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Tuesday, August 11, 2009

Accounts Receivable and Accounts Payable

Account receivable is an asset where as account payable is a liability. Account receivable represents money that customers owe you and on the other hands money that you owe for being a customer of somebody else is account payable.

Both account receivable and account payable do not affect the cash balance but it affect to the net income of the company. These allow you to put money into the income statement without cash actually moving.

When invoices are sent or received, then transactions are recognized.
Assume: You get an invoice from the phone company.
Book the amount as a debit to Telephone Expense and the credit to Accounts Payable.
When you finally get around to paying the bill, book the debit to Accounts Payable instead of Telephone Expense. You don’t want the same bill expenses twice!

GAAP requires that an allowance must be made for bad debts. An estimate must be made on some kind of percentage basis. Credit a contra account"Allowance for Bad Debts" on the Balance Sheet, Debit Bad Debts Expenses.

A contra-account is a balance sheet account whose purpose is to reduce the amount of another account. That is why asset contra-account have credit balances while liability contra-accounts have debit balances. "Contra" is a latin word that means "against".

Professional firms like Law Firms or even us Accounting firms may use an account called "Unbilled Accounts Receivable". This is for work they've racked up but aren't ready to bill the clients yet. The offset account is a liability account "Unearned Revenue".

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