Accounts Receivable - AR
Accounts Receivable: is money owed to a business due to goods sold or services rendered to customers for which the customer has yet to pay.
Accounts Receivable Details
Accounts receivable (AR) is a legal claim to payment by a business for goods supplied or services rendered to customers for which the customers have yet to pay for the goods or services. ARs are generated when companies sell goods or services to customers with the promise that the customer will pay for the goods or services at an agreed-upon date. Businesses generate invoices and send them to their customers to notify them of their debt and to provide a time frame they are expected to pay the money. ARs are recorded in the balance sheet under assets because they can be easily converted to cash.
Large organizations that deal with huge sales (expensive items or services, for example, companies that manufacture and sell airplanes) have a dedicated AR team in charge of following up with customers to ensure that they pay the money owed to the company within the agreed time frame. The AR team receives the money on behalf of the company and applies it towards the balance books. The AR team usually comprises collectors and cashiers: the collectors pursue customers and collect money from them while the cashiers reconcile the money with the balance books. ARs are important to big companies because they are the primary source of income for such companies.
Accounts Receivable Example
The time frame for payments and other conditions are called payment terms. The format shows the expected time to pay and the discount available if the customer pays before the given deadline. An example is net 30 days or n30, which means that the payment period is 30 days from the invoice's date. The customer is free to pay any time before the end of the payment period.
Another way the payment terms may be written is as a fraction. An example is 2/15 n30. The fraction 2/15 means that the customer will get a 2% discount if the customer pays within the first 15 days of receiving the invoice.
An example of accounts receivable will illustrate the concept:
Diaphas is a chemical company that produces and sells different types of chemicals such as sulphuric acid. One of their customers, Mr. Yatek placed an order for 20 tons of the acid, which is to be delivered to his factory. Diaphas generated an invoice that was mailed to Mr. Yatek. Since Diaphas has made a sale of 20 tons of acid, the transaction is entered in the account receivables of the balance book. The payment terms on the invoice were 2/10 n60. The payment amount was $35,000.
Mr. Yatek will receive a discount of 2% if he pays within 10 days from the invoice's date. Mr. Yatek, however, has a whole 60 days to pay the $35,000 debt. If Mr. Yatek fails to pay his debt by the end of 60 days, Diaphas can hand over the AR to a third party debt collection agency that will proceed with debt recovery.
Mr. Yatek wanted the 2% discount, so he paid within the given 10 days. He ended up paying $34,200 instead of the $35,000. Diaphas has now received cash for the transaction recorded in the AR, so Diaphas increases their cash account by $34,000 and decreases their AR by the same amount.