Describe the accounts receivable recognition process

ACCOUNTS RECEIVABLE

Accounts receivable (or trade receivables) is the amount owed to a seller by customers who have purchased goods and services on credit. Typically, the seller expects to collect cash within a reasonably short time, such as 30 days, so an account receivable is usually a current asset. Receivables with terms greater than one year are noncurrent assets.

Not all customers ultimately pay the amounts owed. An account receivable that the seller never collects is an uncollectible account. A firm does not want to sell products and services to customers who do not pay, but the cost of identifying such customers (assuming this is possible) exceeds the benefits of doing so. Consider, for example, what a retailer would need to do to ensure that every credit customer will pay. It would need to gather information about the customer's credit worthiness, for example, a credit history. It would use this information to assess, at the time of sale, the customer's likely ability and willingness to pay the amount owed. This assessment would take time and, if the retailer wanted to avoid bad debts completely, it would most likely deny credit to many customers who would pay their bills, even though they could not pass a stringent credit check designed to eliminate every uncollectible credit sale. Those customers will take their business elsewhere, and the retailer will lose sales. As long as the amount collected from credit sales to a given group of customers exceeds the cost of goods sold and the other costs of serving that group of customers, including the costs of uncollectible accounts, the retailer will be better off selling to that group rather than losing the sales.

Most firms find it optimal to bear the cost of some uncollectible receivables. This does not suggest, of course, that a firm should grant credit indiscriminately or not engage in collection efforts. A cost-benefit analysis of credit policy should dictate a strategy that results in uncollectible accounts of an amount that is reasonably predictable before the firm makes any sales.