Accounts Receivable


  • What is Accounts Receivable
  • How to Record Accounts Receivable 
  • Common Accounts Receivable Payment Term
  • What is Ageing of Accounts Receivable? 
  • Benefits of Recording Accounts Receivable 
  • Challenges Linked to Accounts Receivable Management 
  • Effective Accounts Receivable Management Practises 
  • Accounts Receivable Turnover Ratio 
  • Accounts Receivable in Financial Statements 

What is Accounts Receivable? 

Accounts receivable refers to an asset account that monitors the money owed to an entity by its clients or other debtors. This account essentially reflects the sales made by providing credit to customers until the entity receives the anticipated funds. 

According to AASB 9, accounts receivable are initially recognised when an entity becomes a party to the contractual provisions of the instrument, typically when goods or services are provided to a customer on credit. They are initially measured at fair value plus transaction costs that are directly attributable to their acquisition or issue. 

This asset account is categorised as a current asset, indicating that it records funds expected to be received within one year. Thus, it represents short term obligations.  

For instance, if an entity enters into a five year contract where a customer agrees to pay a fixed amount annually, only the portion due within the current year would be included in the receivable balance on the entity’s balance sheet. 

In cases where accounts receivable remain unpaid, some entities may opt to engage third party collection agencies to recover the outstanding debt. 

Accounts receivable are managed under an accrual accounting method. In this accounting system, transactions are recorded when they occur, regardless of when the funds are received or debited. 

How to Record Accounts Receivable 

To record accounts receivable, they are documented as a current asset on the balance sheet and included on the income statement as revenue, similar to immediate payments for goods or services. 

Some accounting software platforms automatically calculate accounts receivable as client invoices are generated. 

In accrual accounting, accounts receivable represent funds that have been earned but not yet collected, treated as accruals. Conversely, cash accounting records funds only when the client pays the invoice. 

As per AASB 9, an essential aspect of accounting for accounts receivable is assessing impairment or the potential loss arising from customers’ inability to fulfil their payment obligations.  

The standard highlights a simplified approach for trade receivables, mandating the measurement of the loss allowance at an amount equal to lifetime expected credit losses. This means that entities estimate the expected credit losses for the entire lifetime of the receivable at the time of its initial recognition. 

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Common Accounts Receivable Payment Terms 

Common accounts receivable payment terms specify the agreed upon date by which the customer must settle the invoice. The most prevalent term is Net30, meaning payment is due within 30 days. However, terms can vary from a few days to a year, with larger businesses sometimes requesting Net60 or even Net90 terms. 

Extended payment terms can strain small suppliers reliant on that income to cover expenses, underscoring the importance of cash flow management in an entity’s success. Effective cash flow management involves controlling the inflow and outflow of funds to ensure financial stability. 

What is Ageing of Accounts Receivable? 

The process known as accounts receivable ageing is a strategic approach utilised by businesses to manage and assess the money owed to them by customers. This method is crucial for effective debtor management and optimising the collection of payments. 

In essence, when a business sells goods or services on credit, it typically sets a payment window ranging from 30 to 120 days, based on the agreed terms. Once this payment period lapses without receipt of payment, the corresponding invoice is considered aged. This ageing is quantified in terms of the days elapsed since the payment was due. For instance, an invoice that remains unpaid four days past its due date is said to be four days aged. 

The ageing technique categorises accounts receivable based on the issuance date of the invoices, their respective due dates, and the duration for which they have been overdue. This categorisation aids businesses in identifying which customers should be prioritised for payment reminders or possibly referred to collection agencies. 

An ageing report, which is a standard output of this process, itemises these invoices, showcasing each by its issuance date and unique identifier. This report is instrumental for businesses in forecasting cash flows more accurately and making informed decisions regarding credit terms, especially with customers who have a history of late payments. 

AASB 7 Financial Instruments: Disclosures intersects with the concept of accounts receivable ageing through its requirements for disclosing credit risk associated with financial instruments. It emphasises the importance of disclosing information that helps in understanding the credit risk exposure of financial assets, including receivables.  

This includes detailing the extent of exposure to credit risk and how it is managed, which aligns with the objectives of accounts receivable ageing.  

Such disclosures ensure that stakeholders are well informed about the potential risk of financial losses due to receivables that may become uncollectible, thereby highlighting the relevance of the ageing process in financial reporting and risk management. 

Benefits of Recording Accounts Receivable 

Recording and managing accounts receivable is crucial for businesses of all sizes, offering a multitude of benefits that contribute to their financial stability and operational efficiency. Some of these benefits are: 

Enhanced Customer Relations

Facilitating credit extension to customers is enabled by a comprehensive tracking system for owed amounts. The recording of credits in accounts receivable ensures timely bill payments without the necessity of upfront cash, thereby reducing purchase barriers and subsequently enhancing sales.  

Additionally, extending credit fosters goodwill by alleviating the inconvenience associated with upfront payments and addressing customer hesitancy towards paying for goods or services yet to be received. 

Streamlined Accounting Processes

Efficient tracking of accounts receivable contributes to the organisation of the balance sheet and optimisation of invoicing procedures. Each customer payment is reflected three times on the balance sheet: as a credit to receivables, a debit from receivables, and a credit to revenue, facilitating seamless transaction cross referencing.  

An organised balance sheet aids in debt collection and facilitates the analysis of days sales outstanding (DSO), representing the average time taken to receive payment post sale.  

Furthermore, ecommerce accounting software can automate aspects of this process, such as automatically crediting accounts receivable upon invoice issuance and debiting accounts receivable (and crediting revenue) upon payment receipt. 

Effective Cash Flow Management and Liquidity Assessment

The accounts receivable balance serves as a vital indicator of an entity’s financial health, offering insights into its liquidity. Effective management of accounts receivable supports cash flow management, enabling the entity to fulfil obligations while maintaining a reduced cash reserve.  

Without an accurate depiction of accounts receivable on the balance sheet, assessing liquidity becomes challenging, making it crucial for maintaining cash flows and meeting financial obligations with a smaller cash reserve. 

Account receivable

Challenges Linked to Accounts Receivable Management 

  • Cash Flow Problems: One of the significant risks associated with accounts receivable is the potential for cash flow issues. If customers delay payments or fail to pay altogether, it can lead to a shortage of cash on hand. This shortage can make it difficult for the entity to meet its financial obligations, such as paying suppliers, employees, or other expenses. 
  • Higher Financing Costs: Entities with high balances in accounts receivable may need to seek external financing options to cover their expenses while waiting for payments. This reliance on external financing can result in higher interest expenses, adding to the financial burden of the entity. 
  • Loss of Income: When receivables become uncollectible or doubtful, they may eventually have to be written off as bad debt. This write off results in a direct loss of income for the entity, as the expected revenue from those sales is no longer realised. 
  • Credit Risk Exposure: Extending credit to customers without proper monitoring or assessment can expose the entity to credit risk. If customers default on their payments, it can lead to financial losses and impact the entity’s overall profitability. 

Effective Accounts Receivable Management Practises 

Implementing robust strategies for managing accounts receivable is crucial to ensure timely collections and maintain a healthy cash flow. Here are some key practises: 

Establish a Clear Credit Policy

Define criteria for extending credit to customers, including setting credit limits, specifying payment terms, and outlining penalties for late payments. 

Perform Credit Checks

Regularly assess customer credit histories to mitigate the risk of non payment and identify potential credit risks. 

Send Invoices Promptly

Issue invoices promptly upon delivery of goods or completion of services to prompt timely payment from customers. 

Implement a Follow Up Process

Establish a structured process for following up on overdue invoices, including sending reminders, making collection calls, and escalating procedures if necessary. 

Offer Incentives for Early Payment

Encourage customers to pay early by providing discounts or other incentives for prompt payment, which can help improve cash flow. 

Monitor Accounts Receivable Turnover

Regularly analyse accounts receivable turnover to track trends and evaluate the effectiveness of credit policies in facilitating timely collections. 

Review and Update Credit Policies

Periodically review and update credit policies to ensure they remain aligned with business objectives and adapt to changes in economic conditions or customer behaviour. Regular assessments help in refining strategies for better accounts receivable management. 
Tax payment and tax deduction planning involve strategies to minimize tax liability.

Accounts Receivable Turnover Ratio 

The accounts receivable turnover ratio is a crucial financial metric used to assess how effectively an entity manages its accounts receivable. It measures the frequency with which the entity collects payments from its customers. 

The formula for calculating the accounts receivable turnover ratio is: 

Accounts Receivable Turnover Ratio = Net Credit Sales / Average Accounts Receivable 

  • Net Credit Sales: This refers to the total sales made on credit minus any returns or allowances. It represents the amount of revenue generated from credit sales. 
  • Average Accounts Receivable: This is the average of the accounts receivable balances at the beginning and end of a specified period. It provides a snapshot of the entity’s outstanding receivables over that period. 

A higher turnover ratio indicates that the entity is collecting payments from customers more frequently, which is generally favourable as it indicates efficient management of accounts receivable.  

Conversely, a lower turnover ratio suggests that the entity takes longer to collect payments, which may indicate inefficiencies in the collection process or a higher risk of bad debts. 

Accounts Receivable in Financial Statements 

Under AASB 101, accounts receivable are primarily classified as current assets on the statement of financial position. This classification is based on the expectation that these amounts will be converted into cash within 12 months following the reporting period, highlighting the short term benefits they bring to the entity’s liquidity. 

The standard mandates a clear presentation of accounts receivable, segregating them from other financial assets to provide a transparent view of the entity’s financial health. This segregation aids stakeholders in assessing the entity’s operational efficiency and its effectiveness in managing credit and collections. 

Disclosure of Accounting Policies 

AASB 101 emphasises the importance of disclosing significant accounting policies applied to accounts receivable. This includes the basis of measurement, such as whether receivables are measured at amortised cost or fair value, and the method used to determine the allowance for expected credit losses.  

These disclosures are crucial for users of financial statements, as they provide insight into the management’s judgement and estimation processes, affecting the valuation of accounts receivable. 

This article is general information only and does not provide advice to address your personal circumstances. To make an informed decision you should contact an appropriately qualified professional.