The income statement is a financial statement that reports on a company’s profitability over a period. This statement is crucial for stakeholders who want to evaluate its financial performance. Usually, companies prepare the income statement first. The information from this statement then ends up on the balance sheet and other financial statements. Overall, the income statement is critical for reporting profitability.
The income statement uses a specific format. Usually, it starts with a company’s revenues or net sales. Once it reports that information, it reduces all expenses from those revenues. On top of that, companies also classify expenses into various categories. Based on this classification, companies also report several types of profits. These profits may include gross, operating, and net profits.
The information reported in the income statement must meet specific criteria. These criteria come from the definition set for each item that goes into the statement. For example, revenues must include inflows of economic benefits during the period. On the other hand, expenses constitute all outflows. Accounts receivable is an item that most people may confuse about whether it should go on the income statement.
What is Accounts Receivable?
Accounts receivable represents balances on the balance sheet belonging to money owed by clients. It refers to any money that a company’s customers must repay. Usually, account receivable balances come from credit sales. When a company sells its products or services, it may not receive money in exchange simultaneously. They may need to wait for the customer to repay the receivable balance.
Therefore, the money customers owe a company from past transactions becomes a part of accounts receivable. This amount stays on the balance sheet until the customer repays their supply. In some cases, companies may also write these balances off due to recoverability issues with those balances. Nonetheless, accounts receivable is inevitable for companies that allow credit sales.
Accounts receivable is crucial in reporting a company’s assets under the accrual concept. This concept requires companies to record transactions as they occur. Usually, it goes against the cash method for accounting which only recognizes cash transactions. Since companies must account for transactions as they occur, they must create accounts receivable balances. These balances become a part of the balance sheet and classify as assets.
Accounts receivable balances are usually short-term. Most companies allow customers 30-60 days between sale and receipts. Usually, customers repay their owed amounts before that. Some of them may also delay payments and reimburse the company later. Some companies may also charge interest on any delayed income. In most cases, however, that may not be an issue.
Accounts receivables are a crucial part of the accounting process. Primarily, these balances relate to the balance sheet. Therefore, they do not become a part of the income statement. In some cases, companies may also include them within the accounts receivable in the income statement. These cases are not rare and usually, involve bad debts or allowance for doubtful debts.
Does Accounts Receivable Go on the Income Statement?
The accounts receivable does not go on the income statement on its own. The amount is a balance rather than a transaction. Therefore, it becomes a part of the balance sheet and falls under assets. Usually, these balances are short-term and classified as current assets. On top of that, accounts receivable also meet the definition for assets set by accounting standards. Therefore, it becomes a part of the balance sheet.
As mentioned above, accounts receivable represents money owed by customers. When the customers repay the company, it will result in monetary income. While the company may have recorded the related revenues already, the receipt will only decrease the balance. In accounting, assets are resources owned or controlled by a company. These resources can result in inflows of economic benefits in the future.
Accounts receivable satisfy all the requirements in the above definition set by assets. The income statement does not include assets or report them in any capacity. Instead, it only consists of two types of items. These include income and expenses. As mentioned above, these define inflows and outflows of economic benefits during a period, respectively. Since accounts receivable does not satisfy those definitions, it does not go on the income statement.
However, some figures related to the accounts receivable balances may also go on the income statement. As mentioned above, these usually include bad debt and allowance for doubtful debts. While these items do not relate to accounts receivable directly, they can reduce the balance. These items are expenses and also impact accounts receivable adversely.
Overall, accounts receivable does not go on the income statement. Instead, it is a part of the balance sheet, usually reported under current assets. Since it meets the definition for that classification, companies must report the balances under that presentation. However, some items related to the accounts receivable balances may become a part of the income statement. As mentioned above, these include bad debts and allowance for doubtful debts.
How Does Accounts Receivable Impact the Income Statement?
Most people confuse accounts receivable with revenues since both come from the same transaction. As mentioned above, revenues represent economic inflows during an accounting period. However, accounts receivable does not constitute an inflow at that time. Instead, it refers to delayed payments from customers. This feature sets it in line with assets more than revenues or income.
Accounts receivable impacts the income statement in two ways. First, it can include irrecoverable balances that companies must write off to present an accurate amount. Companies may also estimate their bad debts, known as doubtful debts. For these debts, companies must create an allowance or provision. In both these cases, the accounts receivable can impact the income statement.
When a company sells goods or products to customers, it may receive money at that time. Usually, this occurs for retail companies that sell to individual customers. However, some companies also customers to pay them later. When this happens, the sale classifies as a credit sale. Companies record this balance using the following journal entries.
In the above transaction, accounts receivable does not impact the incomes statement. When the company receives that amount from the customer, the company must reduce the balance. Usually, companies use the following journal entries to record receipts from customers.
In this subsequent accounting, accounts receivable does not impact the income statement. However, if the customer fails to repay, the balance may classify as irrecoverable. Therefore, companies must write it off to present an accurate current assets balance. Companies may reduce this balance due to the two reasons provided below.
Bad debts represent irrecoverable balances from customers. Companies record these amounts as expenses, which become a part of the income statement. Usually, bad debts are prevalent for companies that provide credit sales. Companies use the following journal entries to record bad debts.
The above entries impact the income statement by increasing expenses.
Allowance for doubtful debts
Companies also estimate their doubtful debts based on experience. Usually, this process includes analyzing past transactions and balances. Based on that, companies can set a percentage for the allowance. Companies use the following journal entries to record an allowance for doubtful debts.
|Allowance for doubtful debts||XXXX|
The above entries similarly impact the income statement as bad debts.
Accounts receivable represents money owed by customers to a company. Usually, these balances come from credit sales made to those customers. Accounts receivable is a part of the balance sheet and falls under current assets. Sometimes, it may also go on the income statement. This treatment usually involves bad debts and allowance for doubtful debts.