2.5 Current Assets: Inventory and Accounts Receivable
The accountant defines the word, “current,” as in “current asset” – or “current liability” – as an item, which is consumed or exhausted within one calendar year. On the balance sheet, we observe numerous such assets and liabilities. For example, inventory is held by the corporation for sale in the near future and, presumably, is sold in less than one year (in most instances). In fact, the sooner the corporation disposes of its inventory the better, by and large.
“Accounts receivable” is a current asset that bears some further explanation. In many instances, a customer pays for goods purchased at the point of sale. He receives the goods (i.e., the corporation’s inventory) and pays at the same time.That is what usually happens when consumers buy goods at the store. At the time of (a “cash”) sale, the seller reduces inventory (credit) and increases cash (debit).
In many, if not most, large business transactions, the customer may receive the goods, but not pay for them until later. The seller may grant the customer “credit” for the purchase and require “terms of sale” to which the buyer agrees. The terms of sale will dictate that the customer pay for the goods, typically, but not always, within thirty days of delivery. This sale would be referred to as a “credit sale” rather than a “cash sale,” and would be indicated as such on the company’s income statement (see below).
At the time of the credit sale, the seller will record, or “book,” an account receivable for the sale on its balance sheet, while the buyer will book an account payable on its. Simultaneously, the seller reduces (i.e., credits) his inventory and the buyer increases (i.e., debits) his.
When payment is made, the accounts receivable are adjusted (as will the cash account). In the case of the seller, the account receivable is reduced (i.e., credited) and the cash account will be increased (i.e., debited).
In the case of the buyer, the account payable will be reduced (i.e., debited) and cash will be reduced (i.e., credited) as well.