Module 4

ECF2

SALES and RECEIVABLES

March 27, 2023

Date Initiated
March 31, 2023
Date of Completion

San Mateo Municipal College ECF2 – Financial Controllership

Bachelor of Science in Business Administration Major in Financial Management Ester C. Castillo, Instructor
 MODULE 5

MODULE DURATION

This module is designed to be discussed for a period of one week. Lesson Delivery will be
done in synchronous and asynchronous learning. The platform to be used will be facebook
messenger, google classroom and google meet created for the class.

LEARNING OBJECTIVES

At the end of the module, you are expected to:

• Discuss relationship between sales and receivables.
• Identify the types of receivables.
• Describe the accounts receivables cycle.
• Explain management of receivables.

INPUT INFORMATION

What is a Receivable?

A receivable is money owed to a business by its clients and shown on its balance sheet as an
asset. It is one of a series of accounting transactions dealing with the billing of a customer for
goods and services that the customer has ordered. Accounts receivable is an asset which is the
result of accrual accounting. In this case, the firm has delivered products or rendered services
(hence, revenue has been recognized), but no cash has been received, as the firm is allowing
the customer to pay at a later point in time.

Sales on Credit

Receivables represent money owed by entities to the firm on the sale of products or services on
credit. In most business entities, accounts receivable is typically executed by generating an
invoice and either mailing or electronically delivering it to the customer; who, in turn, must pay it
within an established time frame. This is called credit terms or payment terms.

Use of Ledger

The accounts receivable departments use the sales ledger. This is because a sales ledger
normally records:

• The sales a business has made.

• The amount of money received for goods or services.-
• The amount of money owed at the end of each month varies ( debtors ).

San Mateo Municipal College ECF2 – Financial Controllership

Bachelor of Science in Business Administration Major in Financial Management Ester C. Castillo, Instructor
 • Accounts Receivable Department

• The accounts receivable team is in charge of receiving funds on behalf of a company and
applying it towards their current pending balances. Collections and cashiering teams are
part of the accounts receivable department. While the collection’s department seeks the
debtor, the cashiering team applies the monies received.

Types of Receivables

• Receivables can generally be classified as accounts receivables or notes receivable,

though there are other types of receivables as well.

Receivables can be classified as accounts receivables, notes receivable and other receivables (
loans, settlement amounts due for non- current asset sales, rent receivable, term deposits).
Other receivables can be divided according to whether they are expected to be received within
the current accounting period or 12 months (current receivables), or received greater than 12
months ( non-current receivables).

Accounts Receivable
Accounts receivable are amounts that customers owe the company for normal credit purchases.
Since accounts receivable are generally collected within two months of the sale, they are
considered a current asset. Accounts receivable usually appear on balance sheets below short-
term investments and above inventory.

Notes Receivable
Notes receivable are amounts owed to the company by customers or others who have signed
formal promissory notes in acknowledgment of their debts. Promissory notes strengthen a
company’s legal claim against those who fail to pay as promised. The maturity date of a note
determines whether it is placed with current assets or long-term assets on the balance sheet.
Notes that are due in one year or less are considered current assets, while notes that are due in
more than one year are considered long-term assets.

Other Receivables
Accounts receivable and notes receivable that result from company sales are called trade
receivables, but there are other types of receivables as well. For example, interest revenue from
notes or other interest-bearing assets is accrued at the end of each accounting period and
placed in an account named interest receivable. Wage advances, formal loans to employees, or
loans to other companies create other types of receivables. If significant, these nontrade
receivables are usually listed in separate categories on the balance sheet because each type of
nontrade receivable has distinct risk factors and liquidity characteristics.

Recognizing Accounts Receivable

San Mateo Municipal College ECF2 – Financial Controllership

Bachelor of Science in Business Administration Major in Financial Management Ester C. Castillo, Instructor
If you are operating under the accrual basis, you record account receivable transactions
irrespective of any changes in cash.

Other Receivables
Accounts receivable and notes receivable that result from company sales are called trade
receivables, but there are other types of receivables as well. For example, interest revenue from
notes or other interest-bearing assets is accrued at the end of each accounting period and
placed in an account named interest receivable. Wage advances, formal loans to employees, or
loans to other companies create other types of receivables. If significant, these nontrade
receivables are usually listed in separate categories on the balance sheet because each type of
nontrade receivable has distinct risk factors and liquidity characteristics.

Booking a receivable is accomplished by a simple accounting transaction. However, the process

of maintaining and collecting payments on the accounts receivable is more complex. Depending
on the industry in practice, accounts receivable payments can be received up to 10 – 15 days
after the due date has been reached. These types of payment practices are sometimes
developed by industry standards, corporate policy, or because of the financial condition of the
client.

Account receivables are classified as current assets assuming that they are due within one year.
To record a journal entry for a sale on account, one must debit a receivable and credit a revenue
account. When the customer pays off their accounts, one debits cash and credits the receivable
in the journal entry. The ending balance on the trial balance sheet for accounts receivable is
always debit.

Payment Terms
An example of a common payment term is Net 30, which means that payment is due at the end
of 30 days from the date of invoice. The debtor is free to pay before the due date; businesses
can offer a discount for early payment. Other common payment terms include Net 45, Net 60,
and 30 days end of month.

Allowance for Doubtful Accounts

Since not all customer debts will be collected, businesses typically estimate the amount of and
then record an allowance for doubtful accounts which appears on the balance sheet as a contra
account that offsets total accounts receivable. Two methods are available to calculate the
amount of bad debt expense and allowance of doubtful accounts at the end of an accounting
period — percentage of accounts receivable or percentage of sales. When accounts receivables
are not paid, some companies turn them over to third party collection agencies or collection
attorneys who will attempt to recover the debt via negotiating payment plans, settlement offers or
pursuing other legal action.

Examples of Allowance Calculation

An example of how to calculate the allowance for doubtful accounts using the percentage of
receivables method — Assume Furniture Palace has an ending accounts receivable balance of
USD 10,000 and estimates that 5% of receivables are doubtful. To adjust the allowance account
for the new estimate, debit Bad Debt Expense for USD 500 (10,000 *0.05) and credit Allowance
for Doubtful Accounts for USD 500.

To calculate the allowance for doubtful accounts using the percentage of total sales, estimate the
percentage of sales that will be uncollectible. Furniture Palace estimates that 10% of the period’s
USD 20,000 total sales may not be collected. To adjust the allowance account for the new
period’s estimate, debit Bad Debt Expense for USD 2,000 (20,000 *0.10) and credit Allowance
for Doubtful Accounts for USD 2,000.

Valuing Accounts Receivable

Receivables of all types are normally reported at their net realizable value, which is the amount

San Mateo Municipal College ECF2 – Financial Controllership

Bachelor of Science in Business Administration Major in Financial Management Ester C. Castillo, Instructor
the company expects to receive in cash.

Valuation
Receivables of all types are normally reported on the balance sheet at their net realizable value,
which is the amount the company expects to receive in cash.

Business owners know that some customers who receive credit will never pay their account
balances. These uncollectible accounts are called bad debts. Companies use two methods to
account for bad debts: the direct write-off method and the allowance method.

Direct Write-Off Method

For tax purposes, companies must use the direct write-off method, under which bad debts are
recognized only after the company is certain the debt will not be paid. Before determining that an
account balance is not collectible, a company generally makes several attempts to collect the
debt from the customer.

Recognizing the bad debt requires a journal entry that increases a bad debts expense account
and decreases accounts receivable. If a customer named J. Smith fails to pay a $100 balance,
for example, the company records the write-off by debiting bad debts expense and crediting
accounts receivable from J. Smith.

Allowance Method
Under the allowance method, an adjustment is made at the end of each accounting period to
estimate bad debts based on the business activity from that accounting period. Established
companies rely on past experience to estimate unrealized bad debts, but new companies must
rely on published industry averages until they have sufficient experience to make their own
estimates.

The adjusting entry to estimate the expected value of bad debts does not reduce accounts
receivable directly. Accounts receivable is a control account that must have the same balance
as the combined balance of every individual account in the accounts receivable subsidiary
ledger.

Since the specific customer accounts that will become uncollectible are not yet known when the
adjusting entry is made, a contra-asset account named allowance for bad debts, which is
sometimes called allowance for doubtful accounts, is subtracted from accounts receivable to
show the net realizable value of accounts receivable on the balance sheet.

ACCOUNTS RECEIVABLE CYCLE

San Mateo Municipal College ECF2 – Financial Controllership

Bachelor of Science in Business Administration Major in Financial Management Ester C. Castillo, Instructor
ACCOUNTS RECEIVABLES MANAGEMENT

Strong internal control procedures for managing accounts receivable are critical to improving
cash flow, ensuring the reliability of financial information and combating the risk of fraud, error
and loss of assets. The right tools and clear data can help you establish strong internal control of
your accounts receivable management processes. These tools and data can inform how you
standardize invoice creation, maintain and report receivable accounts, and how you collect and
record invoice payments.

The following are some of the most common accounts receivable control methods, a
comprehensive accounts receivable control checklist and additional resources for mitigating risk
for accounts receivable.

Segregation of Duties for Accounts Receivable

Segregation of the duties of accounts receivable management is an important internal control
method. By dispersing the accounts receivable management duties among different employees,
you can increase oversight and reduce the opportunity for fraud. Segregation of duties for
accounts receivable means that no one person has sole responsibility for more than one of the
four main functions of accounts receivable management:
• Custody of accounts receivable
• Authorization to use the accounts receivable receipts
• Recording accounts receivable
• Production of accounts receivable reports

Accounts Receivable Internal Control Checklist

Well-documented policies and procedures for who should handle which accounts receivable
responsibilities, and how those responsibilities should be handled, is an important factor in
establishing strong internal control over accounts receivable. Be sure to implement these
controls along the entire accounts receivable management process:

Receive a Purchase Order from Your Customer

Internal control over accounts receivable often begins with receipt of the purchase order. When a
customer’s purchase order is received, accounts receivable best practice is to review the
purchase order to:
• Check that the pricing, terms and conditions agree with the sales order and company
policy for credit terms;
• Ensure the order is authorized by the proper person;
• Review the customer’s credit rating before extending trade credit; and
• Check current account balance against balance limits.
• Create the Sales Order

Before issuing the sales order, be sure these control procedures for accounts receivable
are in place:
• Check that the details on the purchase order match those on the sales order; and
• Ensure that the sales order is properly authorized or approved.

Prepare the Sales Invoice

The sales invoice details the services or goods provided to the customer, the amount owed for
the goods or services and the due date for the payment. Careful control of this process includes:
• Preparing the numbered invoice on a branded company template;
• Reconciling the invoice information against the sales order;
• Reviewing invoice calculations for accuracy;
• Checking that the customer’s address and contact person are correct; and
• Issuing the invoice to the customer on time.

San Mateo Municipal College ECF2 – Financial Controllership

Bachelor of Science in Business Administration Major in Financial Management Ester C. Castillo, Instructor
Post the Sales Journal
The sales journal provides a clear view of each sales transaction, detailing what customers
purchased, the credit extended and the payment received. Careful internal control over
receivables includes these sales journal steps, including:
• Using an invoice copy to quickly post to the sales journal for each transaction;
• Reviewing journal entries against invoices to ensure accuracy;
• Filing invoice copies by invoice number; and
• Posting the sales journal totals to the accounts receivable control account in the general
ledger.
• Post the Accounts Receivable Ledger
The accounts receivable ledger is a record of all trade credit sales made by a business. Because
the ledger records all customer invoice amounts, it provides a clear look at the amount of unpaid
accounts receivable. Managing the accounts receivable ledger is a separate duty from collecting
on invoices.

Recommended internal control procedures for the accounts receivable ledger include:
• Using an invoice copy to quickly post to the accounts receivable ledger as soon as an
invoice is issued;
• Reviewing journal entries against invoices to ensure accuracy;
• Filing unpaid invoice copies by invoice date;
• Carrying out random checks of customer sales activity to identify any unusual patterns;
• Regularly reviewing credit balances for each customer;
• Creating an aged accounts receivable report;
• Reviewing the balances and flagging large and overdue accounts;
• Recording cash settlement discounts; and
• Reconciling the accounts receivable ledger with the accounts receivable control account
in the general ledger.

Mitigate External Accounts Receivable Risk

Internal controls for the accounts receivable management workflow are vital in avoiding mistakes
that can cause harm to your financial position. For added security, trade credit insurance can
help you better manage commercial risks that are beyond your control, such as an interrupted
cash flow due to late or non-payment of invoices

LEARNING ACTIVITIES:
Answer the following based on the earlier discussion.

1. Explain internal control procedures for managing accounts receivable.

2. Discuss segregation of duties in performing control.
3. What happens when account receivables are not collected?

Study & prepare for a short quiz.

REFERENCE:

https://www.eulerhermes.com/en_US/insights/accounts-receivable-control-methods.html (2)
https://courses.lumenlearning.com/boundless-accounting/chapter/reporting-and-analyzing-receivables/

San Mateo Municipal College ECF2 – Financial Controllership

Bachelor of Science in Business Administration Major in Financial Management Ester C. Castillo, Instructor