Is accounts receivable an asset?

An asset is something a business owns or controls that has value. The SEC's beginner's guide to financial statements puts it simply: assets are things a company owns that have value, and current assets are those it expects to convert to cash within one year.

An unpaid invoice fits that description. You have done the work. The customer has agreed to pay. You have a right to the money, and you expect to receive it soon. Until it arrives, that right is an asset.

Say a design studio finishes a project on March 1 and invoices $9,500 on Net 30 terms. On March 1 the studio has no extra cash, but it does have a $9,500 claim on its customer. That claim is accounts receivable. When the customer pays on March 28, the receivable turns into cash. Total assets do not change on that day. One asset simply becomes another.

Accounts receivable goes under current assets. In the SEC's balance sheet rules for public companies (Regulation S-X, Rule 5-02), "accounts and notes receivable" is one of the captions listed under current assets, followed by "allowances for doubtful accounts and notes receivable". Small private businesses are not bound by those SEC rules, but most follow the same layout.

A simplified balance sheet:

The basic equation still holds: assets equal liabilities plus equity. Accounts receivable is part of the assets side.

Accounts receivable is a debit. Like other asset accounts, it has a normal debit balance. It increases with a debit and decreases with a credit.

Here is the design studio's $9,500 invoice from start to finish.

On March 1, the invoice raises AR with a debit and records the sale with a credit to revenue. On March 28, the payment raises cash with a debit and clears AR with a credit. After both entries, the AR balance for that invoice is zero.

Two other entries are worth knowing:

• A credit memo reduces what the customer owes, so it credits AR. See our page on the credit memo.
• A write-off of an invoice you cannot collect also credits AR. Our page on bad debt expense covers the other side of that entry.

The longer an invoice goes unpaid, the less likely it is to be paid in full. A $9,500 invoice that is 10 days overdue and a $9,500 invoice that is 300 days overdue have the same face value. They are not worth the same.

Accounting deals with this through an allowance for doubtful accounts. This is a contra-asset account: it sits under AR on the balance sheet with a credit balance and reduces it to the amount the business realistically expects to collect. The figure after the allowance is often called "AR, net".

Businesses often base the estimate on how old their receivables are. Your accounts receivable aging report is the usual starting point, because it groups invoices by how far past due they are. The method and rules depend on your accounting framework, so agree the approach with your accountant.

The practical point for an owner: the AR number on the balance sheet only means something if the invoices behind it are being followed up. A large AR balance full of old invoices looks like an asset and behaves like a problem. Measures such as days sales outstanding and the accounts receivable turnover ratio show how quickly that asset is turning into cash.

The SEC's guide describes liabilities as amounts a company owes to others, including money owed to suppliers for materials. Regulation S-X lists "accounts and notes payable" under current liabilities. One business's accounts payable is usually another business's accounts receivable.