Updated July 13, 2023
Definition of Is Account Receivable an Asset or Liability
Accounts receivable can be defined as an economic resource or asset owned by an entity that represents the value of money due to it against the supply of goods or the rendering of services on credit or as a result of any other such event or transaction which will be converted into cash in the near future as per the agreed terms and conditions. In this topic, we are going to discuss Is Account Receivable an Asset or Liability.
Explanation
When an organization sells goods or services on credit to its customers/ clients, the value at which the sale transaction was entered, which needs to be recovered from a customer, is known as accounts receivable. Accounts Receivable are also known as debtors and are usually reported on the current asset side of the balance sheet. However, depending on agreed terms and conditions, account receivables may be disclosed under non-current assets. ARs are converted into cash as per the agreed time interval, usually within one year, and hence are recorded on the asset side of a balance sheet as current assets. Suppose the amount is not recovered within one year; it gets treated as long term assets. There are entities engaged in factoring, which purchases and sales accounts receivable of another entity. Sometimes due to varied reasons, debtors may not get realized in cash. In such a case, it needs to be transferred to the bad debts loss account and written off in P&L A/c as a loss.
Why Is Account Receivable an Asset or Liability
Accounts receivable is an asset, not a liability. This gets implied from its nomenclature itself as there is something that the entity will receive in the future. Any resources capable of generating future economic benefits will be recognized as an asset. Accounts receivable is an entity accrued against the sale value of goods/services. Account receivable is the sale proceeds done for the credit sales of a company. In other words, the amount a seller owes its customers is known as account receivable. It is an asset that will be converted into cash after a specified period of time. These are the amount which has been billed but has not been realized into cash and becomes current assets. When the money is received from a customer, the accounts receivables balance gets converted into cash. Accounts receivable works only with the accrual basis accounting system; the transaction is recorded only when cash is received. While following the principle of conservatism, every organization identifies certain accounts receivable that will not be realized.
Such assets are known as bad debts, i.e., lost assets. Every organization, either as a percentage or by any other suitable working, identifies such debtors and charges them as a loss in Profit and Loss A/c. As of the date of sale, there exists a 100% probability of realization, i.e., future economic benefits will flow into the entity, and Accounts receivable get recorded as an asset. Liability denotes any amount that needs to be disbursed in the future due to past commitments or any event or transaction that will result in cash outflow. Since there is no possibility of cash outflow in the case of accounts receivable, it does not fall within the definition of a liability and, therefore, is not recorded as a liability but as an asset that will get converted into cash in the future, thereby generating future economic benefits.
Examples of Account Receivable Asset or Liability
Following are the examples are given below:
Example #1
Marc. Inc. purchased goods worth $20,000. Marc. Inc. further processed goods by adding $10,000 to their value. It sold these goods to Henry Inc. for $50,000 and incurred $1000 as selling expenses. You are required to identify and record the value of accounts receivable.
Solution:
We are asked questions to determine and record the value of accounts receivable. Accounts receivable have nothing to do with any expense incurred before the sale; hence, all such expenses as purchases cost of $40,000 and further additional costs of $10,000 will be ignored. Also, expenses incurred for selling any product are a part of the cost. This will not be reduced from the accounts receivable value.
Therefore, the Accounts receivable in this question is $50,000, representing the sale price of goods.
Example #2
Calculate the net value of Accounts receivable, which will be reported in the Balance Sheet of Mr. Henry Inc.
- Total Goods Procured during the year 2019 – $10,00,000
- Opening Stock as on 1st Jan,2019 – $2,00,000
- Closing Stock as on 31st Dec,2019 – $4,00,000
- The markup on cost is 20% of the cost
- 80% of sales are on credit.
- $8,000 of debtors cannot be realized as on 31/12/2019
Solution:
- Goods Sold = 2,00,000 + 10,00,000 – 4,00,000
- Goods Sold = 8,00,000
Sales Price 800000 + 20% of 8,00,000
= 9,60,000
Cash sales (20%) 192000
Credit Sales = 7,68,000
Bad debts 8000
Net Accounts receivable as on 31/12/2019
7,60,000
Recording Accounts Receivable on Balance Sheet
Accounts receivable, being an asset in nature, are reported and disclosed on the asset side of the balance sheet under the current ass. This is normally realized within twelve months from the sales or balance sheet date. However, it may happen in some cases that account receivable get disclosed under the non-current asset because it will get realized or converted into cash after twelve months from the balance sheet date. There is one more concept to be discussed in this part. Many organizations create a provision for the non-realization of certain debtors based on experience. This provision is known as a provision for bad debts. Nature being provision, it will always have a credit balance, and therefore while preparing a balance sheet, it will be disclosed as a reduction from the gross debtors or gross Accounts receivable.
Conclusion
Accounts receivable can be defined as an asset generated as a form of sale of goods or against any service on credit whereby payment is not immediately processed by the goods/ service recipient. As this is a certainty of realization on the date of sale, it gets recorded in books of accounts as an asset as it can generate future economic benefits for the entity.
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