Accounts Receivable - Explained
What are Accounts Receivable?
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Table of ContentsWhat are Accounts Receivable (AR)?How Are Accounts Receivable Used?How to Record an Account Receivable Example of Posting to Accounts Receivable Turnover
What are Accounts Receivable (AR)?
Accounts receivable refers to the balance of money owed to a firm for goods or services that the company allowed its customers to purchase on credit. These are the outstanding invoices that a company possesses. In the balance sheet of a company, these accounts are presented as a credit balance. They result from the daily economic activities carried out by the company. Company managers strive to ensure high Accounts Receivables Turnover.
How Are Accounts Receivable Used?
Depending on the period of time arranged to settle the right to collect, these may be classified as short-term receivables (less than 12 months) or long-term receivables (more than 12 months). Long-term receivables must be reclassified at the end of the economic period as short-term accounts receivable if the loan matures in the next 12 months. The accounts receivable, which is a credit granted by the company to its clients, contributes to financing the economic activities of the company. This is because accounts receivable represent an amount of money pending to be charged for the sale of goods and services. In the books of the company that receives the credit, this sum of money is recorded under accounts payable. The accounts receivables are classified into two; Short-term receivables which take less than 12 months to mature and long-term receivables which take more than 12 months to mature. However, after the end of every economic period, long-term receivables are reclassified as short-term receivables if they are expected to mature in the next 12 months.
How to Record an Account Receivable
Recording Accounts Receivables and different types of recognition that we would do:
- Sales on Credit - We are going to debit Accounts Receivable for that amount and then we're going to credit the Service or Sales Revenue for that amount. For products, then we're also going to debit COGS and then credit Inventory.
- Credit Cards - Sellers allow customers to use third-party credit cards. The CC company charges a fee to the retailer for accepting the card payment. We credit Service Revenue for the amount of the good. We debit a Credit Card Expense for the credit card fee. We debit Accounts Receivable by the difference between the amount paid and the fee.
Example of Posting to Accounts Receivable Turnover
Let's assume that a company X sells goods with a worth of $20,000 to another company Y. This sale is free of VAT, and the company X issues an invoice that is payable in 90 days. First of all, an entry is made in the merchandise sale's account for $20,000. Since the credit will be settled in 90 days through an economic effect, another entry is created which will ensure the company's account will be canceled against the customers' account. Through this method, company X finances the purchase of merchandise and gets a commercial credit for 90 days granted to company Y.