One of the quirks of accounting for travel agencies is a little thing called an asset, and specifically an asset known as accounts receivable… or more affectionately, AR.
Why is AR quirky for travel agencies?
But first, what is AR?
AR is an asset.
Well, then what is an asset?
Remember my definition of assets from 5 Easy Ways for Travel Agents to Learn the Accounting Language (what am I saying, of course you do):
An asset is a thing, a resource. It is something you control – tangible or intangible – that brings value now and in the future.
Cash is an asset.
It’s a thing. You control it, and it will be worth something to you in the future.
Your car is an asset.
Your computer is an asset.
AR is an asset.
AR is an amount owed to you usually by a client, or in the case of a travel agent, by a supplier in the form of commission.
It is an asset because you control it or own it, and it will be of value to you in the future (the definition for an asset in a graduate-level accounting course would be much more detailed, but let’s keep it simple). It is owed to you “on account” as it were, and you will “receive” it in the future – hence the term accounts receivable, shortened to AR.
What’s quirky about it for a travel agency?
You arrange travel for a client that might not actually occur for many months.
You might book a cruise for a client in April of 2014. That cruise might not sail until February of 2015. Let’s say you did just that, and you earned $1000 commission. That commission may not be payable by the supplier until after the cruise. So, you won’t get paid until sometime after February of 2015.
Between now and then, you will be the proud owner of an asset called AR in the amount of $1,000.
You may not actually carry this asset on you formal books, nevertheless it’s still out there. And you ought to be tracking it somehow. There are many ways of doing that, we’ll discuss in future posts.
Why might you not carry that asset on your books?
Wait a second, what does “carry that asset on your books” mean? It’s simply a way to indicate that you are listing the asset on your balance sheet (remember financial statements?).
Well, why wouldn’t you do that?
Because chances are you are doing your accounting on the cash basis.
What in the world does that mean?
There are two different “ways” of doing accounting. Each is referred to as an “accounting basis”. They include the cash basis of accounting and the accrual basis of accounting.
How do they differ?
Under the cash basis of accounting you recognize revenue and expenses when the cash is received or paid out.
So, you’ll recognize the $1000 commission off that cruise sometime after February 2015, when you receive the cash. If you had an expense you incurred in April of 2014, but that did not actually come due until May of 2014, you wouldn’t recognize the expense under the cash basis of accounting until May of 2014, when you paid out the cash.
Under the accrual basis of accounting you recognize (or accrue, a verb) revenue and expense when you earn the revenue or incur the expense, not when you receive or pay out the cash.
If you did your accounting on the accrual basis, you would recognize that $1,000 of commission from the February 2015 cruise in April of 2014, when you earned it, instead of after February 2015 when you will likely receive it.
How do you choose?
Nearly all small businesses – and when I say small, I mean solo-entrepreneurs and business with just a few employees – do their accounting on the cash basis. There are various reasons why you might choose accrual as a small business, but we’ll save those for later.
What is an asset?
A thing that you control that brings value now and in the future.
What is AR?
An asset that represents an amount owed to you.
What is the cash basis of accounting?
A method of accounting that includes recognizing revenue and expenses when cash is received or disbursed.
What is the accrual basis of accounting?
A method of accounting that includes recognizing revenue and expenses when that revenue is earned or the expense is incurred, regardless of when cash is received of disbursed.
Easy, don’t you think?