Bookkeeping Guide: Accounts Receivable & Bad Debts

Accounts Receivable and Bad Debts In Accounting

Accounts Receivables (AR) and Bad Debts Process in Bookkeeping

Introduction
Every business, big or small, survives on cash flow. But not all sales are immediate cash transactions. Many businesses allow customers to buy goods or services on credit. This creates Accounts Receivable (AR)—the money owed by customers.
However, not all customers pay on time (or at all). When a receivable becomes uncollectible, it turns into Bad Debt. Understanding how to record and manage these accounts is essential in bookkeeping because they directly affect profitability and financial health.
In this blog, we’ll explore Accounts Receivable, Bad Debts, journal entries, and real examples, making it simple for business owners, students, and aspiring bookkeepers.

What is Accounts Receivable?

Accounts Receivable (AR) refers to the money owed to a business by its customers for products or services delivered on credit.

It is listed as a current asset in the balance sheet.
It represents future cash inflows for the business.

👉 Example:

ABC Construction sells building material worth $10,000 to XYZ Ltd. on credit for 30 days.

For ABC Construction, $10,000 is Accounts Receivable.
For XYZ Ltd., it is Accounts Payable.

Importance of Accounts Receivable in Bookkeeping

Cash Flow Management – Businesses need to track AR to predict when cash will come in.
Customer Relationship – Offering credit builds trust with customers.
Profitability Tracking – Uncollected receivables can eat into profits.
Financial Health – Investors and lenders evaluate AR quality before giving funds.

Journal Entries for Accounts Receivable

When a sale is made on credit, the entry is:

At the time of sale:

Debit: Accounts Receivable $10,000
Credit: Sales Revenue $10,000

When payment is received:

Debit: Cash/Bank $10,000
Credit: Accounts Receivable $10,000

This ensures AR is reduced once payment is received.

What are Bad Debts?

Bad Debt occurs when customers fail to pay their dues, and the receivable becomes uncollectible.
👉 Example:
If ABC Construction cannot recover $2,000 from a customer who went bankrupt, that amount becomes a Bad Debt Expense.

Bad debts reduce Accounts Receivable.
They are recorded as an expense in the income statement.

Journal Entries for Bad Debts

Direct Write-Off Method:

When a receivable is deemed uncollectible:

Debit: Bad Debt Expense $2,000
Credit: Accounts Receivable $2,000

Allowance Method (GAAP preferred):

Businesses estimate bad debts in advance (using % of sales or aging method).

Creating allowance:
- Debit: Bad Debt Expense $2,000
- Credit: Allowance for Doubtful Accounts $2,000
Writing off actual bad debt:
- Debit: Allowance for Doubtful Accounts $2,000
- Credit: Accounts Receivable $2,000

This method ensures that expenses are matched with revenues in the same accounting period.

Examples of Bad Debt in Real Life

A retail shop sells goods on credit to a customer who never returns to pay.
A construction company provides services to a client who later files for bankruptcy.
A freelancer delivers work but never receives payment from an overseas client.

Accounts Receivable Aging Report

Bookkeepers use an aging report to track receivables by due date.

Example of Aging Schedule:

Customer	0-30 Days	31-60 Days	61-90 Days	90+ Days	Total
XYZ Ltd.	$5,000	-	-	-	$5,000
LMN Corp.	-	$3,000	-	-	$3,000
PQR Traders	-	-	$2,500	$1,500	$4,000
Total	$5,000	$3,000	$2,500	$1,500	$12,000

This report helps identify overdue payments and potential bad debts.

Strategies to Minimize Bad Debts

Credit Check – Evaluate customer creditworthiness before offering credit.
Clear Payment Terms – Mention due dates, penalties, and discounts in invoices.
Regular Follow-Ups – Send reminders for pending invoices.
Offer Early Payment Discounts – Encourage customers to pay sooner.
Use Collection Agencies – For old, overdue accounts.

Case Example: A USA Construction Business

Scenario:

XYZ Builders provides $50,000 worth of construction services on credit. After 90 days, $45,000 is collected, but $5,000 is unpaid.

Journal Entries:

At the time of sale:

Debit: Accounts Receivable $50,000
Credit: Sales Revenue $50,000

When $45,000 is received:

Debit: Cash/Bank $45,000
Credit: Accounts Receivable $45,000

Writing off $5,000 as Bad Debt:

Debit: Bad Debt Expense $5,000
Credit: Accounts Receivable $5,000

In this case, the company records $45,000 in actual revenue, and $5,000 becomes an expense.

Impact on Financial Statements

Balance Sheet: AR decreases when bad debts are written off.
Income Statement: Bad Debt Expense reduces net income.
Cash Flow: Expected cash inflows shrink.

Accounts Receivable vs. Accounts Payable

Feature	Accounts Receivable (AR)	Accounts Payable (AP)
Nature	Asset	Liability
Represents	Money customers owe	Money business owes
Recorded in	Balance Sheet (Assets)	Balance Sheet (Liabs)
Example	Customer invoice	Supplier invoice

Why Bookkeepers Must Track AR and Bad Debts

Prevent cash shortages.
Identify risky customers.
Maintain accurate financial reporting.
Assist owners in business planning.

Conclusion

Accounts Receivable is the lifeblood of cash flow for businesses, but it comes with the risk of bad debts. A bookkeeper’s role is to carefully record, monitor, and manage receivables. By using tools like aging reports, allowance methods, and strong internal controls, businesses can safeguard against losses.
Bad debts are inevitable, but with proper bookkeeping strategies, their impact can be minimized, ensuring steady financial growth.

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