Definition
Trade Receivables (Accounts Receivable; Trade Debtors) refers to the amounts owed to a business by its customers for goods sold or services provided on credit. These receivables are recorded as current assets on a company’s balance sheet. Trade receivables are critical for liquidity management as they represent future cash inflows.
Examples
- A Retail Store: A retail store that sells goods to customers on credit terms records the amount due from these customers as trade receivables. If a customer buys $1,000 worth of goods on credit, the store will list this amount under trade receivables.
- A Service Company: A consulting firm that invoices a client $5,000 for services rendered records this amount as accounts receivable until the client makes the payment.
- A Manufacturing Company: A manufacturing firm that delivers bulk products to a distributor on a credit basis will record the total invoiced amount as trade receivables.
Frequently Asked Questions (FAQs)
Q1: What is the difference between trade receivables and non-trade receivables?
- A: Trade receivables arise from the core business activities, such as the sale of goods or services on credit. Non-trade receivables include amounts owed to the business from other sources, like loans to employees or tax refunds.
Q2: How is the provision for bad debts calculated?
- A: The provision for bad debts is typically calculated based on the company’s historical data and current expectations. A general provision might be a percentage of total credit sales, for example, 2% of credit sales during a period.
Q3: Why is a provision for bad debts necessary?
- A: The provision for bad debts aligns with the prudence concept, ensuring that financial statements reflect a realistic picture by accounting for expected credit losses.
Q4: Where are trade receivables reported on a company’s financial statements?
- A: Trade receivables are reported as current assets on the balance sheet.
Q5: How do trade receivables impact a company’s cash flow?
- A: Trade receivables, once collected, become cash inflows, which positively impact a company’s cash flow.
Q6: What credit terms are typically offered to customers for trade receivables?
- A: Common credit terms include net 30, meaning payment is due within 30 days.
Q7: How does the prudence concept relate to trade receivables?
- A: The prudence concept requires businesses to account for potential losses related to uncollectible receivables, thus ensuring that assets are not overstated.
Q8: What happens if a trade receivable turns into a bad debt?
- A: If a receivable becomes uncollectible and turns into a bad debt, the company writes it off against the provision for bad debts.
Q9: Can trade receivables be used as collateral?
- A: Yes, companies can use trade receivables as collateral for securing loans.
Q10: How are overdue trade receivables managed?
- A: Overdue receivables are often followed up with collection efforts or may involve third-party collection agencies.
Related Terms
- Current Assets: Assets that are expected to be converted into cash or used up within a year.
- Provision for Bad Debts: An allowance for potential losses from uncollectible accounts receivable.
- Prudence Concept: A fundamental accounting principle that requires recording expenses and liabilities as soon as possible, but revenues only when they are assured.
Online Resources
- Investopedia: Accounts Receivable
- AccountingTools: Trade Receivables
- Corporate Finance Institute: Accounts Receivable
Suggested Books for Further Study
- “Financial Accounting” by Robert Libby, Patricia A. Libby, and Frank Hodge
- “Intermediate Accounting” by Donald E. Kieso, Jerry J. Weygandt, and Terry D. Warfield
- “Accounting Made Simple: Accounting Explained in 100 Pages or Less” by Mike Piper
- “Accounting for Dummies” by John A. Tracy
Accounting Basics: “Trade Receivables” Fundamentals Quiz
### What are trade receivables?
- [ ] Liabilities owed by a business.
- [x] Amounts owed to a business by customers.
- [ ] Inventory held by a business.
- [ ] Cash equivalents held by a business.
> **Explanation:** Trade receivables are amounts owed to a business by its customers usually as a result of a sale of goods or services on credit.
### Where are trade receivables reported?
- [ ] As a non-current asset.
- [x] As a current asset.
- [ ] As a liability.
- [ ] As owner's equity.
> **Explanation:** Trade receivables are classified as current assets on the balance sheet because they are expected to be converted to cash within a year.
### What is the provision for bad debts?
- [ ] An expense account.
- [ ] A revenue account.
- [x] An allowance for potential losses from uncollectible accounts receivable.
- [ ] A type of liability account.
> **Explanation:** The provision for bad debts is an allowance that a business sets aside to cover potential losses from uncollectible receivables.
### Why is the provision for bad debts created?
- [ ] To inflate the value of receivables.
- [x] To comply with the prudence concept and reflect realistic asset values.
- [ ] To decrease tax liabilities.
- [ ] To hide actual sales revenue.
> **Explanation:** The provision for bad debts is created to comply with the prudence concept and ensure that financial statements reflect a realistic valuation of assets.
### What happens if a trade receivable turns into a bad debt?
- [ ] It remains as a receivable forever.
- [x] It is written off against the provision for bad debts.
- [ ] It is converted to equity.
- [ ] It decreases inventory.
> **Explanation:** If a receivable turns into a bad debt, the company writes it off against the provision for bad debts, reflecting the loss.
### How might a company calculate a general provision for bad debts?
- [ ] Based on the total cash sales.
- [x] As a percentage of total credit sales during a period.
- [ ] As a percentage of total purchases.
- [ ] Based on net income.
> **Explanation:** A general provision for bad debts is often calculated as a percentage of total credit sales made during a period based on historical data.
### Which concept mandates the creation of a provision for bad debts?
- [ ] Going concern concept.
- [ ] Matching concept.
- [x] Prudence concept.
- [ ] Consistency concept.
> **Explanation:** The prudence concept mandates creating a provision for bad debts to ensure that financial statements represent a realistic view of potential losses.
### Can trade receivables be used as collateral?
- [ ] No, they cannot be used for any financing.
- [x] Yes, they can be used to secure a loan.
- [ ] Only in specific industries.
- [ ] Only within the same fiscal year.
> **Explanation:** Companies can use trade receivables as collateral for securing loans as they represent future cash inflows.
### What strategy might a company use for managing overdue trade receivables?
- [ ] Extend further credit.
- [ ] Write them off immediately.
- [x] Follow up with collection efforts or third-party collection agencies.
- [ ] Pay them off.
> **Explanation:** Managing overdue receivables typically involves collection efforts or utilizing third-party agencies to ensure payment is received.
### What is typically included in credit terms for trade receivables?
- [ ] Discounts for early payment and penalties for late payment.
- [x] Net payment terms like net 30.
- [ ] No specific terms.
- [ ] Exchange rate clauses.
> **Explanation:** Credit terms often include net payment terms like net 30, which indicates that payment is due within 30 days of the invoice date.
Thank you for embarking on this journey through our comprehensive accounting lexicon and tackling our challenging sample exam quiz questions. Keep striving for excellence in your financial knowledge!
