Receivables, credit terms and sales discounts
An account receivable is money customers owe us for goods or services sold on credit. It is a current asset.
Terms of sale say when to pay:
- Cash / COD: pay now or on delivery.
- n/30: the net (full) amount is due within 30 days.
- 2/10, n/30: 2% discount if paid within 10 days; otherwise full amount within 30 days.
- EOM: due at the end of the month.
Entries (seller):
- Credit sale: Dr Accounts receivable, Cr Sales.
- Paid within the discount period: Dr Cash, Dr Sales discounts, Cr Accounts receivable.
- Paid after: Dr Cash, Cr Accounts receivable (full amount).
- Goods returned: Dr Sales returns and allowances, Cr Accounts receivable.
Sales discounts and returns are subtracted from sales to get net sales. (Where GST, VAT or sales tax applies, the discount is usually on the price before tax.)
Subledgers and control accounts
The general ledger has one Accounts Receivable control account. Details for each customer are kept in the accounts receivable subledger (customer ledger), one page each. The same idea gives an accounts payable subledger (creditor ledger) with one page per supplier.
Every credit sale or receipt is posted twice: to the customer’s page and (as a total) to the control account. At month end, list all customer balances in a schedule of accounts receivable; its total must equal the control account. If not, something was missed or posted wrongly.
Why keep creditor information accurate and up to date? To pay on time and earn discounts, avoid late fees, avoid paying an invoice twice, plan cash, keep a good credit rating, and answer suppliers’ questions quickly. Accounting software does the double posting automatically and shows an aged payables report.
Bad debts: estimating uncollectible accounts
Some customers never pay. Under the allowance method (required by IFRS-style matching) we estimate the loss in the same period as the sale:
- Percentage of sales: e.g. 1% of credit sales becomes bad debts expense.
- Percentage of receivables / ageing: sort balances by how overdue they are (0–30 days, 31–60, 61–90, over 90) and apply a bigger % to older groups. The total is the balance the allowance should have.
Entry: Dr Bad debts expense, Cr Allowance for doubtful accounts. On the balance sheet: Accounts receivable − Allowance = net realisable value (what we expect to collect).
When a specific customer is known not to pay: write-off: Dr Allowance, Cr Accounts receivable. Net realisable value does not change. If the customer later pays, reverse the write-off, then record the cash. (The direct write-off method just debits bad debts expense when a debt fails; it is simple but breaks the matching idea.)
Notes receivable, payables and purchase discounts
A note receivable is a written promise by a customer to pay a fixed amount on a fixed date, usually with interest. Interest = Principal × Rate × Time (time in years). Entries: receive the note: Dr Notes receivable, Cr Accounts receivable. At maturity: Dr Cash, Cr Notes receivable, Cr Interest revenue. If the customer fails to pay (a dishonoured note), move the amount plus interest back to Accounts receivable.
Payables (buyer’s side):
- Credit purchase: Dr Purchases (or Inventory), Cr Accounts payable.
- Paid within the discount period: Dr Accounts payable, Cr Cash, Cr Purchase discounts (or Inventory in a perpetual system).
- Return to supplier: Dr Accounts payable, Cr Purchase returns.
A 2% discount for paying 20 days early is like earning about 36% a year, so businesses try hard to take it.
Key formulas and definitions
- Discount = Invoice amount × Discount % (only if paid inside the discount period)
- Cash received = Invoice − Discount
- Net realisable value = Accounts receivable − Allowance for doubtful accounts
- Interest on a note = Principal × Annual rate × Time (in years)
- Maturity value = Principal + Interest
Worked examples
1. Goods of 10,000 are sold on terms 2/10, n/30. Write the entry for the sale.
Dr Accounts receivable 10,000; Cr Sales 10,000.
2. The customer pays on day 8. Write the entry.
Discount = 2% × 10,000 = 200. Dr Cash 9,800; Dr Sales discounts 200; Cr Accounts receivable 10,000.
3. Customer pages: Asha 20,000, Ben 18,000, Chen 12,000. The control account shows 51,000. What do you conclude?
Subledger total = 50,000. It is 1,000 less than the control account, so a posting is missing or wrong; check the month’s entries.
4. Receivables 50,000. Ageing estimate: 4% uncollectible. The allowance has a zero balance. Record the adjustment and find net realisable value.
Dr Bad debts expense 2,000; Cr Allowance 2,000. NRV = 50,000 − 2,000 = 48,000.
5. A 6,000, 8%, 3-month note receivable is collected at maturity. Find interest and write the entry.
Interest = 6,000 × 0.08 × 3/12 = 120. Dr Cash 6,120; Cr Notes receivable 6,000; Cr Interest revenue 120.
6. We buy goods of 5,000 on 2/10, n/30 and pay on day 7 (periodic system). Write both entries.
Purchase: Dr Purchases 5,000; Cr Accounts payable 5,000. Payment: Dr Accounts payable 5,000; Cr Cash 4,900; Cr Purchase discounts 100.
Common mistakes
- Taking the discount after the discount period. On day 25 under 2/10, n/30 the full amount is due.
- Writing off a bad debt to expense under the allowance method. The write-off goes against the allowance; the expense was already recorded by the estimate.
- Forgetting to post to the customer’s subledger page as well as the control account.
- Using the full year in the note interest formula when the note is for only some months.