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AccountingCoach.com
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Accounts Receivable & Bad Debts Expense
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All underlined words are defined in the attached Glossary (Pages 21 – 24).
Introduction to Accounts Receivable & Bad Debts Expense
If we imagine buying something, such as groceries, it's easy to picture ourselves
standing at the checkout, writing out a personal check, and taking possession of the
goods. It's a simple transaction—we exchange our money for the store's groceries.
In the world of business, however, many companies must be willing to sell their goods
(or services) on credit. This would be equivalent to the grocer transferring ownership of
the groceries to you, issuing a sales invoice, and allowing you to pay for the groceries at
a later date.
Whenever a seller decides to offer its goods or services on credit, two things happen:
(1) the seller boosts its potential to increase revenues since many buyers appreciate the
convenience and efficiency of making purchases on credit, and (2) the seller opens
itself up to potential losses if its customers do not pay the sales invoice amount when it
becomes due.
Under the accrual basis of accounting (which we will be using throughout our
discussion) a sale on credit will:
1. Increase sales or sales revenues, which are reported on the income statement,
and
2. Increase the amount due from customers, which is reported as accounts
receivable—an asset reported on the balance sheet.
If a buyer does not pay the amount it owes, the seller will report:
1. A credit loss or bad debts expense on its income statement, and
2. A reduction of accounts receivable on its balance sheet.
With respect to financial statements, the seller should report its estimated credit losses
as soon as possible using the allowance method. For income tax purposes, however,
losses are reported at a later date through the use of the direct write-off method.
For personal use by the original purchaser only. Copyright © 2009 AccountingCoach.com. 1
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Recording Services Provided on Credit
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Assume that on June 3, Malloy Design Co. provides $4,000 of graphic design service to
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one of its clients with credit terms of net 30 days. (Providing services with credit terms is
also referred to as providing services on account.)
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Under the accrual basis of accounting, revenues are considered earned at the time
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when the services are provided. This means that on June 3 Malloy will record the
revenues it earned, even though Malloy will not receive the $4,000 until July. Below are
the accounts affected on June 3, the day the service transaction was completed:
Date Account Name Debit Credit
June 3 Accounts Receivable 4,000
Service Revenues 4,000
In this transaction, the debit to Accounts Receivable increases Malloy's current assets,
total assets, working capital, and stockholders' (or owner's) equity—all of which are
reported on its balance sheet. The credit to Service Revenues will increase Malloy's
revenues and net income—both of which are reported on its income statement.
Recording Sales of Goods on Credit
When a company sells goods on credit, it reports the transaction on both its income
statement and its balance sheet. On the income statement, increases are reported in
sales revenues, cost of goods sold, and (possibly) expenses. On the balance sheet, an
increase is reported in accounts receivable, a decrease is reported in inventory, and a
change is reported in stockholders' equity for the amount of the net income earned on
the sale.
If the sale is made with the terms FOB Shipping Point, the ownership of the goods is
transferred at the seller's dock. If the sale is made with the terms FOB Destination, the
ownership of the goods is transferred at the buyer's dock.
In principle, the seller should record the sales transaction when the ownership of the
goods is transferred to the buyer. Practically speaking, however, accountants typically
record the transaction at the time the sales invoice is prepared and the goods are
shipped.
For personal use by the original purchaser only. Copyright © 2009 AccountingCoach.com. 2
tia
en
fid
on
C
, C
on
fid
en
AccountingCoach.com
tia
Accounts Receivable & Bad Debts Expense
l
All underlined words are defined in the attached Glossary (Pages 21 – 24).
Introduction to Accounts Receivable & Bad Debts Expense
If we imagine buying something, such as groceries, it's easy to picture ourselves
standing at the checkout, writing out a personal check, and taking possession of the
goods. It's a simple transaction—we exchange our money for the store's groceries.
In the world of business, however, many companies must be willing to sell their goods
(or services) on credit. This would be equivalent to the grocer transferring ownership of
the groceries to you, issuing a sales invoice, and allowing you to pay for the groceries at
a later date.
Whenever a seller decides to offer its goods or services on credit, two things happen:
(1) the seller boosts its potential to increase revenues since many buyers appreciate the
convenience and efficiency of making purchases on credit, and (2) the seller opens
itself up to potential losses if its customers do not pay the sales invoice amount when it
becomes due.
Under the accrual basis of accounting (which we will be using throughout our
discussion) a sale on credit will:
1. Increase sales or sales revenues, which are reported on the income statement,
and
2. Increase the amount due from customers, which is reported as accounts
receivable—an asset reported on the balance sheet.
If a buyer does not pay the amount it owes, the seller will report:
1. A credit loss or bad debts expense on its income statement, and
2. A reduction of accounts receivable on its balance sheet.
With respect to financial statements, the seller should report its estimated credit losses
as soon as possible using the allowance method. For income tax purposes, however,
losses are reported at a later date through the use of the direct write-off method.
For personal use by the original purchaser only. Copyright © 2009 AccountingCoach.com. 1
, C
on
Recording Services Provided on Credit
fid
Assume that on June 3, Malloy Design Co. provides $4,000 of graphic design service to
en
one of its clients with credit terms of net 30 days. (Providing services with credit terms is
also referred to as providing services on account.)
tia
Under the accrual basis of accounting, revenues are considered earned at the time
l
when the services are provided. This means that on June 3 Malloy will record the
revenues it earned, even though Malloy will not receive the $4,000 until July. Below are
the accounts affected on June 3, the day the service transaction was completed:
Date Account Name Debit Credit
June 3 Accounts Receivable 4,000
Service Revenues 4,000
In this transaction, the debit to Accounts Receivable increases Malloy's current assets,
total assets, working capital, and stockholders' (or owner's) equity—all of which are
reported on its balance sheet. The credit to Service Revenues will increase Malloy's
revenues and net income—both of which are reported on its income statement.
Recording Sales of Goods on Credit
When a company sells goods on credit, it reports the transaction on both its income
statement and its balance sheet. On the income statement, increases are reported in
sales revenues, cost of goods sold, and (possibly) expenses. On the balance sheet, an
increase is reported in accounts receivable, a decrease is reported in inventory, and a
change is reported in stockholders' equity for the amount of the net income earned on
the sale.
If the sale is made with the terms FOB Shipping Point, the ownership of the goods is
transferred at the seller's dock. If the sale is made with the terms FOB Destination, the
ownership of the goods is transferred at the buyer's dock.
In principle, the seller should record the sales transaction when the ownership of the
goods is transferred to the buyer. Practically speaking, however, accountants typically
record the transaction at the time the sales invoice is prepared and the goods are
shipped.
For personal use by the original purchaser only. Copyright © 2009 AccountingCoach.com. 2
