Receivables and Payables
This chapter discusses accounts receivable, uncollectible accounts, bad debts, and accounts payable.
Pay attention to aging schedules, how to write off receivables, and how credit card transactions should be identified and recorded from the business entity's perspective. Various forms of liabilities that a company might incur are described. Since most businesses operate mainly on credit sales, it is important to understand the implications of your credit and collections policies. Liabilities can be strategically important for a business, and are a necessary part of doing business. However, debt increases the risk of a company, and managing liabilites is crucial for business survival.
Key terms
Accounts receivable turnover Net credit sales (or net sales) divided by average net accounts receivable.
Aging schedule A means of classifying accounts receivable according to their age; used to determine the necessary balance in an Allowance for Uncollectible Accounts. A different uncollectibility percentage rate is used for each age category.
Allowance for Uncollectible Accounts A contra-asset account to the Accounts Receivable account; it reduces accounts receivable to their net realizable value. Also called Allowance for Doubtful Accounts or Allowance for Bad Debts.
Bad debts expense See Uncollectible accounts expense.
Bank discount The difference between the maturity value of a note and the actual amount - the note's proceeds - given to the borrower.
Cash proceeds The maturity amount of a note less the bank discount.
Clearly determinable liabilities Liabilities whose existence and amount are certain. Examples include accounts payable, notes payable, interest payable, unearned delivery fees, wages payable, sales tax payable, federal excise tax payable, current portions of long-term debt, and various payroll liabilities.
Contingent liabilities Liabilities whose existence is uncertain. Their amount is also usually uncertain. Both their existence and amount depend on some future event that may or may not occur. Examples include liabilities arising from lawsuits, discounted notes receivable, income tax disputes, penalties that may be assessed because of some past action, and failure of another party to pay a debt that a company has guaranteed.
Credit Card Expense account Used to record credit card agency's service charges for services rendered in processing credit card sales.
Credit cards Nonbank charge cards (e.g. American Express) and bank charge cards (e.g. VISA and MasterCard) that customers use to charge their purchases of goods and services.
Current liabilities Obligations that (1) are payable within one year or one operating cycle, whichever is longer, or (2) will be paid out of current assets or result in the creation of other current liabilities.
Discount on Notes Payable A contra account used to reduce Notes Payable from face value to the net amount of the debt.
Discounting a note payable The act of borrowing on a non interest-bearing note drawn for a maturity amount, from which a bank discount is deducted, and the proceeds are given to the borrower.
Dishonored note A note that the maker failed to pay at maturity.
Estimated liabilities Liabilities whose existence is certain, but whose amount can only be estimated. An example is estimated product warranty payable. Interest The fee charged for use of money over a period of time (I = P X R X T).
Interest Payable account An account showing the interest expense incurred but not yet paid; reported as a current liability in the balance sheet.
Interest Receivable account An account showing the interest earned but not yet collected; reported as a current asset in the balance sheet.
Liabilities Obligations that result from some past transaction and are obligations to pay cash, perform services, or deliver goods at some time in the future.
Long-term liabilities Obligations that do not qualify as current liabilities.
Maker (of a note) The party who prepares a note and is responsible for paying the note at maturity.
Maturity date The date on which a note becomes due and must be paid. Maturity value The amount that the maker must pay on the note on its maturity date.
Net realizable value The amount the company expects to collect from accounts receivable.
Number of days' sales in accounts receivable The number of days in a year (365) divided by the accounts receivable turnover.
Operating cycle The time it takes to start with cash, buy necessary items to produce revenues (such as materials, supplies, labor, and/or finished goods), sell goods or services, and receive cash by collecting the resulting receivables. Payable Any sum of money due to be paid by a company to any party for any reason.
Payee (of a note) The party who receives a note and will be paid cash at maturity.
Percentage-of-receivables method A method for determining the desired size of the Allowance for Uncollectible Accounts by basing the calculation on the Accounts Receivable balance at the end of the period.
Principal (of a note) The face value of a note.
Promissory note An unconditional written promise by a borrower (maker) to pay a definite sum of money to the lender (payee) on demand or at a specific date.
Rate (of a note) The stated interest rate on the note.
Receivable Any sum of money due to be paid to a company from any party for any reason.
Time (of a note) The amount of time the note is to run; can be expressed in days, months, or years.
Trade receivables Amounts customers owe a company for goods sold or services rendered on account. Also called accounts receivable or trade accounts receivable.
Uncollectible accounts expense An operating expense that a business incurs when it sells on credit; also called doubtful accounts expense or bad debts expense.