How Should a Credit in Accounts Receivable Be Treated?

Financial managers treat a credit in customer receivables — the other name for accounts receivable — as a reduction to the account's balance. This treatment is in sync with basic accounting rules that require a company to credit an asset or expense account to lower its worth and to debit the account to increase its value.

Basics

Accounts receivable arise when a business conveys goods to a customer and agrees to receive payments at a future date. The same concept applies when the organization provides services. In modern economies, credit terms span anywhere from a few days to a few months — but a longer stretch is not unusual, especially in industries with a long operating cycle, such as airline and vessel manufacturing. When a corporation cannot recover an account receivable, it records the item as bad debt and transfers it into the "doubtful accounts" category. This conversion typically happens when a client's account is 30, 60 or 90 days past due, depending on credit terms and the customer's payment history.

Accounting

When properly treated, a credit to the customer receivables account affects various financial items. A bookkeeper records bad debt by crediting the "allowance for doubtful items" account and debiting the bad debt expense account. Allowance for doubtful items is a contra-asset account that reduces the worth of accounts receivables — as such, it acts as a credit to customer receivables. A more straightforward credit to customer receivables happens when a business writes off a client's account outright, generally owing to bankruptcy or gradual liquidation. To charge off an account receivable, a bookkeeper debits the bad debt expense account and credits the customer receivables account.

Reporting

Accounts receivable entries make it into different performance data summaries — also known as financial statements or accounting data synopses. Accounts receivable are part of a statement of financial position, which finance people often refer to as a balance sheet or report on financial condition. Allowance for doubtful items, cash and inventories also are integral to the last report. Bad debt expense flows into a statement of profit and loss — the other name for an income statement or report on income.

Accounts Payable

In addition to accounts receivable, investors pay special attention to accounts payable to figure out whether a company's profitability equation is up to par with the industry's average. Simply put, financiers compare receivables and payables to determine whether the business can settle its operational commitments with money in its coffers and customer remittances. A positive scenario -- such as higher accounts receivable and lower accounts payable — may be proof that corporate leadership's market expansion policies are working.

References

• Carnegie Mellon University; Accounts Receivable Financing and Information Asymmetry; Hagit Levy; March 2010
• Auburn University: Reporting and Analyzing Receivables; Talitha Smith
• Deloitte: IAS 1 Presentation of Financial Statements
• Jacksonville State University: The Allowance Method of Accounting for Bad Debts