Once paid, that account is “zeroed”out.
Cash collection of A/R does not affect income.
A company's balance of A/R on Sept. 1 is $35,000. During the month of September, sales on account are $157,000 while
cash collections from customers total $148,000. What is the A/R balance on Sept. 30?
End A/R = Beg A/R + sales on account - cash collections = 35,000 + 157,000 - 148,000 = 44,000
• In our example, we assumed Pete’s would pay and it did.
In some cases, sales on account will not be collected in cash.
Why would a company sell to customers it doesn’t expect to pay?
The company doesn’t know
customers won’t pay, but expects (given economic factors) that some ultimately won’t be
able to pay.
Companies set credit policies to balance:
Desire for greater revenues vs.
Assurance of collectibility
Bad debt expense is recorded to account for the expectation that not all credit sales will be collected.
• Some proportion of A/R will not convert to cash
Accounting for Bad Debt:
1. Record sales on account (current period)
2. Record adjusting entry for bad debt expense (current period)
3. Record write-offs (future periods)
4. Record recoveries, if they occur (future periods)
Accounting for Bad Debt: Step 1
• Revenue is earned now (coffee has been delivered).
• Realization (cash collection) is expected in the future.