So, I’m hoping you already know about basic accounting p accounting principles state that sales revenue needs to be recognized when a sale is made and that the sale is made when a business provides goods or services to a customer.
In other words — and this is really an important point — sales revenue doesn’t get recorded when you receive payment from a customer. Sales revenue gets recorded when a customer has a legal obligation to pay you because you have (or your business has) provided the customer the goods or services.
Recording a Sale
This requirement to record sales revenue at the time that goods or services are provided means that accounting for sales revenue is slightly more complicated than you may have first guessed. The first transaction, for example, the transaction that records a sale, is shown in the following table.
Journal Entry 1 shows how a $1,000 sale may be recorded. The journal entry shows a $1,000 debit to accounts receivable and a $1,000 credit to sales revenue. To record a $1,000 sale — a credit sale — the journal entry needs to show both the $1,000 increase in accounts receivable and the $1,000 increase in sales revenue.
Recording a Payment
When the business receives payment from the customer for the $1,000 receivable, the business records a journal entry like that shown in this table:
Journal Entry 2 shows a $1,000 debit to cash, which is the $1,000 increase in the cash account that occurs because the customer has just paid you $1,000. Journal Entry 2 also shows a $1,000 credit to accounts receivable. This credit to the accounts receivable asset account reduces the accounts receivable balance.
At the point when you record both Journal Entry 1 and Journal Entry 2, the net effect is a $1,000 debit to cash (showing that the cash has increased by $1,000) and a $1,000 credit to sales revenue (showing that sales revenue has increased by $1,000). The $1,000 debit to accounts receivable and the $1,000 credit to accounts receivable net to zero.
If you think about this accounts receivable business a bit, you should realize that it makes sense. Although the accounts receivable account includes a $1,000 receivable balance, this just means that the customer owes you $1,000. But when the customer finally pays off the $1,000 bill, you need to zero out that receivable.
QuickBooks, by the way, automatically records Journal Entry 1 and Journal Entry 2 for you. Journal Entry 1 gets recorded whenever you issue or create a customer invoice. Therefore, you don’t need to worry about the debits and credits shown in Journal Entry 1 except for one special occasion: When you set up QuickBooks and QuickBooks items (items are things that get included on the invoices), you do specify which account should be credited to track sales revenue. So although you may not need to worry much about the mechanics of Journal Entry 1, you should understand how this journal entry works so that you can set up QuickBooks correctly.
Journal Entry 2 also gets recorded automatically by QuickBooks. QuickBooks records Journal Entry 2 for you whenever you record a cash payment from a customer. You don’t need to worry, then, about the debits and credits necessary for recording customer payments. However, I find that it’s helpful to understand how this journal entry works and how QuickBooks records this customer payment transaction.
Estimating Bad Debt Expense
One other important journal entry to understand is shown in the following table:
|Bad debt expense||100|
|Allowance for uncollectible A/R||100|
Journal Entry 3 records an estimate of the uncollectible portion of accounts receivable. (Businesses that don’t want to keep accrual-based accounting statements may not need to worry about Journal Entry 3.) Unfortunately, some of the money you bill customers may be uncollectible. Yet Journal Entry 1 records every dollar that you bill your customers as revenue. Therefore, you need a way to offset, or reduce, some of the sales revenue by the amount that ultimately turns out to be uncollectible.
Journal Entry 3 shows a common way of doing this. Journal Entry 3 debits bad debt expense — which is an expense account that you may use to record uncollectible customer receivables. Journal Entry 3 also credits another account shown as allowance for uncollectible A/R. This allowance account is called a contra-asset account, which means it basically reduces the balance reported on the balance sheet of an asset account. In the case of the allowance for uncollectible A/R accounts, for example, this $100 credit reduces the accounts receivable balance shown on the balance sheet by $100.
Where the bad debt expense shown in Journal Entry 3 appears varies from business to business. Some businesses report the bad debt expense with the other sales revenue, thereby allowing the income statement to show net sales revenue. Other businesses report bad debt expense with the other operating expenses. You should report bad debt expense wherever it makes most sense in terms of managing your business.
QuickBooks doesn’t automatically record the transaction in Journal Entry 3. You record estimates of bad debt expense yourself by using the QuickBooks Make Journal Entries command.
Removing uncollectible accounts receivable
If you do set up an allowance for uncollectible accounts, you also need to periodically remove the uncollectible accounts from both the accounts receivable balance and the allowance for uncollectible accounts. You don’t want to do this while any chance exists to collect on the accounts. But at some point, obviously, you may as well clean out the bad receivables from your records. It makes no sense, for example, to have uncollectible receivables from 17 years ago still appearing on your balance sheet. The next table illustrates how to clean out bad receivables.
|Allowance for uncollectible||100|
This journal entry debits the allowance from the uncollectible A/R account for $100. The journal entry also credits the accounts receivable account for $100. In combination, these two entries zero out the allowance for the uncollectible A/R account and remove the uncollectible amount from the accounts receivable account.
Writing off an actual, specific uncollectible receivable for invoice should be done on a case-by-case basis. This is what Journal Entry 4 shows.
None of these entries is particularly tricky as long as you understand the logic — something I hope I’ve illuminated for you in this discussion. If you do have trouble with these journal entries or with recording the economic events that they attempt to summarize, you may want to consult your CPA. Most likely, you would record these same transactions (of course, with different customers and amounts) many, many times over the year. If you can get a bit of help or a template that shows you how to record these transactions, you should be able to record them yourself without any outside help.
To write off an uncollectible account receivable, you record a credit memo and then apply the credit memo to the uncollectible account. The item shown on your credit memo should cause the allowance for uncollectible accounts to be debited.