Are Accounts Receivable Considered an Asset?
Uncover the true nature of accounts receivable, their essential role as a company asset, and how they impact financial reporting.
Accounts receivable reflect money owed for goods or services already provided. They are a fundamental aspect of a company’s financial health and play a significant role in financial reporting, impacting a company’s perceived value and operational liquidity.
Understanding Accounts Receivable
Accounts receivable (AR) refers to money customers owe a business for products or services delivered on credit. The business has completed its part of the transaction, but payment has not yet been received. Instead of immediate cash, the company receives a promise of future payment, typically documented through an invoice. These amounts are usually collected within 30 to 90 days.
AR is common in industries where businesses extend credit terms. This allows customers to receive goods or services immediately and pay later, facilitating sales and customer relationships. While revenue is earned, cash inflow is deferred until the customer settles their balance.
Why Accounts Receivable Qualify as Assets
Accounts receivable are considered assets because they embody future economic benefits for the business. An asset is a resource controlled by an entity from which future economic benefits are expected to flow, resulting from past events.
The “past event” is the delivery of goods or services, establishing the right to receive payment. The company has a legal claim to collect this money, providing “future economic benefits” in the form of cash. This cash can then be used to fund operations, pay expenses, or reinvest in the business. The expectation of converting these receivables into cash makes them a valuable resource.
Accounts Receivable on Financial Statements
On a company’s balance sheet, accounts receivable are listed under current assets. Current assets are resources expected to be converted into cash, consumed, or sold within one year or the company’s normal operating cycle. Since AR is typically collected within this timeframe, their classification as current assets reflects their liquidity and importance for short-term financial stability.
Accounts receivable are presented at their “net realizable value,” which is the estimated amount of cash the company realistically expects to collect from outstanding invoices. To arrive at this figure, an allowance for doubtful accounts is subtracted from the total gross accounts receivable. This allowance accounts for amounts that may not be collected due to non-payment, ensuring the asset’s value is not overstated.