Classification of Account Receivable an Asset or 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 is classified as an asset and is 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.
Examples of Account Receivable Classification
Account receivable 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. 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 account receivable is considered an asset? Because it is similar to cash equivalent and would be converted into cash in a future date.
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 USD $15 each tire-set to Company ABC.
- The company ABC delivers the product to company XYZ and generates an invoice of USD $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, sale is recorded in the books of company ABC, but till that time when the amount of USD $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 USD $1500 and the account receivable would be decreased by the same amount.
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.
This is the other reason for account receivable is to be considered as assets. Like any other assets, 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. This is called invoice discounting.
Let’s discuss this with an example,
There is one company Sai Industries manufacturer wall paint. It has USD $ 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 discounting 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 debtor will never pay back for the products or services, they received from the seller company.
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 basically 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 of time.
There are various other examples that 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 period 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.
So, from the above discussion, we understood that account receivable is recorded as an asset under current assets in the Balance sheet. We would like to summarize this discussion in the following manner,
- An account receivable is an amount that is outstanding to one client for the product or services delivered but not paid yet. The client would have a time frame to pay back its dues as agreed by the seller, which is called the credit period.
- The seller company can use account receivable accounts to raise short term funds from its bank or other non-financial banking institutes. Once the amount gets credited from the seller as per the agreed terms, this short-term loan from banks would get cleared with some interest portion. Here account receivable work like any other kind of assets and are acceptable as collateral securities with banks.
- The outstanding amount which is supposed to receive from the clients, if not cleared within the agreed timeframe or seller company is failed in recovering this amount, account receivable becomes bad debt and is recorded as expenses.
- In order to make account receivable an asset, it should be recovered within an agreed time-frame, otherwise it would give a sense of money is going out from the business.
- Account Receivable are short term gains, so they would be recorded under current assets in the balance sheet.
This 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 –