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What is Accounts Receivable and its Journal Entries?

Accounts Receivable – Definition

The customer accounts (debtors) who owe money to a business for purchasing goods on credit are called accounts receivable. When the money is received within the same accounting period it becomes part of the company’s operating revenue, however, if not received in the same year it becomes “trade debtors” which is another name for accounts receivable. It is also commonly abbreviated as “AR”. The entire life-cycle is termed as “O2C” (Order to Cash). 

In layman terms, the total amount which is yet to be collected by debtors as per a firm’s sales book is known as accounts receivables. Large firms using ERP packages replace traditional sales book with sales ledger control account

The buyer can be a sole trader, a partnership firm, a private company, etc. It is a short-term addition, hence an asset that is supposed to be received from the customers. Accounts receivables are shown on the asset side under the head current assets (right-hand side of a horizontal balance sheet).

Related Topic – What is Days Sales Outstanding (DSO)?

Example

Let us assume that you sold goods worth 10,000 to one of your buyers who is supposed to pay you within 45 days of receipt of invoice. Now, you send the customer a bill for 10,000. In this case, the amount acts as “dues to be received” and shall be booked in your records as accounts receivable.

It is similar to the situation where your mobile phone company generates an invoice on the 1st day of a month and gives you 30 days to pay the bill. It is an account receivable for the mobile phone company.

Key Highlights

  1. They are created when a business sells goods on credit.
  2. They should be collected from the customers within the agreed period. 
  3. If goods are returned by the buyer during the allowed time limit then a credit note is sent by the seller to notify the buyer that he has been provided appropriate credit. This cancels out his payment & results in a reduction of total accounts receivable.

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Journal Entries Related to Accounts Receivable

Below are the two main scenarios linked to accounts receivable cycle where, in the first case, credit sale is recorded and the customer is assumed to be billed, and, in the second case, cash proceeds from the customer is recorded in books of accounts.

At the time of recording a credit sale and billing the customer

Accounts Receivable A/C Debit
 To Sales (on credit) A/C Credit

(This can also be recorded at a particular customer level subledger wise, in that case, the customer who is billed will be debited)

Related – Journal entry for recovery of bad debts

At the time of money received from the customer

Cash A/C or Bank A/C Debit
 To Accounts Receivable A/C Credit

(This can also be recorded at a particular customer level subledger wise, in that case, the customer paying for the goods/services will be credited)

 

Short Quiz for Self-Evaluation

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