Not all purchases of goods or services are paid for at the time of the purchase. Those that aren't are called accounts receivable. In this lesson, you will learn the basics about accounts receivable.
Do you have any idea what accounts receivable are? You may already have an idea of what they are, but just allow me to take a few minutes and teach you exactly what they are, how they come about and how they are recorded in the accounting records of a company. Accounts receivable, which are often times simply called AR, are the money that is owed to the company by customers for goods sold or services rendered.
It's a simple turn of events that creates an accounts receivable. In order to have an accounts receivable, you need two things: a sale and a purchase. A company sells an item or a service to a buyer and extends credit to that buyer so that the total cost of the sale can be paid later and on terms that are agreed upon by the seller and the buyer. When the buyer agrees to the terms set forth by the seller, then a purchase has been made. Now, if that extension of credit is not given, and payment is rendered at the time of sale, then no accounts receivable was created.
Once the accounts receivable is created, it has to be recorded in the accounting records. Since the AR account is considered an asset account, it is recorded in the ledger and reported on the balance sheet of a company. Whoa - that's a lot of terms there, isn't it? Let me explain them just a little better. An asset is something that a company owns. The ledger is the place where all the increases and decreases in balance sheet accounts are recorded. The balance sheet is the financial statement that reports all the accounts of a company and their balances. Now that clarifies things, doesn't it?
Let's talk about the actual recording process. Every single transaction that occurs in a company has at least one account that is credited and one account that is debited. To record a sale that resulted in an accounts receivable, you would need to make a debit entry to the accounts receivable account for the sale amount and a credit entry to the revenue account for the same amount. Revenue is the amount of money that is received or will be received from a sale. By debiting the AR account and crediting the revenue account, the balances in both accounts increase. When payment is received on the account, the cash account is debited for the payment amount, and the AR account is credited. This decreases the amount in the AR account and increases the cash account balance. Each time a payment is made on a customer account, it will decrease the AR balance, just as each time a new credit sale is made, it will increase the balance in the AR account.
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Now that I have given you the basics, let's look at an example. A couple of days ago, I had an unfortunate event occur. Lightning struck my television and completely destroyed it. Since I do like to watch TV, replacing it was a must, so I strolled right on down to the local electronics store, and I started to select my TV. There were TVs of all sizes and prices. At first, I only intended to purchase a 32-inch flat screen that cost $549. I knew that I could pay cash for that. But then, there it was: the TV of all TVs. I saw this 60-inch smart TV that could virtually read my mind and decide what channel I wanted to watch. That thing had more bells and whistles than I knew how to use and a price that matched. But I didn't care. That was the TV for me. I didn't even think twice about signing my name on the dotted line of the store credit agreement and agreeing to the terms set forth in that agreement. In that one action, I created both a bill for myself and an account receivable for the store. The price of the 60-inch TV is $2,000. So, how would journal entries look for this transaction?
Since the electronics store sold me the TV, and I purchased it, the entry would look like this:
The terms of the agreement are that I will pay $200 per month on the TV for ten months. So, what will the future journal entries look like as I make payments? Now remember, when recording a payment on an AR account, the cash account is debited for the payment amount, and the AR account is credited. That would mean that the journal entry would look like this:
Now, this is the way that all the payments on the AR accounts are going to be recorded.
The accounts receivable of a company, which are also called AR, are the money that is owed to the company by customers for goods sold or services rendered. In order for an AR account to be created, there must be a sale made by a company to a buyer that involves an extension of credit. If a sale is made where cash is received at the time of the sale, then no AR is created.
Accounts receivable is considered assets of a company that are recorded in the accounting ledger and reported on the company's balance sheet. An asset is something that a company owns. The ledger is the place where all the increases and decreases in balance sheet accounts are recorded. The balance sheet is the financial statement that reports all the accounts that a company has and their balances.
When an AR is recorded in the accounting records, it is recorded as a debit to the accounts receivable account and a credit to a revenue account. Revenue is the amount of money that is received or will be received from a sale. This increases the balances in both the AR account and revenue account. When a payment is made on an AR account, that payment is recorded as a debit entry to the cash account and a credit entry to the AR account, which reduces the balance in the AR account and increases the balance in the cash account. With each new AR transaction that occurs, the steps in the recording process are repeated.
Following this lesson, you should be able to:
Describe accounts receivable and how they are created
Define asset, ledger, balance sheet and revenue
Explain how accounts receivable are recorded in the accounting records
The following exercise is designed to help students apply their knowledge of the Accounts Receivable and the transactions that impact its balance.
You are newly hired as a bookkeeping analyst at Yum Yum Cream, a company that manufactures gourmet ice cream and sells to a variety of retail stores in the Detroit, Michigan area. Your manager explains to you that the company is a bit behind in its bookkeeping and that the previous analyst did not really understand how to account for credit sales. You assure the manager by explaining that you are a master in dealing with Accounts Receivable given the lesson that you learned.
Below is a list of transactions that the company is yet to enter in its books. For each of these transactions, determine whether there is (1) a debit entry, (2) a credit entry, or (3) No entry to Accounts Receivable.
The company bought cream and sugar from one of its main suppliers and promised to pay in a few days.
The company sold $500 worth of goods to Frozen Delights, a retail store downtown. Frozen Delights opted to pay within 30 days.
The company sold $1,000 worth of goods to a family of 10 that just loves ice cream. They paid cash.
The company paid its supplier for its cream and sugar.
Frozen Delights paid its entire balance on time.
No entry - This impacts Accounts Payable.
Debit - Accounts receivable increases by $500.
No entry - This is a cash sale.
No entry - This impacts Accounts Payable.
Credit - Accounts receivable decreases by $500.
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