When a firm extends credit to clients for products and services delivered, the sum owing to the firm is known as accounts receivable.
But, from a financial perspective, what is account receivable? Is accounts receivable is an asset?
If that’s the case, why are accounts receivable considered an asset? With the help of this guide, you’ll learn everything you need to know about account receivable assets.
What Is Accounts Receivable (AR)?
Accounts receivable (AR) is the amount owed to a company for products or services provided or utilized but not yet paid for by consumers. Accounts receivable are classified as a current asset on the balance sheet. AR is any sum of money owing by consumers for credit purchases.
What are Assets?
Generally, a few distinct items qualify as assets, such as –
- The firm owns valuable assets or resources.
- Prepaid costs that have not yet expired or been utilized.
- Costs that have a quantifiable future worth.
Inventory, cars, cash, long-term investments, real estate, and other assets are examples of assets. The next point is whether accounts receivable is considered an asset.
Is Accounts Receivable an Asset or liability?
Accounts receivable is considered an asset since it is money owed to a firm by a client. Consider a utility business that bills its consumers after providing them with power. The sum due by the client to the utility business is recorded on the balance sheet as accounts receivable, calling it an asset.
So, it’s apparent that accounts receivable is an asset, but why is it an asset? It’s a really simple process. Simply said, accounts receivable are assets since the amount due to the firm will be converted to cash later. More receivables mean more cash, which contributes to business development over the years.
Are Account Receivables Included in the Income Statement?
Revenue is the gross sum reported for the sale of products and services. This figure appears on the income statement’s top line.
The value in the accounts receivable account is made up of all outstanding receivables. This implies that the account balance generally includes unsettled invoice balances from both previous and current times.
As a result, the revenue shown in the financial statements only applies to the current reporting period.
So, accounts receivable balances in any reporting period tend to be more than the amount of reported revenue, particularly if payment schedules are stretched for longer than the timeframe of the statement.
How Does Accounts Receivable Work?
The following are the steps in the accounts receivable method:
Step 1: Offer Credit for Goods and Services
The process begins with selling products or services on credit to clients.
Step 2: Submitting an Invoice
You must send an invoice to your client once the sale has been approved. An invoice is a sales document that contains a list of the items and services offered and their quantities and pricing.
When you submit an invoice to a client, you inform them of the amount owing for the services and goods given by your company. The invoice might be given to clients before or after the products or services are delivered based on the sales agreement.
Remember to add the below data in your invoice:
- Invoice date
- Customer’s data such as name, shipping, and billing addresses, and so on.
- Name, quantity, and price of services and commodities
- The amount owed.
- Invoice The deadline.
- If your customer shared it with you, including the relevant purchase order number and details.
- Please include your contact information.
- Terms of payment
When you send a bill to a client, you must also enter the invoice journal entry. You must debit the accounts receivable account for the money owed by your client and credit the sales account for the same amount when making the invoice journal entry.
To keep your file up-to-date, you must also make a diary entry for the cost of products sold.
Step 3: Collecting Payment
When your client receives the invoice, they must pay it. All clients must settle their invoices before the given due date. Once you have got the money, you must provide them with a payment receipt and enter the payment into the system.
You must debit cash to reflect an increment owing to the payment and credit accounts receivable to lower the amount owed by your client when making the payment journal entry.
What Happens If Accounts Receivable Are Never Paid?
When a client cannot pay an account, it must be written off as a bad debt charge.
Furthermore, if your recovery firm charges costs that are greater than the entire debt amount, you should deduct the difference as a bad debt expenditure.
Bad depth occurs when a client cannot pay owing to a lack of accessible funds or when the customer is about to become bankrupt.
Account Receivable Classification Examples
Consider, a firm, X Tyre Pvt. Ltd., which manufactures two-wheeler tyres and tubes. On the other hand, Company Y Pvt. Ltd, which is into two-wheeler manufacturing, gives an order of 100 tire sets at the cost of $15 for each tire set to Company ABC.
The merchandise is delivered by X to Y. It produces a $1500 bill with a credit period of 30 days, implying that Company Y must clear the payments to Company X before 30 days.
In this instance, if Company X delivers the goods to Company Y with the requirement of a 30-day credit term, the transaction is recorded in the books of Company X, but until the sum of $1500 transfers to Company X bank account, it becomes account receivable in the books of Company X.
When the money is credited to company X, the money or bank balance rises by $1500, while the account receivable falls by the same amount.
Consider one manufacturer of wall paint named YULU Industries. It has $10,000 in account receivable on its income statement, which is owed to Blue Constructions, a real estate business.
YULU Industries have granted Blue Constructions 60 days of credit. However, YULU Industries required cash quickly and asked their bank for invoice discounting, which would incur some interest and would be repaid off after YULU Industries received payments from Blue Constructions.
Account receivable is thus an essential type of collateral for short-term financing.
So, here we concluded this article on “Is accounts receivable an asset or liability.”
On your company’s balance sheet, accounts receivable is reported as an asset.
That is why maintaining all kinds of records properly using effective methods is crucial for a company’s growth.