Accounts Receivable: Definition, Process & Examples

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  • 0:10 AR Defined
  • 0:20 AR Process
  • 2:25 Example
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Lesson Transcript
Instructor
Rebekiah Hill

Rebekiah has taught college accounting and has a master's in both management and business.

Expert Contributor
Steven Scalia

Steven completed a Graduate Degree is Chartered Accountancy at Concordia University. He has performed as Teacher's Assistant and Assistant Lecturer in University.

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.

AR Defined

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.

AR Process

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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Additional Activities

Accounts Receivable - A Practical Exercise:

The following exercise is designed to help students apply their knowledge of the Accounts Receivable and the transactions that impact its balance.

Exercise:

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.

No.Event
1The company bought cream and sugar from one of its main suppliers and promised to pay in a few days.
2The company sold $500 worth of goods to Frozen Delights, a retail store downtown. Frozen Delights opted to pay within 30 days.
3The company sold $1,000 worth of goods to a family of 10 that just loves ice cream. They paid cash.
4The company paid its supplier for its cream and sugar.
5Frozen Delights paid its entire balance on time.

Solution:

See below.

No.Impact
1No entry - This impacts Accounts Payable.
2Debit - Accounts receivable increases by $500.
3No entry - This is a cash sale.
4No entry - This impacts Accounts Payable.
5Credit - Accounts receivable decreases by $500.

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