CAT / FIA FFM Syllabus F. Credit Management - Accounts receivables records - Notes ^{1 / 4}

When you sell goods or services to a customer and allow it to pay you at a later date, this is known as selling on credit, and creates a liability for the customer to pay your business.

Conversely, this creates an asset for your company, which is called accounts receivable.

This is considered a short-term asset, since you are normally paid in less than one year.

An account receivable is documented through an invoice, which you are responsible for issuing to the customer through a billing procedure. 

The invoice describes the goods or services you have sold to the customer, the amount it owes you (including sales taxes and freight charges), and when it is supposed to pay you.

• Cash accounting

  If you are operating under the cash basis of accounting, you only record transactions in your accounting records (which are then compiled into the financial statements) when cash is either paid or received. 

  Since issuing an invoice does not involve any change in cash, there is no record of accounts receivable in your accounting records. 

  Only when the customer pays you then you record a sale.

• Accruals accounting

  If you are operating under accrual basis of accounting, you record transactions irrespective of any changes in cash. 

  This is the system under which you record an account receivable. 

  In addition, there is a risk that the customer will not pay you. 

  If so, you can either charge these losses to expense when they occur (known as the direct write-off method) or you can anticipate the amount of such losses and charge an estimated amount to expense (known as the allowance method). 

  The later method is preferred, because you are matching revenues with bad debt expenses in the same period (known as the matching principle).