Is accounts receivable a current asset? Some customers or clients can purchase goods or services from businesses on credit. On such occasions whereby sales are made on credit, the business records the amount that the customer owes the business as accounts receivable. This account on the business’s balance sheet shows that customers owe the company a certain amount of cash for the goods or services provided. Is accounts receivable a current asset?; being that it is the amount of money that customers owe the business.
In this article, we will discuss accounts receivable, what current assets are, and whether accounts receivable should be considered a current asset and why.
See also: Is Merchandise Inventory an Asset?
What is accounts receivable?
Accounts receivable (AR) is the balance of money that is due to a business for goods sold or services rendered that has not been paid for by the customers. It is any amount of money that customers owe the business for purchases made or services gotten on credit. Therefore, accounts receivable on the financial reports amount to the outstanding invoices that a company has. This account reports the amounts that a business has the right to receive because it has delivered a good or service.
AR usually represents a line of credit extended by a company. Hence, it has terms that require payments due within a relatively short period which usually range from a few days to a fiscal or calendar year. A common example of a product received on credit is seen in an electric company. This company bills its clients after they have received and used the electricity and record the unpaid invoices as accounts receivable as it waits for its clients to pay their bills.
Several companies function by allowing a portion of their sales to be on credit. They normally offer sales or services on credit to frequent or special customers that receive periodic invoices. This practice would allow customers to avoid the stress of physically making payments as each transaction occurs.
Accounts receivable is recorded in the company’s balance sheet as an asset. It is considered to be an asset because it is the cash owed to a company by a customer. Hence, AR is found on a company’s balance sheet as an asset that can be convertible to cash on a future date.
Now, that we have basic knowledge of what accounts receivable is; is accounts receivable a current asset on the balance sheet? Let’s discuss current assets in order to answer this question.
Related: Service revenue is what type of account?
What is a current asset?
Assets are resources with economic value that an individual, corporation, or country owns with the expectation that they will provide an economic benefit in the future. They can be grouped based on their liquidity into current or fixed assets. Current assets are the assets that can be convertible to cash within one year. These include cash, cash equivalents, stock inventory, prepaid expenses, accounts receivable, marketable securities, and other liquid assets.
Current assets can also be called current accounts. The current assets account is a company’s balance sheet line item that is listed under the Assets section. This account accounts for all company-owned assets that can be converted to cash within one year. This means that any asset whose value is reported in the Current Assets account is considered to be a current asset. They are highly liquid assets that can be sold and converted into cash easily.
Assets, liabilities, and equity are the three major types of accounts on a balance sheet. The assets on the balance sheet would add value to the business and be used to generate cash flow and reduce expenses. This means that an asset will help a business increase its equity and settle its liabilities.
On a balance sheet, assets will usually be classified into current assets and long-term (fixed) assets. The fixed assets are the assets that the company uses over the long term to help generate income. Whereas, current assets are the assets that are reasonably expected to be sold, consumed, or exhausted through the normal operations of a business within the current fiscal year or operating cycle.
This simply means that the assets that are held for a short period are considered current assets. Such assets are expected to be convertible to cash or consumed during the normal operating cycle of the business. The current asset is used to calculate a company’s current ratio which is calculated by dividing total current assets by total current liabilities. This ratio is frequently used as an indicator of a company’s liquidity that shows the ability of a company to meet its short-term obligations.
Since accounts receivable is money that is owed to the company which has terms that require payments due within a relatively short period, it means it can be convertible to cash on a future date. This means accounts receivable can be considered a current asset since current assets are assets expected to be convertible to cash within one year. Let’s discuss this further.
Related: Is unearned revenue an asset?
Is accounts receivable a current asset?
Yes, accounts receivable is a current asset. It is recorded as a current asset because it is the outstanding balance with customers resulting from the sale of products or services which are recoverable within one year. Companies usually record accounts receivable as a current asset on their balance sheets because the customers are bound by a legal obligation to pay the debt owed.
Also, accounts receivable are considered to be liquid assets because they can be used as collateral to secure a loan to help meet short-term obligations. Therefore, accounts receivable is part of a company’s working capital. The Current Assets account is always the first account listed on a company’s balance sheet. It is listed under the Assets section and comprises sub-accounts like accounts receivable, cash, etc that make up the Current Assets account.
For example, in the image below, Apple Inc. lists several sub-accounts under Current Assets that combine to make up the total current assets:
As seen in the balance sheet above, accounts receivable is listed on the balance sheet as a current asset. Nevertheless, in a case whereby the receivable amount only converts to cash in more than one year, it is not recorded as a current asset. Rather, it is recorded as a long-term asset on the balance sheet (possibly as a note receivable). This means that if a business makes sales by offering longer credit terms to its clients, some of its receivables may not be included in the Current Assets account.
Furthermore, due to the fact that there are possibilities that some accounts receivable will never be collected, the account is offset (under the accrual basis of accounting) by an allowance for doubtful accounts. This allowance account is an estimate of the total amount of bad debts related to the receivable asset. Hence, the number of receivables outstanding that the company actually expects to collect will be the net reported amount of the allowance and the gross receivable.
See also: Is Prepaid Rent an Asset?
Why is accounts receivable a current asset?
The reason why accounts receivable is a current asset is relatively straightforward. It is considered to be a current asset because the amount that is owed to the company is expected to be paid within one year. Current assets are considered to be liquid because they can be converted to cash or sold easily without their price being affected.
Since the account balance of accounts receivable is due from the debtor in one year or less, it is therefore a typical example of a current asset. A company having accounts receivable shows that the company has made sales on credit but is yet to collect the money from the customer/clients. Usually, the company accepts a short-term IOU from its customer/client which is normally due in a short period of time. Therefore, accounts receivable is a current asset and will have a debit balance.
Related: Is Merchandise Inventory Debit or Credit?
Example on accounts receivable as a current asset
Let’s look at an example to explain accounts receivable is an asset.
Assume on 1st Jan, ABC Company sells $2,000 worth of gems jewelry to a retailer on credit and the credit terms show that the retailer has 90 days to pay the full amount. In order to record this transaction, ABC Company will have to decrease its inventory by a credit of $2,000 and then increase its accounts receivable account by a debit of $2,000. This is what the entry would look like:
|1st Jan||Accounts receivable||$2,000|
If the retailer pays the $2,000 after 90 days, ABC Company will increase its cash balance by $2,000 and decrease its accounts receivable account by $2,000. This is what the entry would look like:
The accounts receivable here is therefore a current asset because it was recovered in less than one year.
See also: Is Capital Debit or Credit?
Is accounts receivable a current asset?- Video
- Disadvantages of Vertical Integration - May 30, 2023
- Vertical integration benefits - May 25, 2023
- Bank Service Charge Journal Entry - May 19, 2023