In commercial transactions, it is often seen that sales and delivery of goods takes place on a certain date whereas payment for the same may take place at a subsequent date. This is because the seller often extends a credit period to the buyer. This allows the buyer a specified time frame within which he can make payment for the purchased goods or services. These become receivables for the seller entity and managing these receivables is an important follow up function of sales. There are often dedicated collection departments whose function is to follow up on and manage these receivables.
This article looks at meaning of and differences between two aspects of the cycle of receivables management for an entity – bills receivable and accounts receivable.
Definitions and meanings
Bills receivable:
A bill receivable is a bill of exchange drawn by an entity on its customer or debtor so as to serve as a proof of debt. When the customer accepts a bill, it serves as an acceptance of the debt and an undertaking to pay the specified amount on a specified date. On the specified date (called maturity date), the bill matures and becomes due for payment by the debtor.
A bill receivable is essentially a type of negotiable instrument. Prior to its maturity date, it can be transferred by the drawer in favor of one of its creditors. Where an early cash is needed, the drawer can discount the bill with a bank at a certain discount rate. In case the debtor does not make payment against the bill on maturity, the bill is considered to be dishonored. Consider the following example to understand how a bill of exchange or a bill receivable works in real business environment:
Example – relevant journal entries:
Stephen Inc. sells goods amounting to $50,000 to Mr. X. As per terms of the sale, Stephen Inc. draws a bill receivable on Mr. X for payment of this amount after 3 months. Mr. X accepts the bill and returns the same to Stephen Inc. The possible journal entries in the books of Stephen Inc. would be as follows:
Journal entry for realizing the credit sale:
Accounts receivable…..50,000 [Dr]
Sales…..50,000 [Cr]
Journal entry for drawing up the bill receivable:
Bills receivable a/c…..50,000 [Dr]
Accounts receivable…..50,000 [Cr]
(Being bill receivable drawn on Mr. X for balance due)
The above entry would convert an account receivable into a bill receivable. In general ledger, it would reduce the balance of accounts receivable account and increase the balance of bills receivable account. Both are asset accounts.
Journal entry for discounting the bill at 5% discount:
Bank a/c…..47,500 [Dr]
Discount a/c…..2,500 [Dr]
Accounts receivable…..50,000 [Cr]
(Being bill discounted with the bank at 5%)
Journal entry for honoring the bill on maturity after 3 months:
Bank a/c…..50,000 [Dr]
Bills receivable…..50,000 [Cr]
(Being bill receivable honored by Mr. X)
Journal entry in case of dishonor of bill on maturity:
Accounts receivable a/c…..50,000 [Dr]
Bills receivable…..50,000 [Cr]
(Being bill receivable dishonored by Mr. X; his balance retransferred to accounts receivable)
Accounts receivable:
Accounts receivable represent the balance that is due to a business from its credit customers. Accounts receivable typically arise on sale of any product or service. When a customer purchases and receives goods, the seller raises an invoice on the customer for the amount due. On the basis of this invoice, an account receivable is created in the books. A credit period is typically offered within which the customer is required to settle their outstanding balance.
To encourage a prompt settlement, a seller may offer a cash discount to the buyer at a certain rate if he settles the dues within a specified time. Such arrangement is made through establishing a payment term between seller and buyer (e.g., 1/15, n/45 etc.).
Accounts receivable are reflected as current asset in the balance sheet of the seller because the payment settlement from them is mostly expected within a year period or accounting cycle.
Example – relevant journal entries
Continuing the same example as above, let us assume Stephen Inc. does not draw a bills receivable on Mr. X but retains him as a debtor (i.e., an account receivable) with a credit period of 2 months. The possible journal entries in the books of Stephen are as follows:
Journal entry on creation of accounts receivable:
Accounts receivable a/c…..50,000 [Dr]
Sales a/c 50,000…..[Cr]
(Being credit sales recorded to Mr. X)
Journal entry on receipt of account balance after 2 months:
Bank a/c…..50,000 [Dr]
Accounts receivable a/c…..50,000 [Cr]
(Being account settled by Mr. X)
Journal entry on payment default due to bankruptcy:
In case Mr. X declares bankruptcy and is unable to pay his dues:
Bad debts a/c…..50,000 [Dr]
Accounts receivable…..50,000 [Cr]
(Being – Mr. X’s dues written off as bad debts)
Difference between bills receivable and accounts receivable:
The seven key points of difference between bills receivable and accounts receivable are given below:
1. Meaning
- A bill receivable is a negotiable instrument that provides for payment of specified dues to the drawer (seller) by the drawee (customer) on the specified maturity date.
- Accounts receivable is a current asset that indicates the balance due to a seller from its customer.
2. Due date
- A bill receivable is a tangible bill of exchange that has a specified maturity date.
- Accounts receivable is an account balance that is due. It may have an indicative due date based on the extended credit period. Such dates are generally defined by credit terms like:
Net 30 days: No discount is allowed and the payment is due within 30 days.
2/10, n/60: A 2% discount would be allowed to buyer in case he pays within 10 days. Otherwise the payment is due within 60 days without discount.
3. Basis of creation
- A bill receivable is created on the basis of an underlying account balance that is subsequently being acknowledged as a specific debt payable at a specific time.
- An accounts receivable is created on the basis of a sales transaction that is evidenced by an invoice.
4. Transferability
- A bill receivable can be endorsed in favor of other entities or discounted with a bank in the normal course of business.
- An accounts receivable balance on the other hand typically has no such provisions or attached facilities, other than in special business circumstances.
5. Subset of
- All bills receivable are accounts receivable as they represent legally enforceable debt.
- All accounts receivables, however, need not be represented by bills receivable.
6. Reporting in financial statements
- Bills receivables can be reported as current or non-current assets depending on the term to maturity.
- Accounts receivable are reported as current assets in the seller’s balance sheet.
7. Effect of default
- In case a bill receivable is dishonored, it gets reversed and is transferred back into an accounts receivable balance. It then becomes due from the debtor as a regular account balance. The defaulting drawee will be responsible for paying any noting fees or other charges that arise on account of the dishonor of the bill.
- In case an accounts receivable balance is declined to be paid, it becomes a bad debt and is written off from the books of accounts. Any subsequent legal action depends on the terms between the seller and his customer.
Conclusion – bills receivable vs accounts receivable:
Both bills receivable and accounts receivable are assets that represent legally enforceable debt. Bills receivable are more of a formal legal arrangement between the seller and customer for recovery of dues. It lends more certainty on dues to the seller as compared to accounts receivable balance that may be more open ended in terms of timeline of repayment.
In fact, most bills receivable are originally recorded as accounts receivable. With mutual agreement and understanding, a creditor may subsequently ask his debtor to accept a bill of exchange. After debtor’s acceptance of the bill, the account receivable (i.e., debtor) needs to be converted into a bill receivable in the books of accounts. The following journal entry serves this purpose:
Bills receivable…..XXXX [Dr]
Account receivable…..XXXXX [Cr]
As the result of above entry in journal, accounts receivable account in the general ledger is credited and bills receivable account is debited. Hence, the balance of accounts receivable account decreases and the balance of bills receivable account increases.
