Revenue transactions are usually undertaken for cash or on credit. Firms obviously prefer to make sales for cash because funds are immediately available to meet obligations, invest in productive endeavors, pay dividends, and so on. Moreover, cash sales entail no uncertainty about collectibility.
Accounts receivable are the short-term financial assets of a wholesaler or retailer that arise from sales on credit. This type of credit is often called trade credit. Terms of trade credit usually range from 5 to 60 days, depending on industry practice. For some companies that sell to consumers, installment accounts receivable, which allow the buyer to make a series of time payments, constitute a significant portion of accounts receivable. Department stores, appliance stores, furniture stores, used car dealers, and other retail businesses often offer installment credit.
On the balance sheet, accounts receivable designates amounts arising from credit sales made to customers in the ordinary course of business. Because loans or credit sales made to employees, officers, or owners of the corporation increase the risk of uncollectibility and conflict of interest, they appear separately on the balance sheet under asset titles like receivables from employees.
Normally, individual accounts receivable have debit balances, but sometimes customers overpay their accounts either by mistake or in anticipation of making future purchases. When these accounts show credit balances, the company should show the total credits on its balance sheet as a current liability. The reason for this is that if the customers make no future purchases, the company will have to grant them refunds.
Companies that sell on credit do so to be competitive and to increase sales. In setting credit terms, a company must keep in mind the credit terms of its competitors and the needs of its customers. Obviously, any company that sells on credit wants customers who will pay their bills on time. To increase the likelihood of selling only to customers who will pay on time, most companies develop control procedures and maintain a credit department. The credit department’s responsibilities include examining each person or company that applies for credit and approving or rejecting a credit sale to that customer. Typically, the credit department asks for information about the customer’s financial resources and debts. It may also check personal references and credit bureaus for further information. Then, based on the information it has gathered, it decides whether to extend credit to the customer.
Following are the topics covered under the topic of Accounts Receivable.