How Accounts Receivables are Classified on the Balance Sheet

Accounts receivable (AR) represents money that is due to a company by its customers for goods or services supplied but still unpaid. An appropriate classification of AR is important for understanding financial reporting. As per the Companies Act (2013), Schedule III offers a format for the demonstration of financial statements, consisting of classification of receivables. This guide will provide the required information about the classification of accounts receivable according to Ind AS and Notified AS.

Based on Ind AS:

As per the Ind AS (United with IFRS), the classification of the trade receivables according to their risk of credit and condition of impairment. Below is the analysis:

1.Trade receivables -Secured

These are receivables in regard to which the company maintains some collateral. The security decreases the risk of credit that makes the receivables more consistent and facilitating recovery if the debtor defaults.

2. Trade Receivables – Unsecured

These receivables are considered recoverable, but they are not backed by any security. Although unsecured, these are receivables that the company expects to collect in full.

3. Trade Receivables with a Significant Increase in Credit Risk

These are the receivables where the risk of credit has boosted considerably from the first identification, leading to a greater possibility of default. According to the Ind AS 109, companies need to provide changes in credit risk and identify a provision for predicted credit losses.

4. Trade Receivables – Credit Impaired

This section involves receivables where the available proof is suggesting that the amount may not be completely recoverable. This can take place because of bankruptcy, a critical financial situation. These receivables demand a noticeable write-down on the balance sheet.

Based on Notified AS:

According to Accounting Standards reported by the Companies Act (2013), trade receivables are categorized based on whether they are disputed or not and their collectability:

1. Undisputed Trade Receivables – Considered Good

These are receivables where there is no conflict between the company and the customer about the amount that is due and the company assesses the amounts that are recoverable.

2. Undisputed Trade Receivables – Considered Doubtful

These receivables are not in dispute, but the company has uncertainties about their recoverability, usually because of the monetary struggles that the customer is facing.

3. Disputed Trade Receivables – Considered Good

In this type of receivable, the dispute happens between the company and customer, and the company looks for recovering the amounts.

4. Disputed Trade Receivables – Considered Doubtful

The receivables, which are disputed about the amount or terms of the sale, and also the company has distrust about the recoverability.

Measurement of Accounts Receivables

Financial experts use plenty of methodologies for the measurement of account receivables. Some of the regular use methods are given below:

Accounts Receivable-to-Sales Ratio

The accounts receivable-to-sales ratio can be calculated by dividing the accounts receivable by the sales for the required period of time. This ratio provides the figure of sales that are outstanding. The greater ratio shows that the risk is higher with a low probability for accounts receivable.

Days Sales Outstanding

DSO can be measured by dividing the average of accounts receivable to the net credit sales and multiplying by 365. A smaller DSO indicates the enhanced quality of the accounts receivables and signifies that the company can obtain cash from the customers quickly.

Accounts Receivable Turnover Ratio

This ratio calculates how quickly any company can change its accounts receivable into cash. A higher ratio indicates that the company is shifting its accounts receivable to cash quickly. It can be calculated by dividing sales for the required period by the average receivable balance for the same period.

Questions to Understand your ability

Que.1 What type of trade receivables, according to Ind AS, has some form of collateral to lower the credit risk?

A) Unsecured Receivables

B) Receivables with Increased Credit Risk

C) Secured Receivables

D) Credit-Impaired Receivables

Que.2  Which accounting standard is in sync with IFRS for how trade receivables are classified?

A) Notified AS

B) Ind AS

C) GAAP

D) Companies Act (2013)

Que.3 Under Notified AS, if there’s no dispute about the amount but doubts about collecting it, how are these receivables classified?

A) Disputed Receivables – Considered Doubtful

B) Undisputed Receivables – Considered Good

C) Undisputed Receivables – Considered Doubtful

D) Disputed Receivables – Considered Good

Que.4  A higher Accounts Receivable Turnover Ratio suggests what about a company’s receivables?

A) Receivables are converting to cash quickly

B) The company’s receivables are piling up

C) The company is slow in collecting money

D) There’s a high risk of not recovering receivables

Que.5  If Days Sales Outstanding (DSO) is low, what does that say about the company?

A) It’s collecting cash fast

B) It’s facing collection problems

C) Its receivables quality is poor

D) It has high risk of defaults

Conclusion

In conclusion, accounts receivables play a crucial role in financial reporting, with their classification based on credit risk, security, and dispute status under Ind AS and Notified AS. Proper classification aids in assessing the financial health and credit risk of a company. Measurement methods like the accounts receivable-to-sales ratio, DSO, and turnover ratio help gauge liquidity and cash flow efficiency.