If your company sells on credit or loans funds to other companies, receivables can make up a significant portion of your balance sheet. In most cases, you will want to collect from these customers as soon as you can. However, in some circumstances it will be advantageous for you to extend credit to a customer for greater than a year. Understanding how to record these long-term liabilities is key to making sure your financial statements are properly presented when you have granted extended payment terms to your customers.
The point at which you first realize you are owed funds and go to record the receivable is known as initial recognition in accounting terms. Upon initial recognition, debit the accounts receivable account for the amount of the receivable. You will record the credit based on the circumstances that gave rise to the receivable. For example, if the receivable is related to the sale of goods or services to another company, you would credit the sales account. This entry would reflect the recognition of revenue. However, if you are loaning funds to another party, you would credit the cash account. In this case, the credit reduces the balance in the cash account, reflecting the cash outflow.
In most cases, accounts receivable are considered current, or short-term, assets. However, this certainly is not a rule. Assets are determined to be long-term if they are not expected to be converted into cash within one year or one accounting cycle, whichever is longer. In most small businesses, the accounting cycle parallels the calendar year. This means that you should only recognize a long-term receivable when you believe the balance will not be collected for greater than one year from the date of initial measurement.
The difference between recorded long-term and short-term receivables comes in presentation. In many cases, the accounting entries for both kinds of receivables will be the same. However, the difference will come when your prepare your financial statements. You should subtract the amount of long-term receivables from the accounts receivable balance and make a new line on the financial statements. You will call this line "Accounts Receivable, long-term" and place it in the long-term assets portion of the balance sheet. In most cases, this line should be the first entry in the long-term assets section of the balance sheet. The amount you've subtracted from the accounts receivable account line should now be the balance of this new line item. Check your work by adding the two lines together. They should equal the entire accounts receivable balance.
Generally accepted accounting principles require that you reduce accounts receivable on the balance sheet by an estimate of the total amount of these accounts that will eventually become uncollectible. Small-business owners usually make this estimate by examining the age of the receivables on hand. For example, you may determine that, on average, only 40 percent of receivables that are greater than 90 days past due are ultimately collectible. However, if your company has long-term receivables, you must exercise caution. When you record a long-term receivable, you are usually adjusting the other party's due date to be greater than a year in the future. If you lump these receivables in with normal short-term receivables it may appear that the balance is many months past due. In this case, you may inadvertently assign this receivable a high probability of uncollectibility when preparing the estimate. In order to avoid this, remove long-term receivables from the estimate calculation and evaluate collectibility for these items on a one-off basis.