Question

: we have to coise one topic and explain this to min 10 pages . our choises is account recivables types and differences.

Answer 1

The term receivables is defined as debt owed to the firm by customers arising from sale of goods or services in the ordinary course of business or trade , thereby creating trade credit . Trade credit creates accounts receivables.

When a company makes a sale of goods or services and does not receive payment immediately upon transfer of goods of after providing service, the company grants trade credit and creates accounts receivable which would be collected in the future.

Receivables are generally classified as accounts receivable , notes receivable and other types of receivable.
Receivable can also be grouped as current receivable and non current receivable.

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.

          Few points are considered before allowing goods on credit to any customer are:

         Credit Policy: This includes decisions regarding credit period, discount rate, early payment, etc.

Credit Analysis: This includes decisions regarding whether a particular customer is allowed extended credit period or not. The techniques used in this regard are the evaluation of credit ratings, past credit history, etc.

Collection Policy: The Timely collection of receivables enables the reduced risk of losses.

Control on Receivables: This includes follow-up of debtors and faster collection of debts.

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-Other amounts receivable from different entities, e.g. short term loans to customers, other amounts receivable from different parties . 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. 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.

This sale of goods on credit is an essential marketing tool and acting as a bridge for the movement of goods through the production and distribution stages to customers. Receivable management is also called trade credit management. Thus accounts receivable represents an extension of credit to customers, allowing the customers a reasonable period of time to pay for the goods purchased or services received.

A credit sale has three characteristics::

First, it involves an element of risk. Unlike cash sales which is absolutely risk free, in credit sale the payment will be received later on.

Second, it is based on economic value. To the buyer, the economic value in goods or service passes immediately at the time od sale, while the seller expects an equivalent value to be received later on.

Third, it implies futurity. The buyer will make the payment for goods or services received at a future date.

Management should , therefore, weigh the benefits as well as cost involved to determine the objective of receivable management.

The main purpose of extension of credit to customers is ::

i)To protect its sales from the competitors and to attract potential customers to buy its products or services at favourable terms.

ii) If a company doesn’t have bargaining power , it will grant credit to customers for a long period..

1. There are a number of business sector which are not able to operate without extended credit as they have to sell their product on credit or the conversion period is quite lengthy.

iv)Large buyers demand easy credit terms because of bulk purchase and higher bargaining power.

v)Sometimes credit is extended to build long term relationship with customers or to reward them for loyalty.

As credit sale involves risk, the selling company follows certain credit standards. Credit standards are the criteria which a firm follows for the purpose of credit to its customers.

Extension of credit or no credit will depend on the customers worthiness or the quality of customers, there are two aspects of the quality of customers : a) the time taken to repay credit obligations and b) the default rate.

Default rate sometimes is governed by prevailing economic condition of the economy. In times of recession, there could be more default than normal times.

Apart from risk associated with credit sale, cost of credit sale is another major factor. The major categories of costs associated with the extension of credit are :

1. Collection cost-These are administrative cost incurred in collecting the receivables from the customers to whom credit sales have been made.
2. Capital Cost-The increase level of accounts receivable is an investment in assets, which have to be financed , thereby involving cost.
3. Delinquency cost-This arises out of the failures of the customers to meet their obligations when payment on credit sales become due after the expiry of credit period.
4. Default cost-When the buyer is not able to pay or the company is not able to recover because of the inability of the customers. Such credit has to be written off as bad debt.

           Differences between accounts receivable and accounts payable are :

1. Accounts Receivables shows the cash expected to be received in the future, for the sales made on the credit basis. Accounts Payable is the cash to be paid within a short period, to the creditors for the sale of goods and services.
2. Accounts Receivable is shown under the head current assets while Accounts Payable appears under the head current liabilities in the balance sheet.
3. Accounts Receivable represents an amount owned by the company whereas Accounts Payable represents the amount owed by the entity.
4. Accounts Receivable reflects the amount to be collected at a future specified date, but Accounts Payable discloses the debt to be paid at a later date.
5. Accounts Receivable increases cash, but it is just opposite in Accounts Payable.
6. Accounts Receivable is the result of credit sales. In contrast to, Accounts Payable, which is the outcome of credit purchases.
7. The two primary components of accounts receivable are bills receivable and debtors. On the other hand, bills payable and creditors are the essential elements of accounts payable.