Principles of Financial Accounting: Receivables - Types of Receivables, Accounts Receivable Notes Receivable Other Receivables

What It Is

Accounts receivable, notes receivable, and other receivables are types of assets that represent amounts owed to a company by its customers or other entities. These assets are critical to financial accounting as they impact a company's liquidity, profitability, and cash flow. For example, if a company sells $10,000 worth of goods on credit to a customer, the amount becomes an account receivable until it is collected.

Key Concepts & Formulas

• Accounts Receivable (AR): A current asset representing amounts owed to a company by its customers. AR is reported on the balance sheet and is typically classified as a current asset.
  • Example: A company sells $5,000 worth of goods on credit to a customer. The AR account is debited for $5,000, and the Sales Revenue account is credited for $5,000.
• Notes Receivable: A type of receivable that represents a written promise to pay a specific amount of money at a future date. Notes receivable are typically reported at their face value.
  • Example: A company lends $10,000 to a customer with a 6% interest rate and a 90-day maturity date. The Notes Receivable account is debited for $10,000, and the Cash account is credited for $10,000.
• Other Receivables: A miscellaneous category of receivables that does not fit into the accounts receivable or notes receivable categories. Examples include deposits, prepayments, and advances.
  • Example: A company receives a $2,000 deposit from a customer for a future service. The Other Receivables account is debited for $2,000, and the Cash account is credited for $2,000.
• Allowance for Doubtful Accounts (ADA): A contra-asset account that represents the estimated amount of uncollectible accounts receivable. The ADA is subtracted from the accounts receivable balance to arrive at the net realizable value.
  • Example: A company estimates that 2% of its accounts receivable will be uncollectible. The ADA account is debited for $200 (2% of $10,000), and the Accounts Receivable account is credited for $200.
• Days Sales Outstanding (DSO): A ratio that measures the average number of days it takes to collect accounts receivable. DSO is calculated by dividing the accounts receivable balance by the daily sales revenue.
  • Example: A company has $50,000 in accounts receivable and $10,000 in daily sales revenue. The DSO is 5 days ($50,000 ÷ $10,000).
• Receivables Turnover Ratio: A ratio that measures the number of times accounts receivable are collected and replaced during a given period. The ratio is calculated by dividing the net sales revenue by the average accounts receivable balance.
  • Example: A company has $100,000 in net sales revenue and an average accounts receivable balance of $20,000. The receivables turnover ratio is 5 times ($100,000 ÷ $20,000).

Journal Entry Examples

1. Debit Accounts Receivable, Credit Sales Revenue

   • Dr. Accounts Receivable $5,000
   • Cr. Sales Revenue $5,000

   Explanation: The Accounts Receivable account is debited to record the amount owed by the customer, and the Sales Revenue account is credited to record the revenue earned by the company.

2. Debit Notes Receivable, Credit Cash

   • Dr. Notes Receivable $10,000
   • Cr. Cash $10,000

   Explanation: The Notes Receivable account is debited to record the amount borrowed by the customer, and the Cash account is credited to record the cash received by the company.

3. Debit Other Receivables, Credit Cash

   • Dr. Other Receivables $2,000
   • Cr. Cash $2,000

   Explanation: The Other Receivables account is debited to record the deposit received from the customer, and the Cash account is credited to record the cash received by the company.

Common Mistakes

1. Mistake: Confusing debits and credits for expense accounts.

   • Correction: Expense accounts are debited, and revenue accounts are credited. Use the "ADE" mnemonic to remember: Assets, Drawings, Expenses.

   • Mistake: Not considering the normal balance of an account when making a journal entry.

   • Correction: Always consider the normal balance of an account when making a journal entry. For example, if an account has a normal debit balance, make a debit entry to increase the account.

   • Mistake: Not using the correct contra-asset account when estimating uncollectible accounts receivable.

   • Correction: Use the Allowance for Doubtful Accounts (ADA) contra-asset account to estimate uncollectible accounts receivable. The ADA is subtracted from the accounts receivable balance to arrive at the net realizable value.

Exam Tips

1. Tip: When recording a sale on credit, debit the Accounts Receivable account and credit the Sales Revenue account.

   • Trap: Be careful not to confuse the Accounts Receivable account with the Sales Revenue account.

   • Tip: When recording a note receivable, debit the Notes Receivable account and credit the Cash account.

   • Trap: Be careful not to confuse the Notes Receivable account with the Cash account.

   • Tip: When estimating uncollectible accounts receivable, use the Allowance for Doubtful Accounts (ADA) contra-asset account.

   • Trap: Be careful not to use the wrong contra-asset account or forget to subtract the ADA from the accounts receivable balance.

Quick Practice

1. Problem: A company sells $10,000 worth of goods on credit to a customer. What is the adjusting entry for the accounts receivable?

   • Answer: Debit Accounts Receivable $10,000, Credit Sales Revenue $10,000. Explanation: The Accounts Receivable account is debited to record the amount owed by the customer, and the Sales Revenue account is credited to record the revenue earned by the company.

   • Problem: A company lends $5,000 to a customer with a 6% interest rate and a 90-day maturity date. What is the adjusting entry for the notes receivable?

   • Answer: Debit Notes Receivable $5,000, Credit Cash $5,000. Explanation: The Notes Receivable account is debited to record the amount borrowed by the customer, and the Cash account is credited to record the cash received by the company.

   • Problem: A company receives a $1,000 deposit from a customer for a future service. What is the adjusting entry for the other receivables?

   • Answer: Debit Other Receivables $1,000, Credit Cash $1,000. Explanation: The Other Receivables account is debited to record the deposit received from the customer, and the Cash account is credited to record the cash received by the company.

Last-Minute Cram Sheet

1. Accounts Receivable (AR): A current asset representing amounts owed to a company by its customers.
2. Notes Receivable: A type of receivable that represents a written promise to pay a specific amount of money at a future date.
3. Other Receivables: A miscellaneous category of receivables that does not fit into the accounts receivable or notes receivable categories.
4. Allowance for Doubtful Accounts (ADA): A contra-asset account that represents the estimated amount of uncollectible accounts receivable.
5. Days Sales Outstanding (DSO): A ratio that measures the average number of days it takes to collect accounts receivable.
6. Receivables Turnover Ratio: A ratio that measures the number of times accounts receivable are collected and replaced during a given period.
7. Debit Accounts Receivable, Credit Sales Revenue: The adjusting entry for a sale on credit.
8. Debit Notes Receivable, Credit Cash: The adjusting entry for a note receivable.
9. Debit Other Receivables, Credit Cash: The adjusting entry for other receivables.
10. Dividends are NOT an expense – they go directly to retained earnings.