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Is accounts receivable an asset or revenue?

Is accounts receivable an asset or revenue?

Is accounts receivable an asset or revenue? Some businesses sell goods or services to their customers on credit. That is, these businesses deliver the goods and services immediately, send an invoice to their customers, and then get paid a few weeks later. In order to keep track of all the money its customers owe them, the business uses an account in its books called accounts receivable.

In this instance, the business has made sales but hasn’t collected the revenue yet. Hence, one may ask if accounts receivable is an asset or revenue; being that it is revenue from sales that the customers owe the business. This article aims to answer the question of whether accounts receivable is an asset or revenue. First, let’s have an understanding of what accounts receivable is in business.

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What is accounts receivable?

Accounts receivable (AR) is the money owed to a seller from buyers who have not yet paid for their purchase of goods or services. The seller issues invoices to the buyer, stating the amount owed. Hence, when accounting for unpaid invoices, the seller records the amount in an accounts receivable account to show that he has granted credit to a customer and is yet to receive the stated amount.
Is accounts receivable an asset or revenue?
Is accounts receivable an asset or revenue?

Usually, the business or seller’s credit department sets the total amount of accounts receivable allowed to an individual customer which is based on the finances of the buyer and their past payment history with the seller. Also, the seller can reduce these credit limits during difficult financial conditions when the business cannot afford to incur excessive bad debt losses.

A business may use its accounts receivable as collateral for a loan, or probably sell them off in exchange for immediate cash. Accounts receivables are prized by lenders because they are usually easily convertible into cash within a short period of time. It is usually reported on the balance sheet of the company.

An example of accounts receivable would be a farm supply business that sells a tractor to a farmer for $75,000. The farm supply business makes this sale on credit giving the farmer 60-day terms for paying the receivable. As soon as the tractor is delivered to the farmer, the business records the $75,000 as an account receivable on its books. If the farmer pays the $75,000 after 60 days, the business records the full payment to the cash and sales revenue account.

Now, that we have an understanding of accounts receivable, is it an asset or revenue? Let’s discuss what an asset is.

See also: Is unearned revenue an asset?

Understanding asset

An asset is a resource with economic value that a business owns with the expectation that it will provide an economic benefit in the future. This means that anything that adds value to a business and is used to generate cash flow and reduce expenses is an asset. An asset can be grouped based on physicality, liquidity, and operational activities. Based on liquidity, they can be grouped into current and fixed assets. Assets can be grouped into tangible and intangible assets and based on operational activities can be divided into operating and non-operating assets.

Typical examples of assets in business would include cash, cash equivalents, prepaid expenses, and accounts receivable. Assets also include inventory, PPE (Property, Plant, and Equipment), vehicles, marketable securities, furniture, patents, etc.

Assets such as cash, cash equivalents, stock inventory, marketable securities, accounts receivable, and prepaid expenses are said to be current assets because they can be convertible to cash within one year. They are held for a short period and are expected to be convertible to cash or consumed during the normal operating cycle of the business.

You can see that accounts receivable is mentioned as a current asset. This is because it is the money that is owed to the company which usually has credit terms that require payments within a relatively short period. Hence, accounts receivable can be convertible to cash on a future date, making it a type of current asset. This simply means accounts receivable is an asset; but is it revenue? Let’s discuss revenue to answer this.

Related: Service Revenue Asset or Liability?

Understanding revenue

Revenue is the gross amount recorded for the sales of goods or services. This amount is reported on the top line of the income statement. When a customer pays cash for goods or services to the company, it is known as a receipt. Hence, the revenue account is the account that contains the receipts that the company receives through its business transactions.

In accounting, revenue is recorded on a company’s income statement instead of the balance sheet where assets, liabilities, and equity are recorded. If a business makes sales or renders services and the resulting revenue has not yet been collected, the amount owed is not recorded as revenue on the income statement but as accounts receivable on the balance sheet. This means that accounts receivable accounts for the money that clients or customers owe a business for receiving a good or service.

Therefore, when the business creates an invoice for this transaction, it would be accounted for by a debit entry to the Accounts receivable account and a credit entry to the Revenue account. This simply means that the accounts receivable account is increased and the revenue account is increased as well. Then, when the invoice is paid, a credit entry will be made to the accounts receivable account, decreasing it and a debit entry will be made to the Cash account, which increases the account.

From the journal entry explained above, accounts receivable are not counted as revenue in accounting. The amount owed is reported in the account receiveable account because it is yet to be collected and also reported in the revenue account because revenue is recognized from the sales even though the money is yet to be received. Hence, an accounts receivable is a current asset account with a balance that comprises all unpaid receivables.

This means that the account balance of accounts receiveable includes unpaid invoice balances from both prior and current periods that can add value to the business in the future. While the amount of revenue reported in the income statement is only for the current reporting period. As a result, accounts receivable balances tend to be larger than the amount of the reported revenue in any reporting period, most especially if the payment terms are extended longer than the duration of the reporting period.

Now, that we know that accounts receivable is reported as an asset and not revenue, we can now properly answer the big question ‘is accounts receivable an asset or revenue?’. Let’s discuss this further.

See also: Is accumulated depreciation an asset?

Is accounts receivable an asset or revenue?

In financial accounting, accounts receivable is recorded as an asset and not revenue. It is the amount owed to a business by a customer and as such is an asset because it is convertible to cash on a future date. Accounts receivable is the outstanding balance with customers resulting from the sale of goods or services which are recoverable within one year. It is therefore listed as a current asset on the balance sheet because it is the amount owed by customers that is expected to be received in less than one year.

AR is classified as an asset under the ‘current assets’ section of the balance sheet or general ledger because it provides value to the business. Therefore, accounts receivable is recorded as a current asset and not revenue.

Revenue can be calculated differently based on standard accounting practices using cash basis accounting or accrual basis accounting. In accrual accounting, revenue is recognized when a company makes sales on credit for goods or services delivered to the customer. That is, revenue is recognized under accrual accounting even if the payment for the goods or service has not yet been received. Hence, a journal entry is made as a debit to the accounts receivable account and a credit to the revenue account.

For cash basis accounting, revenue is only recognized when the payment has been received. This means that, unlike in accrual accounting, revenue is not recognized when a company makes sales on credit, only when payment has been made.

In conclusion, accounts receivable is an asset account and not a revenue account. However, under accrual accounting, the amount is recorded as revenue at the same time that the amount is recorded as account receivable. For example, assume you own a furniture business and you sell some furniture worth $500 on credit to a customer. You send the customer the invoice and then make the following entry in your books:

26/10/2022Accounts Receivable$500
Journal entry for furniture sold on credit

As shown in the journal entry above, accounts receivable has a natural debit balance because it is an asset whereas revenue accounts have a natural credit balance. It is important to note that under cash basis accounting, there are no accounts receivable recorded because, under this accounting system, a transaction doesn’t count as a sale until the money is received.

Later on, when the customer makes a cash payment for the $500 worth of furniture bought on 26/10/2022, you record the cash payment as a debit to your Cash account, and as a credit to the Accounts receivable account to close it out once and for all. That is:

Accounts Receivable$500
Journal entry for full payment of furniture sold on credit

The journal entry above would increase the cash account and decrease the accounts receivable account by $500.

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Why accounts receivable is an asset and not revenue

Accounts receivable is considered to be an asset and not a revenue account because it is cash owed to the business by a customer which can be convertible to cash on a future date. It is recorded as a current asset because it is expected to be recovered within a year. In a situation whereby the account receivable amount converts to cash in more than one year, it is still recorded as an asset and not revenue, but this time not as a current asset but as a long-term asset instead (probably as a note receivable).

Even though revenue is recognized when sales are made on credit under the accrual accounting method, the amount from this transaction can’t be recorded as only revenue but as accounts receivable as well because there are possibilities that the customers may not pay their debts. Hence accounts receivable is best treated as an asset rather than as revenue.

Some customers can sometimes default and never pay back what they owe for the products or services received from the company. So, when the company discovers that an account receivable won’t get paid for by a customer, it is written off as a bad debt expense or a one-time charge and then reported in the profit and loss account.

Now, imagine if this owed amount that ended up not being paid for was already recorded as revenue, and not accounts receivable, what do you think would happen to the company’s financial records? Balancing the books would definitely be a hassle. Now, you can see why it is important for accounts receivable to be treated as a current asset account rather than a revenue account.

Furthermore, due to the fact that some receivables will never be collected, the accounts receivable account is offset by an allowance for doubtful accounts. This allowance for doubtful accounts is an estimate of the total amount of bad debts related to the receivable asset. Then, the number of outstanding receivables that the company actually expects to collect becomes the net reported amount of the allowance and the gross receivable.

See also: Is Merchandise Inventory an Asset?