Accounting for Sales & Receivables: Revenue, Bad Debts & Credit Management

TAKEAWAYS:

• Sales transactions are recorded as debits to Accounts Receivable (credit sales) or cash (cash sales) and credits to Sales Revenue.
• Revenue recognition follows the accrual basis (earned, not received) and matching principle (expenses vs. revenue in the same period).
• Bad debts are estimated using the percentage of sales method or aging schedule to adjust Accounts Receivable.
• Allowance for Doubtful Accounts is a contra-asset account that offsets receivables, improving financial statement accuracy.
• Credit terms (e.g., 2/10, n/30) impact cash flow and receivable aging; collection policies reduce bad debt risk.
• Trial balance must reconcile Sales Revenue, Accounts Receivable, and Allowance for Doubtful Accounts before financial statements.

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1. Introduction to Sales Transactions

Sales are revenue earned from selling goods/services. They can be:

• Cash sales: Paid immediately (e.g., Daraz cash-on-delivery).
• Credit sales: Paid later (e.g., Daraz credit card orders).

Recording Sales in Journal

Key Rules:

• Debit Accounts Receivable (asset increases).
• Credit Sales Revenue (revenue increases).

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2. Revenue Recognition Principles

Revenue is recognized when:

1. Earned (goods/services delivered).
2. Realizable (payment likely).
3. Measurable (price fixed).

Example: Pathao recognizes revenue when a ride is completed (not when payment is received).

Accrual vs. Cash Basis

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3. Accounts Receivable Management

Definition: Amounts owed by customers for credit sales.

Journal Entry for Credit Sales

Subsidiary Ledger for Accounts Receivable

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Mermaid Diagram: Accounts Receivable Flow

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4. Bad Debts and Allowance Method

Not all receivables are collectible. Bad debts are uncollectible accounts.

Methods to Account for Bad Debts

Allowance Method Steps

1. Estimate bad debts (e.g., 5% of receivables).
2. Debit Bad Debt Expense, Credit Allowance for Doubtful Accounts.
3. Write off uncollectible accounts (debit allowance, credit receivable).

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Worked Example: Kathmandu Retail Shop (NPR) Given:

• Accounts Receivable: Rs 200,000
• Bad debt estimate: 3% of receivables.

Journal Entry:

Net Realizable Value (NRV):

Accounts Receivable (200,000)
− Allowance for Doubtful Accts (6,000)
= **Net Realizable Value (194,000)**

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5. Credit Terms and Collection Policies

Credit Terms: Conditions for payment (e.g., 2/10, n/30 = 2% discount if paid in 10 days, else net in 30 days).

Example: Ncell offers 3% cashback for early payment (similar to credit terms).

Impact of Credit Terms on Cash Flow

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6. Financial Statement Presentation

Income Statement (Partial)

Balance Sheet (Partial)

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In the Real World

1. Daraz (E-commerce Platform)

   • Uses: Accounts Receivable for customer orders (credit sales) and Allowance for Doubtful Accounts to estimate unpaid invoices.
   • Example: If a customer’s order is Rs 5,000 but they fail to pay, Daraz writes it off using the allowance method.

2. Pathao (Ride-Hailing App)

   • Uses: Revenue Recognition when a ride is completed (not when payment is processed).
   • Example: If a ride costs Rs 200 but the rider pays Rs 210 (including service charge), Pathao records Rs 200 as revenue immediately.

3. Ncell (Telecom Provider)

   • Uses: Credit Terms (e.g., "Pay in 30 days") and Bad Debt Expense for unpaid bills.
   • Example: If 2% of Rs 100 million monthly revenue is uncollectible, Ncell estimates Rs 2 million in bad debts annually.

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Exam Tip

1. Focus on Journal Entries:

   • Always debit Accounts Receivable for credit sales and credit Sales Revenue.
   • For bad debts, debit Bad Debt Expense and credit Allowance for Doubtful Accounts.

2. Understand Allowance Method:

   • The trial balance must include Accounts Receivable and Allowance for Doubtful Accounts as separate lines.
   • Net Realizable Value = Accounts Receivable − Allowance.

3. Real-World Scenarios:

   • Expect questions on credit terms (e.g., 2/10, n/30) and collection policies.
   • Practice aging schedules to estimate bad debts (common in exams).

4. Common Mistakes to Avoid:

   • Direct write-off instead of allowance method (violates GAAP).
   • Forgetting to adjust for discounts in revenue recognition.
   • Misclassifying Sales Revenue vs. Cash in journal entries.

5. Numerical Problems:

   • Always show workings for bad debt estimation (e.g., 5% of receivables).
   • Present final figures in Income Statement and Balance Sheet formats.

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Mermaid Diagram: Accounting Cycle for Sales & Receivables