Classification of Account Receivable an Asset or a Liability?
Account receivable is the amount outstanding to a company by its customers or clients and will get converted to cash in the future, therefore accounts receivables are classified as an asset. They are posted under current assets in the balance sheet. In this article, we discuss some of the examples to understand whether account receivable is an asset or a liability.
Account receivableAccount ReceivableAccounts receivables refer to the amount due on the customers for the credit sales of the products or services made by the company to them. It appears as a current asset in the corporate balance sheet. is the money that the company has the right to receive from its clients as the company has provided a product or a service, but has not received the money yet. An account receivable is an asset because the money would be collected at a specific future date. Usually, the future date would be 30,60- or 90-days post invoice received by the client. Why is account receivable considered an asset? Because it is similar to cash equivalentCash EquivalentCash equivalents are highly liquid investments with a maturity period of three months or less that are available with no restrictions to be used for immediate need or use. These are short-term investments that are easy to sell in the public market.. and would be converted into cash in a future date.
Examples of Account Receivable Classification
Let’s take one example of ABC Tyres Pvt. Ltd., which is into manufacturing of two-wheeler tires and tubes. Company XYZ, which is into two-wheeler manufacturing, gives an order of 100 tire-sets at the rate of $15 each tire-set to Company ABC.
- The company ABC delivers the product to the company XYZ. It generates an invoice of $1500 with the condition of 30 days credit period, which means the company XYZ has to clear the payment to Company ABC within 30 days.
- In this case, when Company ABC delivers the product with the condition of 30 days credit period to company XYZ, the sale is recorded in the books of company ABC, but till that time when the amount of $1500 transfers to the bank account of company ABC, becomes account receivable in the books of company ABC.
- When the amount gets credited into company ABC, the cash or bank balance will increase by $1500, and the same amount would decrease the account receivable.
As we understood from the above example, that an account receivable is an asset and would be recorded under the current assets side in the balance sheet. The account receivable would be transferred into cash or bank account once the money gets credited into the bank account of the seller of goods or service providers. Companies can raise short term credit against accounts receivable like any other assets.
It is the other reason for account receivable is to be considered as assets. Like any other asset, we can put account receivable as collateral and raise short term funds from banks or other non-banking financial institutions. Once the amount gets transferred to the company account, the loan account would be closed with some interest. It is called invoice discounting.
Let’s discuss this with an example,
There is one company, Sai Industries, manufacturer of wall paint. It has $10,000 worth of account receivable in its balance sheet, which is due from one real estate firm called Green Constructions.
The Sai Industries has given 60 days of the credit period to Green Constructions. But Sai Industries needs cash urgently, and they approached their bank for invoice discountingInvoice DiscountingInvoice discounting refers to invoice financing where businesses borrow money as loans from finance companies by keeping the amounts due from customers as the collateral, accounts receivable is used as collateral, and finance companies, in return, issue the loan less than the amount receivable as per the invoice., which would attract some interest portion and would be paid off once Sai Industries gets funds from Green Constructions.
This way, account receivable is an important kind of collateral for short term funding.
There is always a potential risk of having a huge amount of accounts receivable. It is also an important responsibility for the seller company to follow up with outstanding invoices or payment.
Companies have to be careful before giving credit to the customers as sometimes some of the customers can default to the debtorDebtorA debtor is a person or entity that owes money to the other party in a transaction. The receiver is referred to as the creditor, and the payment terms vary for each transaction based on the terms and conditions agreed upon by the parties. will never payback for the products or services they received from the seller company.
Account receivable is supposed to be collected within one year, if the seller company failed to collect the amount within one year, it would become a fixed assetFixed AssetFixed assets are assets that are held for the long term and are not expected to be converted into cash in a short period of time. Plant and machinery, land and buildings, furniture, computers, copyright, and vehicles are all examples..
When one or more customers are not paying the amount which they are supposed to pay back to the seller company, it becomes bad debts and would be recorded in the Profit and loss account.
Account receivable is a good thing as it indicates that the company was able to sell its products or services, and business was able to obtain orders and successfully delivering them on time. It also tells us that funds are coming into the company’s account in a short period.
Various other examples explain accounts receivable.
Let’s take one example of a mobile network service provider; they would have a huge account receivable each month.
These companies would generate mobile bills on the 1st of every month for their customers and gives 30 days credit periodCredit PeriodCredit period refers to the duration of time that a seller gives the buyer to pay off the amount of the product that he or she purchased from the seller. It consists of three components - credit analysis, credit/sales terms and collection policy. to their customers. Within 30 days time period, the company would receive almost all dues on time, and the account receivable account would be transferred into a cash account.
In the same way, newspaper agencies, credit card companies, etc. are working in the same way.
This article has been a guide to Is Account Receivable An Asset or Liability. Here we discuss some practical examples of Account Receivable classification along with a detailed explanation. You can learn more about accounting from the following articles –