The term Accounts receivable generally denotes all claims involving a future inflow of cash (You will receive cash from these accounts). These receivables result from business transactions involving sales of goods and services, loans and miscellaneous claims. The accounting procedures surrounding the creation of receivables as well as the controls over the credit granting function and the collection process are, therefore, of considerable importance. usually in financial statement, uses A/R term replace of accounts receivable. Debtors are the commonly part of accounts receivable in any business.
Trade accounts receivables represent the sale of goods and services in the normal course of business operations and account for the major portion of a firm's revenue-producing activities.
The open account, or trade account, created by a transaction between business concerns is generally unsecured (an informal arrangement rather than illegal agreement) and non-interest-bearing. This can be contrasted to retail trade
receivables, which typically involve the addition of an interest or service charge to revolving charge accounts and installment agreements.
Trade accounts receivables sometimes take the form of commercial credit instruments such as promissory notes or time drafts. Since these are signed agreements, a measure of legal commitment is provided and the holder may borrow against them (see Notes Receivable).
Revenue is sometimes generated from sources other than trade receivables. Among these are short-term advances to customers or subcontractors, insurance claims, claims for rebates on taxes or other over payments, sale of plant and equipment and accruals of interest, rent, royalties, etc. Such receivables are properly classified as current assets when collection is expected within one year and as other assets or miscellaneous assets if a longer collection period is anticipated.
Generating Cash from Accounts Receivable
Accounts receivable may be sold or used as collateral in order to generate immediate cash for the business. These procedures are quite common in some industries while in others they are used to raise funds in times of financial difficulty.
Factoring accounts receivable: When a receivable is sold or factored, the risk of credit and all collection efforts are assumed by the buyer, or factor. The firm selling the receivables receives its cash immediately, fora fee. Factoring arrangements vary widely, and usually depend on such things as the amount of receivables purchased and the credit standing of the firm's customers. The fees imposed by the factor generally consist of an interest charge on the funds actually borrowed plus a commission of from 1 to 3% of the net amount of receivables purchased.
The factoring of accounts receivable does not raise any particular accounting problems.
Cash is debited for receipts from the sale, Accounts Receivable is credited and the factor's commission and interest charges are recorded as expenses. If the factor holds back a percentage of the proceeds as protection against returns and allowances, the seller records that amount as a receivable from the factor.
Method of Assigning Receivable
Under this method, the business (assignor) pledges the receivables to the lender (assignee) as collateral for a loan. The assignor retains a credit risks and generally makes all collections since the customer is rarely notified of the .assignment. The assignee generally advances less than 100% of the receivables pledged, which means that the assignor has some equity in the receivables.
For accounting purposes the following procedures should be used:
- Accounts that have been assigned should be transferred to a separate account called Accounts Receivable Assigned.
- Funds received from the assignee should be credited to a Notes Payable, Assignee account.
- Collections on those accounts turned over to the assigned would require a debit to Notes Payable, Assigned and a credit to Accounts Receivable Assigned.
- Charges for interest, commissions, etc. should be handled as period expenses and included in payments to the assignee.
In the balance sheet, the assignor's equity in pledged receivables is indicated by deducting the balance due the assigned from the total receivables assigned.