Definition of Is Account Receivable an Asset or Liability
Accounts receivable can be defined as an economic resource or asset owned by an entity which represents the value of money due to it against supply of goods or 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 organisation 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, account receivables may also be disclosed under non-current assets depending on agreed terms and conditions. ARs are converted into cash as per the agreed time interval, usually within one year and hence is 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 the business of factoring which purchases and sales accounts receivable of another entity. Sometimes due to varied reason, debtors may not get realised in cash. In such a case, it needs to be transferred to 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 which entity will receive in future. Any resources which is capable of generating future economic benefits will be recognized as an asset. Accounts receivable is something which entity had accrued against the sale value of goods/ service. Account receivable is the sale proceeds done for the credit sales of a company, in other words, the amount owed by a seller from its customers is known as account receivable. It is an asset which will be converted into cash after a specified period of time. These are the amount which has been billed but has not been realised into cash becomes current assets. At the time when the money is received from a customer , these 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. Every organization while following the principle of conservatism identifies certain accounts receivable which will not be realised.
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 charge of them as a loss in Profit and Loss A/c. As on the date of sale, there exist 100% probability of realisation i.e. future economic benefits will flow into the entity, Accounts receivable gets 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 in the case of accounts receivable, there does not exist any possibility of cash outflow, it does not fall within the definition of a liability and therefore 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 $10,000in its value. It sold these goods to Henry Inc. for $50,000 and incurred $1000 as selling expenses. You are required to identify and record value of accounts receivable?
Solution:
We are asked in question to determine and record value of accounts receivable. Accounts receivable has got nothing to do with any expense incurred prior to sale and hence all such expenses like purchases cost of $40,000 and further addition cost of $10,000 will be ignored. Also, expenses incurred for selling any product are a part of cost. This will not be reduced from the accounts receivable value.
Therefore, Accounts receivable in this question is $50,000 which represents the sale price of goods.
Example #2
Calculate the net value of Accounts receivable which will be reported in Balance Sheet of Mr. Henry Inc.
- Total Goods Procured during 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
- Markup on cost is 20% of cost
- 80% of sales is on credit.
- $8,000 of debtors cannot be realised as on 31/12/2019
Solution:
Goods Sold = Opening Stock + Purchases – Closing Stock
- 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 getting normally realised within twelve months from the date of sales or from the balance sheet date. However, it may so happen in some cases that accounts receivable get disclosed under the non-current asset due to the fact that it will get realised 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 non-realisation of certain debtors based on past experience. This provision is known as 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 goods/ service recipient. As this is a certainty of realisation on the date of sale, it gets recorded in books of accounts as an asset as it is capable of generating future economic benefits for the entity.
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