If you think about this accounts receivable business a bit, you should realize that it makes sense. Although the accounts receivable account includes a $1,000 receivable balance, this just means that the customer owes you $1,000. But when the customer finally pays off the $1,000 bill, you need to zero out that receivable.
QuickBooks, by the way, automatically records Journal Entry 1 and Journal Entry 2 for you. Journal Entry 1 gets recorded whenever you issue or create a customer invoice. Therefore, you don’t need to worry about the debits and credits shown in Journal Entry 1 except for one special occasion: When you set up QuickBooks and QuickBooks items (items are things that get included on the invoices), you do specify which account should be credited to track sales revenue. So although you may not need to worry much about the mechanics of Journal Entry 1, you should understand how this journal entry works so that you can set up QuickBooks correctly. (Book II, Chapter 1, describes the mechanics of setting up QuickBooks.)
Journal Entry 2 also gets recorded automatically by QuickBooks. QuickBooks records Journal Entry 2 for you whenever you record a cash payment from a customer. You don’t need to worry, then, about the debits and credits necessary for recording customer payments. However, I find that it’s helpful to understand how this journal entry works and how QuickBooks records this customer payment transaction.
Estimating bad debt expense
One other important journal entry to understand is shown in Table 3-3.
Table 3-3 Journal Entry 3: Recording an Allowance for Uncollectible Accounts
Journal Entry 3 records an estimate of the uncollectible portion of accounts receivable. (Businesses that don’t want to keep accrual-based accounting statements may not need to worry about Journal Entry 3.) Unfortunately, some of the money you bill customers may be uncollectible. Yet Journal Entry 1 records every dollar that you bill your customers as revenue. Therefore, you need a way to offset, or reduce, some of the sales revenue by the amount that ultimately turns out to be uncollectible.
Journal Entry 3 shows a common way of doing this. Journal Entry 3 debits bad debt expense – which is an expense account that you may use to record uncollectible customer receivables. Journal Entry 3 also credits another account shown as allowance for uncollectible A/R. This allowance account is called a contra-asset account, which means that it basically reduces the balance reported on the balance sheet of an asset account. In the case of the allowance for uncollectible A/R accounts, for example, this $100 credit reduces the accounts receivable balance shown on the balance sheet by $100.
Where the bad debt expense shown in Journal Entry 3 appears varies from business to business. Some businesses report the bad debt expense with the other sales revenue, thereby allowing the income statement to show net sales revenue. Other businesses report bad debt expense with the other operating expenses. You should report bad debt expense wherever it makes most sense in terms of managing your business.
Removing uncollectible accounts receivable
If you do set up an allowance for uncollectible accounts, you also need to periodically remove the uncollectible accounts from both the accounts receivable balance and the allowance for uncollectible accounts. You don’t want to do this while any chance to collect on the accounts exists. But at some point, obviously, you may as well clean out the bad receivables from your records. It makes no sense, for example, to have uncollectible receivables from 17 years ago still appearing on your balance sheet. Table 3-4 illustrates how to clean out bad receivables.
Table 3-4 Journal Entry 4: Writing Off an Uncollectible Receivable
This journal entry debits the allowance from the uncollectible A/R account for $100. The journal entry also credits the accounts receivable account for $100. In combination, these two entries zero out the allowance for the uncollectible A/R account and remove the uncollectible amount from the accounts receivable account.
None of these entries is particularly tricky as long as you understand the logic – something that I hope I’ve illuminated for you in this discussion. If you do have trouble with these journal entries or with recording the economic events that they attempt to summarize, you may want to consult your CPA. Most likely, you would record these same transactions (of course, with different customers and amounts) many, many times over the year. If you can get a bit of help or a template that shows you how to record these transactions, you should be able to record them yourself without any outside help.
Recording Accounts Payable Transactions
Within QuickBooks, you have the option of working with or without an accounts payable account. If you want to, you can record expenses when you write checks. This means that in order to have a complete list of all your expenses, you must have recorded checks that pay all your expenses. This approach works fine – and, in fact, is the approach that I’ve always used in my businesses.
QuickBooks also supports a more precise approach of recording expenses. By answering a few questions during the QuickBooks setup process, you can set up an accounts payable account, which is just an account that tracks the amounts that you owe your vendors and other suppliers.
Recording a bill
When you use an accounts payable account, you enter the bills that you get from vendors when you receive them.
Table 3-5 shows the way this transaction is recorded. Journal Entry 5 automatically debits office-supplies expense for $1,000 and credits accounts payable for $1,000. This is the journal entry that would be recorded by QuickBooks if you purchased $1,000 of office supplies and then entered that bill into the QuickBooks system.
Table 3-5 Journal Entry 5: Recording a Credit Purchase
Paying a bill
When you later pay that bill, QuickBooks records Journal Entry 6, shown in Table 3-6. In Journal Entry 6, QuickBooks debits accounts payable for $1,000 and credits cash for $1,000. The net effect on accounts payable combining both the purchase and the payment is zero. That makes sense, right? The approach shown in Journal Entries 5 and 6 counts the amount that you owe some vendor or supplier as a liability – accounts payable – only while you owe the money.
Table 3-6 Journal Entry 6: Recording the Payment to Vendor
When you record Journal Entry 6 in QuickBooks, you must supply the name of the account that gets debited. QuickBooks obviously knows which account to credit: the accounts payable account. However, QuickBooks also has to know the expense or asset account to debit.
QuickBooks does need to know which cash account to credit when you pay an accounts payable amount. You identify this when you write the check to pay the bill.
Taking some other accounts payable pointers
Let me make a couple of additional