Receivables

Selling on credit increases sales: business customers expect to pay on terms such as 30 days, and many consumers buy larger items on instalments. But credit sales create a new asset, receivables, and a new risk, that some customers will never pay. This lesson covers the kinds of receivables, how they are recorded, how a business estimates and reports the amount it expects not to collect, how write-offs and recoveries are recorded, how notes receivable earn interest, how card sales and factoring turn receivables into cash, and how managers measure how well receivables are being collected.

Kinds of receivables

Accounts receivable, also called trade receivables, are amounts customers owe for goods and services sold on credit in the normal course of business. They are usually due within 30 to 60 days, carry no interest unless paid late, and are reported as current assets. Notes receivable are written promises to pay a definite sum, usually with interest, on a specified date; they are used for larger or longer credit arrangements, to settle an overdue account, or for loans. Other receivables include amounts owed by employees, interest receivable, tax refunds receivable and amounts owed by related parties, which are reported separately because they do not arise from ordinary sales.

Large businesses keep a control account, Accounts receivable, in the general ledger and a subsidiary ledger (subledger) with a separate account for each customer. The total of the subledger must equal the control account; reconciling the two each month is a basic control. The subledger also produces customer statements and the aging schedule used below.

Recognizing accounts receivable

A receivable is recorded when revenue is earned and the customer is invoiced, at the amount the business expects to be entitled to: the invoice price less any trade discounts. Sales returns and early-payment discounts reduce receivables as covered in lesson 8. When the customer pays, Cash is debited and Accounts receivable credited.

Why an allowance is needed

Some customers will not pay. Under accrual accounting, the cost of those bad debts belongs in the period of the sales that created them, and the balance sheet should show receivables at the amount the business actually expects to collect. Waiting until a specific customer is known to be uncollectible, months later, would put the expense in the wrong period and overstate the asset in the meantime. So businesses estimate expected losses at each reporting date and record them in an allowance account.

The allowance for doubtful accounts (also called the allowance for expected credit losses or loss allowance) is a contra asset account, deducted from accounts receivable. The adjusting entry debits Bad debt expense (or credit loss expense) and credits the allowance. The net amount, receivables less the allowance, is the amount expected to be collected.

Under IFRS 9, trade receivables without a significant financing component are measured with the simplified approach: the loss allowance is always equal to lifetime expected credit losses, often estimated with a provision matrix that applies loss rates to aging buckets, adjusted for current conditions and reasonable forecasts. ASPE requires receivables to be written down when they are impaired, and in practice uses the same aging and percentage-of-sales techniques. Both are covered in more depth in ACCT-211.

Estimating the allowance

Two traditional techniques are used, often together. The percentage-of-sales approach estimates bad debt expense as a percentage of credit sales for the period, based on experience; it focuses on the income statement and is quick to apply monthly. The aging approach classifies receivables by how long they have been outstanding and applies a higher expected loss rate to older balances; it focuses on the balance sheet, produces the required ending balance of the allowance, and the expense is whatever amount brings the allowance to that balance. The aging approach is closer to the expected-loss thinking of modern standards and is usually used at year end.

# Aging schedule and required allowance (illustrative loss rates)
receivables = [   # customer, amount, days outstanding
    ("Cycling club", 1000, 14), ("Courier Co.", 2400, 38),
    ("School board", 3600, 9), ("R. Singh", 450, 75),
    ("Trail Riders", 1250, 52), ("B. Laurent", 380, 130),
    ("City parks", 2900, 22), ("J. Moreau", 620, 95),
]
buckets = [(0, 30, 0.01), (31, 60, 0.04), (61, 90, 0.15), (91, 10**6, 0.40)]
total_required = 0
for lo, hi, rate in buckets:
    amt = sum(a for _, a, d in receivables if lo <= d <= hi)
    req = amt * rate
    total_required += req
    label = f"{lo}-{hi}" if hi < 10**6 else f"over {lo - 1}"
    print(f"{label:<10} days  {amt:>7,}  x {rate:>4.0%} = {req:>7,.2f}")
print(f"Total receivables {sum(a for _, a, _ in receivables):,}")
print(f"Required allowance {total_required:,.2f}")

existing_credit_balance = 210.00
expense = total_required - existing_credit_balance
print(f"Bad debt expense to record {expense:,.2f}")

0-30       days    7,500  x   1% =   75.00
31-60      days    3,650  x   4% =  146.00
61-90      days      450  x  15% =   67.50
over 90    days    1,000  x  40% =  400.00
Total receivables 12,600
Required allowance 688.50
Bad debt expense to record 478.50

Total receivables are $12,600 and the required allowance is $688.50. If the allowance already has a credit balance of $210 left over from earlier estimates, the adjusting entry records only the difference: debit Bad debt expense $478.50, credit Allowance for doubtful accounts $478.50. If the allowance had a debit balance, because write-offs during the year exceeded earlier estimates, the expense would be the required balance plus that debit balance. Reported net receivables are $12,600 − $688.50 = $11,911.50.

Write-offs and recoveries

When a specific account is judged uncollectible, for example because the customer has gone bankrupt or collection efforts have failed, it is written off by debiting the allowance and crediting Accounts receivable (and the customer's subledger account). The write-off does not affect expense or net receivables, because the expense was already recognized when the allowance was set up; it simply removes an amount both from receivables and from the allowance. If the customer later pays after all, the write-off is reversed (debit Accounts receivable, credit Allowance) and the collection recorded as usual (debit Cash, credit Accounts receivable), so the customer's history shows the payment.

The direct write-off method, which records bad debt expense only when a specific account is written off, is simple but does not follow accrual accounting. It is acceptable only when bad debts are immaterial. Canadian income tax rules allow a deduction for a reasonable doubtful debt reserve; tax treatment is a separate matter from the accounting.

Notes receivable

A note receivable earns interest. Interest is calculated as principal times annual rate times time, as in lesson 6, and is accrued at each period end if the note spans it. At maturity, the business receives principal plus interest. If the maker fails to pay at maturity, the note is dishonoured: the business transfers the principal and interest to Accounts receivable and pursues collection, and the amount is included in the allowance assessment.

Turning receivables into cash

Many businesses avoid carrying receivables at all by accepting credit and debit cards. The card issuer bears the credit risk, and the business receives cash within a day or two, less a processing fee (the merchant discount), commonly between about 1.5 and 3 per cent depending on the card and provider. The fee is recorded as an expense: a $650 card sale with a 2.5 % fee is recorded as debit Cash 633.75, debit Card fees expense 16.25, credit Sales revenue 650. Businesses that need cash sooner can also sell receivables to a factor, usually at a discount, or borrow against them using them as security.

In Canada, merchants may add a surcharge for credit card payments within limits set by the card networks (generally up to 2.4 per cent) and with clear disclosure, following a 2022 class action settlement; Quebec prohibits surcharges under its consumer protection law. Rules can change, so businesses should check the current requirements.

Measuring collection

Two ratios show how quickly receivables are collected. Receivables turnover is net credit sales divided by average net accounts receivable. Days sales outstanding (DSO), also called the average collection period, is 365 divided by the turnover. If credit terms are 30 days and DSO is 48 days, customers are paying late on average, and the business should look at its credit approval and collection procedures. Lesson 12 uses these ratios alongside others.