are expected to be received within the current accounting period or 12 months (current receivables), or received greater than 12 months (non-current receivables).
  • Not all accounts receivables will be paid, and an allowance has to be made for bad debts. The allowance for bad debts can be calculated either as the percentage of net credit sales or by the ageing method of estimating bad debts.

Key Terms

  • allowance for bad debts: Since not all customer debts will be collected, businesses typically estimate the amount of and then record an allowance for doubtful accounts which appears on the balance sheet as a contra accounts that offsets total accounts receivable. When accounts receivable are not paid, some companies turn them over to third party collection agencies or collection attorneys who will attempt to recover the debt via negotiating payment plans, settlement offers or pursuing other legal action.

Accounts receivable represents money owed by entities to the firm on the sale of products or services on credit. In most business entities, accounts receivable is typically executed by generating an invoice and either mailing or electronically delivering it to the customer. In turn, the customer must pay it within an established time frame, which is called the credit terms or payment terms.

An example of a common payment term is Net 30, which means that payment is due at the end of 30 days from the date of invoice. The debtor is free to pay before the due date. To encourage this, businesses can offer a discount for early payment. Other common payment terms include Net 45, Net 60, and 30 days end of month.

On a company’s balance sheet, receivables can be classified as accounts receivables or trade debtors, bills receivable, and other receivables (loans, settlement amounts due for non-current asset sales, rent receivables, term deposits). Accounts receivable is the money owed to that company by entities outside of the company. Trade receivables are the receivables owed by the company’s customers. Other receivables can be divided according to whether they are expected to be received within the current accounting period or 12 months (current receivables), or received greater than 12 months (non-current receivables).

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Balance sheet: Sample balance sheet

Not all accounts receivables will be paid, and an allowance has to be made for bad debts. The allowance for bad debts can be calculated either as the percentage of net credit sales or by the ageing method of estimating bad debts. These are determined by historical accounting information. Accounts receivable therefore can be classified according to their age. The Accounts Receivable Age Analysis Printout, also known as the Debtors Book is divided in categories for current, 30 days, 60 days, 90 days, 120 days, 150 days,180 days, and overdue.

Dealing with Foreign Currency and Bad Debts

To deal with foreign currency and bad debts, we have a “gain or loss” account and methods to measure the net value of accounts receivable.

Learning Objectives

Explain how the “gain or loss” account is used for foreign currency transactions and bad debts

Key Takeaways

Key Points

  • On a company’s balance sheet, accounts receivable is the money owed to that company by entities outside of the company.
  • To deal with foreign currency, companies have a “foreign currency transaction gain or loss” that typically is included in arriving at earnings in the income statement for the period in which the exchange rate is changed.
  • To deal with bad debts, companies have two methods available to them for measuring the net value of accounts receivable, which is generally computed by subtracting the balance of an allowance account from the accounts receivable account, namely the allowance method and the write-off method.

Key Terms

  • functional currency: Functional currency refers to the main currency used by a business or unit of a business. It is the monetary unit of account of the principal economic environment in which an economic entity operates.

On a company’s balance sheet, accounts receivable is the money owed to that company by entities outside of the company. The receivables owed by the company’s customers are called trade receivables. Account receivables are classified as current assets, assuming that they are due within one calendar year or fiscal year.

A foreign currency transaction requires settlement in a currency other than the functional currency. A change in exchange rates between the functional currency and the currency in which a transaction is denominated increases or decreases the expected amount of functional currency cash flows upon settlement of the transaction. This change in expected functional currency cash flows is a “foreign currency transaction gain or loss” that typically is included in arriving at earnings in the income statement for the period in which the exchange rate is changed.

To deal with bad debts, companies have two methods available to them for measuring the net value of accounts receivable, which is generally computed by subtracting the balance of an allowance account from the accounts receivable account.

The first method is the allowance method, which establishes a contra-asset account, allowance for doubtful accounts, or bad debt provision, that has the effect of reducing the balance for accounts receivable. The allowance for bad debt/doubtful accounts is a permanent account. While the corresponding bad debt expense account is a temporary account that is zeroed out annually.

The amount of the bad debt provision can be computed in two ways: either by reviewing each individual debt and deciding whether it is doubtful (a specific provision), or by providing for a fixed percentage (e.g. 2%) of total debtors (a general provision). The change in the bad debt provision from year to year is posted to the bad debt expense account in the income statement.

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Allowance for Doubtful Accounts: Allowance for Doubtful Accounts (the allowance method)

The second method is the direct write-off method. It is simpler than the allowance method in that it allows for one simple entry to reduce accounts receivable to its net realizable value. The entry would consist of debiting a bad debt expense account and crediting the respective accounts receivable in the sales ledger.

Reporting Receivables

Accounts receivable are reported as a line item on the balance sheet and in a more detailed again report.

Learning Objectives

Review the purpose of the accounts receivable aging report

Key Takeaways

Key Points

  • An accounts receivable aging report summarizes receivables based on their age—that is, how long they have been outstanding.
  • The accounts receivable age analysis, also known as the Debtors Book, is divided in categories— current, 30 days, 60 days, 90 days, 120 days, 150 days, 180 days, and overdue—that are produced in modern accounting systems.
  • The aging report can help a business identify issues soon after they arise and prevent larger problems from occurring later on.

Key Terms

  • General Ledger: General Ledger is the final repository of the accounting records and data. In modern accounting softwares, the general ledger works as a central repository for accounting data transferred from all sub-ledgers or modules like accounts payable, accounts recievable, cash management, fixed assets, purchasing and projects. General ledger is the backbone of any accounting system which holds financial and non-financial data for an organization.
  • aging the accounts receivable: dividing the account receivable according the days until due ranging from current to overdue

Accounts receivable are reported as a line item on the balance sheet. Supplementary reports, such as the accounts receivable aging report, provide further detail.

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Balance sheet: Accounts receivable are a line item in a balance sheet.

The aging report, for example, shows how long invoices from each customer have been outstanding. Generally the accounts in an aging report are subdivided into categories based on how overdue the invoices are.

An accounts receivable aging report summarizes receivables based on their age—how long they have been outstanding. The accounts receivable age analysis, also known as the Debtors Book, is divided into categories for current, 30 days, 60 days, 90 days, 120 days, 150 days, 180 days, and overdue that are produced in modern accounting systems. For example, all the unpaid invoices posted in the past month are current, all the unpaid invoices from the prior month are over 30 days, the unpaid invoices from two months ago are over 60 days, etc. The aging report can help a business identify issues soon after they arise and prevent larger problems from occurring later on.

Using the Receivables Turnover Ratio

The receivables turnover ratio measures how efficiently a firm uses its assets.

Learning Objectives

Summarize the importance of the receivables turnover ratio

Key Takeaways

Key Points

  • The receivables turnover ratio measures how efficiently a firm gives credit and collects debts.
  • [latex]text{Receivables turnover ratio} = dfrac{text{Net receivable sales}}{text{Average net receivables}}[/latex]
  • The receivables turnover ratio is also used in calculating the days’ sales in receivables, the average collection period, the average debtor collection period, and the average payment period in days.

Receivables Turnover Ratio

The receivables turnover ratio, also called the debtor’s turnover ratio, is an accounting measure used to measure how effective a company is in extending credit as well as collecting debts. The receivables turnover ratio is an activity ratio, measuring how efficiently a firm uses its assets.

The formula of the receivables turnover ratio is:

[latex]text{Receivables turnover ratio} = dfrac{text{Net receivable sales}}{text{Average net receivables}}[/latex]

A high ratio implies either that a company operates on a cash basis or that its extension of credit and collection of accounts receivable is efficient; in contrast, a low ratio implies the company is not making the timely collection of credit.

Other Uses

Sometimes the receivables turnover ratio is expressed as the “days’ sales in receivables”:

[latex]text{Days’ sales in receivables} = dfrac{365}{text{Receivables turnover ratio}}[/latex]

The average collection period can be calculated as follows:

[latex]text{Average collection period} = dfrac{text{Days} cdot text{AR}}{text{Credit sales}}[/latex]

The average debtor collection period can be calculated as follows:

[latex]dfrac{text{Trade receivables}}{text{Credit sales} cdot 365} = text{Average collection period in days}[/latex]

Finally, the average creditor payment period can be calculated as follows:

[latex]dfrac{text{Trade payables}}{text{Credit purchases} cdot 365} = text{Average payment period in days}[/latex]


Source: Accounting