Classification of receivables
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 receivable, term deposits). 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).accounts receivable upload file page information
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 percentage of net credit sales or by ageing method of estimating bad debts. These are determined by historical accounting information
Allowance methods of accrual accounting for bad debts
e.g. percentage of net credit sales : two years ago of $1000 net credit sales, $50 was uncollectable, and last year net credit sales was $2000 , and an allowance of 5% was made for bad debts , so the bad debts allowance for this period is $100.
e.g. ageing of accounts receivables : overdue accounts receivable was divided into periods of 0–30 days, 30–60 days, 60–90 days, 90–180 days, and the amounts that were never paid that were due in each period was divided by the amounts that were eventually collected for each period, giving a predictably increasing percentage of bad debts , the longer the amounts were overdue e.g. 2% at 0–30 days, 4% at 30–60 days, 20% at 60–90 days, 40% at 90–180 days.
The allowance for bad debts is an estimate of how much of a period's reported accounts receivables will eventually be not collectible, and is an attempt to predict that a bad debt has occurred , which of course , is only known for sure when the bad debt has to be written off, which will occur a long time after the credit sale is made.
Hence, at the end of a reporting period, when reporting the accounts receivables , a bad debts expense is reported for that same period, which is equal to the allowance that is made with either of the 2 methods The account , allowance for bad debts, is then a contra-asset account vs. accounts receivables asset account, and is hence increases with a contra to a debit ( for asset accounts), so is increased by a credit. Hence the recording should be ,
- bad debts expense - debit
- allowance for bad debts - credit ( the custom is to show debit lines above credit lines).
Writing off a bad debt determined to be unrecoverable in allowance methods for accounts receivables bad debt
When the bad debt is determined in the future to be bad, an amount in the accounts receivable needs to be reduced (credited), and hence the transaction is
- allowance for bad debts - debit
- accounts receivable - credit
tracing of gst transactions in allowance method for writing off bad debts from the initial credit sale
GST , if applicable, according to the accrual principle, is collected at the time of a credit sale, so when the accounts receivable is debited to record the credit to sales account, it is also debited to record the GST cash receivable, and GST liability account is credited, at the time of the sale.
- A/R - debit = sale amount + GST amount
- Sales - credit sale amount
- GST (Collections/Liability) - credit GST amount
In a good debtor situation, on the debtor paying,
- the cash in bank account is debited for the sale amount + gst amount, and
- the accounts receivable is credited for the equivalent total amount.
GST can be regarded as an accrual item, and not a cash item, and is related to the sale action, not the cash collection.
In a bad debtor situation, when a bad debt is written off, it is certain the GST that was owing can't be collected either, so the transaction is :-
- to debit the allowance for bad debts for the sale amount,
- debit the GST liability account for the GST amount, and
- credit the account receivable for the sum of sale+GST,
to acknowledge the receivable can't be collected.
other differences between percentage of net sales allowance method, and ageing of accounts receivables allowance method
GST also highlights a difference between the net credit sales allowance method, and the ageing of accounts receivable allowance methods : in the latter, an overall weighted amount of the accounts receivables is calculated as the estimate of bad debts, but the allowance made should be less the GST that was collectible from the bad debt amount as well.
A more obvious difference between the two methods, is that the allowance of percentage of net credit sales does not take into account residual amounts in the bad debts allowance account, whereas the residual in the allowance account in the ageing of accounts receivables is regarded as part of the current ageing estimate for the bad debts : so in the percentage of net credit sales method, the allowance account increases by the allowance calculated for the current net credit sales, but in the ageing of accounts receivables method , the allowance is made equal to current ageing allowance calculated. Therefore, the bad debts expense recorded at end of period for the ageing of AR method will be the difference of the allowance calculated and the residual balance of the allowance for bad debts account.
Recovery of bad debts previously written off
This reverses the bad debt written off almost, so needs to account for gst recollected, accounts receivable previously written off, as well as cash. The amount is not recorded back in the bad debts allowance account though, it is recorded in a separate bad debts recovered account. The original transaction for writing off was
- DR - Allowance for Bad Debts
- DR - GST
- CR - A/R,
so the reversal is is
- DR - A/R,
- CR - Bad Debts Recovered,
- CR - GST
(In the above, sum of DR equals sum of CR). Bad Debts Recovered increases with Credits, so isn't an asset, and it isn't a liability, so it is actually an equity (income) account. The Allowance for Bad Debts account is not re-credited because this allows tracking of recoverable bad debts that were previously written off.
To record the cash recovered, a second entry is then
- DR -Cash in Bank
- CR - A/R
Recording the equivalent DR to A/R and Cr to A/R in the separate transactions may not be necessary, but it seems clearer.
Management indices for receivables
- Receivables turnover ratio is net credit sales / average receivables.
average monthly receivable, or average quarterly, or mean of starting / ending receivable
- Average Collection period is 365 / receivables turnover.
These ratios are useful in comparing the efficiency of debt recovery for this company , and for comparison with other companies of similar turnover.
ethical issues with receivables
Money can be made illicitly by employees by issuing false discounts, false sales returns, writing off false bad debts, omitting cash received, issuing higher than actual accounts owing statements to customers, so it advisable to have at least one person for accounts receivable bookkeeping, one person for cash receipt recording, one person for accounts owing issuing to customers. Collusion could be a problem. Examples of ethical problems , where intention is not to steal money but to assist marketing , include to overstate turnover, such as in the recent (2010) IT outsourcing industry scandal.