Receivables in the accounting or do you work with them correctly? Part 1

16. November 2021
  • Vendula Novobilská
  • Renata Dudášová

Everyone probably knows the term receivable or has at least some idea of what it means. A receivable as such represents expected receipt of financial flow for a certain provided performance. In today’s article, we will focus on receivables from the perspective of double-entry accounting in compliance with Czech accounting regulations (from its creation to its its fulfilment/termination) and related options for how to work with them. The aim is to present a basic, but comprehensive overview of the given topic. In today’s part, we will go through the basic terms, classification of receivables, their valuation, they way of their termination and how to work with them.

Receivables are active balance sheet entries and they are entered in account group 3 – accounting relations. This captures business relations of the accounting entity with its business partners, employees, the state, insurance companies, partners etc. 

Creation of a receivable

A receivable is the right of a creditor (supplier) to a transaction, monetary or in kind (payment of debt) from a debtor (purchaser). A receivable is thus created when a negotiated performance is provided and it is expected to be collected (fulfilled).  

Receivables may be divided according to several aspects, for example:

1) according to due date

a) current (maturity shorter than 1 year)
b) non-current (maturity longer than 1 year) – here it is necessary to realise than even a part of a non-current receivable may be of current nature – for example the provision of a loan for use, where maturity is set to 5 years, but continuous instalments are negotiated (annual/quarterly/monthly etc.). 

2) according to the type of receivable in the balance sheet (Czech accounting standard no. 017 – accounting relations)

a) Trade receivables

Mainly receivables from customers are entered here, and for a majority of accounting entities, these receivables represent the main business activity of the company (sale of goods, provision of services). This category also includes advance payments provided, which in some cases also serve as means of security, which the creditor is obliged to return in case he does not perform the agreed service/supply of goods.

b) Receivables in the group (controlled or controlling party; significant influence, partners)

In this account group, the individual business transactions are entered (except for receivables from trade relations mentioned above), for example short-term loans for use and loans provided by accounting entities within the consolidated group (to companies in the group). 

c) Other receivables

These include mainly settlements with employees and institutions (health insurance companies, the social security administration and others), settlement of subsidies, receivables on grounds of the individual taxes and all other receivables that cannot be classified into any other category. 

d) Deferred tax receivable (only exists in long-term nature)

It represents the income tax, by which the tax liability in the future will probably be lower, i.e. the accounting entity will probably “save” on income tax. It arises from temporary differences between the accounting and the tax conception of captured cases.

3) according to the risk of repayment

Based on assessment of the risk of payment, we divide receivables into: 

  • certain ones (fully collectable receivables)
  • doubtful (within maturity as well as past maturity, where certain doubt arises as to its repayment)
  • disputed (currently subject to litigation)
  • bad (claimed unsuccessfully, even at court – e.g. insufficient assets of the debtor)
  • lapsed (no action has been brought against the debtor within the prescribed limitation period and any performance by the debtor is now only voluntary)

Valuation of receivables

Under article 25 of Act no. 563/1991 Coll., on Accounting (hereinafter “the AA”, receivables are valuated at nominal value upon their creation. In case of acquiring a receivable against remuneration or as a contribution, receivables are valuated at acquisition cost, including incidental costs related to their acquisition (expert valuation, remuneration for lawyers or commission). Incidental costs are specified in article 50 of Decree no. 500/2002 Coll., implementing all stipulations of the AA (hereinafter “the Decree”). 

Accounting entities are obliged to convert receivables denominated in foreign currency to Czech currency using the exchange rate announced by the Czech National Bank (hereinafter “CNB”). For the valuation at the time of the accounting event (creation of the receivable), the accounting unit may use the daily exchange rate for the conversion of foreign currency into Czech currency, or a fixed exchange rate determined by the accounting unit in accordance with an internal guideline, but always on the basis of the foreign exchange market rate announced by CNB (e.g. the monthly rate – the rate on the first calendar day announced by the CNB, etc.). At the end of the accounting period, all receivables denominated in foreign currency need to be converted using the exchange rate announced by CNB as of balance sheet date.

Extinguishment of a receivable

A receivable may be extinguished in several ways, as follows: 

1) by payment – payment on the part of the purchaser
2) by off-setting (contractual arrangement on off-setting mutual receivables and payables with the business partner). Widely used, to reduce the movement of funds between entities due to recording receivables and payables. 
3) assignment to another creditor – transfer of all rights and obligations to a third party (the negotiated selling price is usually lower than the nominal value of the receivable)
4) by limitation – expiry of the limitation period 

How to work with receivables?

Receivables belong among economic tool that an accounting entity may work with in various ways. This is a future financial flow, which should be collected to a full extent, if possible, and adequate “attention” should therefore be paid to it. Below we state the basic mechanisms for working with receivables, which should be set up at a company for reducing/ preventing future non-fulfilment by purchasers.

Securing receivables

It is possible to use collateral to settle a claim, which also ensures enforced payment by the debtor. To minimize payment risk, a professionally drafted commercial contract is used most frequently, which, among other things, includes the setting of appropriate payment/collateral terms. However, these parameters also affect the customer's decision whether or not to purchase goods (or services) from a supplier that requires such contractual arrangement.  

Securing claims is not necessary, though. Especially in case of repeated and secured payments by reliable clients, receivables may be provided unsecured. On the other hand, securing is recommended for unknown customers, one-off transactions and large deliveries of goods. 

Common forms of security for receivables include pledge of movable/immovable property, pledge of receivables, lien, assignment of receivables and various forms of surety. 

Setting up and monitoring maturity

The usual maturity for trade receivables reaches between 14 and 30 days. Secured receivables, see above, generally have longer maturity periods, as they carry a lower risk of default.

Receivables are significant assets for most entities, and by means of an internal guideline, the accounting entity should establish an internal control system to monitor the age structure of receivables, the reminder process, and the deadline for the creation of accounting provisions.

We can divide receivables into:
a) receivables within maturity
b) receivables past maturity 

As soon as a receivable exceeds its maturity, it becomes risky. Risky receivables need to be monitored and handled actively (see the item claiming receivables).

The value of receivables that are more than six months past maturity should be reduced in the accounting by means of provisioning, to reflect the risk of recovery. The six-month period is one of the most commonly used periods with which an accounting entity works and based on which it takes further action. As described above, it always depends on the established internal control procedure. In some cases, a receivable may become risky while still within maturity, whereas receivables six months past maturity may carry a lower risk. The company should therefore continuously take active steps to monitor the status of its receivables and then take individual actions.  

The accounting entity may also use the option of insuring receivables against the risk of non-payment. The insurance provider provides this service for a fee, so it is necessary to think carefully about which claims will be insured and which ones will not. At the same time, the entity must continually monitor and update this division.

In the next part, we will continue with claiming receivables, provisioning, or possible depreciation of receivables.

The field of receivables is diverse and each accounting case (work with receivables) can have multiple solutions. Are you currently dealing with any decision relating to receivables and are you unsure as to what the correct/effective solution is? Our company provides not only accounting and tax consulting, but also legal analysis and will help find the optimal solution for you.

Author: Vendula Novobilská, Renata Dudášová