Do You Debit or Credit Accounts Receivable?

Understanding how money flows into and out of a business is fundamental to financial management. Accounting uses a system of debits and credits to meticulously track every financial transaction. For businesses, a common aspect of this financial tracking involves money owed to them by customers, a concept known as accounts receivable. Accurate recording helps understand a company’s financial health and its ability to collect payments.

The Fundamentals of Debits and Credits

Accounting operates on a dual-entry system, where every transaction affects at least two accounts. This system relies on debits and credits, which are entries made on the left and right sides of an account, respectively. Debits increase asset and expense accounts, while decreasing liability, equity, and revenue accounts. Conversely, credits increase liability, equity, and revenue accounts, and decrease asset and expense accounts.

The accounting equation, Assets = Liabilities + Equity, forms the basis for these rules. Assets are economic resources owned by the business, such as cash, equipment, or money owed to it. Liabilities represent obligations to other entities, like loans or amounts owed to suppliers. Equity is the owners’ claim on the assets after liabilities are settled.

Each account type has a “normal balance,” which is the side (debit or credit) that increases that account. For assets and expenses, the normal balance is a debit, meaning a debit increases their balance. For liabilities, equity, and revenue, the normal balance is a credit, so a credit increases their balance.

For example, if a business receives cash, the Cash account (an asset) is debited to increase its balance. If it incurs a loan, the Loans Payable account (a liability) is credited to increase its balance.

Understanding Accounts Receivable

Accounts receivable represents money owed to a business by its customers for goods or services that have been delivered but not yet paid for. This arises when a business sells on credit, meaning it allows customers to pay at a later date, typically within a specified period like 30 or 60 days.

On a company’s balance sheet, accounts receivable is classified as a current asset. This classification indicates that these amounts are expected to be collected within one year or within the normal operating cycle of the business, whichever is longer.

The existence of accounts receivable means the business has earned revenue by providing goods or services, but it has not yet received the cash. Managing accounts receivable helps a business’s cash flow, as it tracks the funds anticipated to be received. Businesses often issue invoices to formalize these claims, detailing the amount due and the payment terms.

Recording Increases in Accounts Receivable

When a business makes a sale on credit, the amount owed by the customer increases its accounts receivable balance. Since accounts receivable is an asset account, an increase in this account is recorded with a debit. The transaction simultaneously recognizes the revenue earned from the sale, even though cash has not yet been received.

For instance, if a business sells goods or services worth $500 on credit, the journal entry would involve a debit to Accounts Receivable for $500. This action increases the asset account, reflecting the customer’s obligation to pay. The corresponding credit entry would be to a Revenue account (such as Sales Revenue or Service Revenue) for $500. This credit increases the revenue account, indicating that the business has earned the income.

The debit to Accounts Receivable establishes the legal claim for payment, while the credit to Revenue acknowledges the completion of the earnings process. This recording method helps accurately reflect the business’s earnings and its outstanding claims.

Recording Decreases in Accounts Receivable

Accounts receivable decreases when a customer pays their outstanding balance. When a business receives cash from a customer for a previous credit sale, the amount of money owed by that customer is reduced. Since Accounts Receivable is an asset account, a decrease in this account is recorded with a credit.

For example, if the customer who owed $500 now pays their bill in full, the business would make a journal entry to reflect this cash collection. The entry would involve a debit to the Cash account for $500.

Simultaneously, a credit to Accounts Receivable for $500 would be recorded. This credit reduces the Accounts Receivable balance, indicating that the customer’s debt has been settled. This transaction shifts the form of the asset from a receivable to cash, maintaining the total asset value while reflecting the change in its composition.