How to Decrease Accounts Receivable With a Journal Entry

Accounts Receivable (AR) represents the money owed to a business by its customers for goods or services delivered on credit. Effectively managing and accurately tracking AR is important for a company’s cash flow and financial health. When these amounts are collected or adjusted, the balance of Accounts Receivable must be appropriately decreased in the accounting records.

Understanding Scenarios for Decreasing Accounts Receivable

Various common business situations lead to a reduction in the Accounts Receivable balance. The most direct scenario is when a customer makes a payment for an outstanding invoice, which directly reduces the amount they owe. Beyond direct payments, other events also necessitate a decrease in AR.

Sales returns occur when a customer sends back previously purchased goods, perhaps due to defects or dissatisfaction. This action reverses the original sale, meaning the customer no longer owes the business for those specific items. Similarly, sales allowances are granted when a business reduces the price of goods or services due to a minor issue, but the customer keeps the product. This reduction in price lessens the amount the customer is obligated to pay.

Another scenario involves bad debts, which are accounts receivable deemed uncollectible because a customer is unwilling or unable to pay. Finally, businesses sometimes offer early payment discounts, which incentivize customers to pay their invoices before the standard due date by providing a small reduction in the total amount owed.

Recording Customer Payments

When a customer pays an outstanding invoice, this transaction directly reduces the amount owed, which is reflected through a specific journal entry. The primary objective of this entry is to acknowledge the inflow of cash and simultaneously decrease the Accounts Receivable balance.

The journal entry involves a debit to the Cash or Bank account, increasing the business’s liquid assets. Concurrently, the Accounts Receivable account is credited, which reduces its balance. For example, if a customer pays a $500 invoice, the journal entry would involve debiting Cash for $500 and crediting Accounts Receivable for $500.

Recording Other Accounts Receivable Adjustments

Beyond direct customer payments, businesses frequently encounter other situations that require adjustments to Accounts Receivable, such as sales returns, sales allowances, bad debts, and early payment discounts. Each of these scenarios necessitates a distinct journal entry to accurately reflect the change in the amount owed by customers.

When a customer returns goods, a sales return occurs, necessitating a reduction in the Accounts Receivable balance. The journal entry for a sales return typically involves debiting a “Sales Returns and Allowances” contra-revenue account and crediting Accounts Receivable. For instance, if a customer returns $100 worth of goods that were originally sold on credit, the entry would be a debit to Sales Returns and Allowances for $100 and a credit to Accounts Receivable for $100.

Sales allowances are granted when a customer accepts goods with minor defects in exchange for a price reduction, without returning the goods. The journal entry for a sales allowance involves debiting the “Sales Returns and Allowances” account and crediting Accounts Receivable. For example, if a $50 allowance is granted on an outstanding invoice, the entry would be a debit to Sales Returns and Allowances for $50 and a credit to Accounts Receivable for $50.

Bad debts represent accounts receivable that are deemed uncollectible. Businesses typically use one of two methods to account for bad debts: the direct write-off method or the allowance method. For financial reporting under Generally Accepted Accounting Principles (GAAP), the allowance method is preferred because it adheres to the matching principle. Under the direct write-off method, when a specific account is determined to be uncollectible, “Bad Debt Expense” is debited and Accounts Receivable is credited. For instance, writing off a $200 uncollectible account would involve debiting Bad Debt Expense for $200 and crediting Accounts Receivable for $200.

The allowance method involves estimating uncollectible receivables and establishing an “Allowance for Doubtful Accounts,” which is a contra-asset account that reduces the net value of Accounts Receivable on the balance sheet. When a specific account is later identified as uncollectible, the write-off involves debiting the Allowance for Doubtful Accounts and crediting Accounts Receivable. This approach ensures that the estimated expense is recognized in the same period as the related revenue.

Finally, early payment discounts are offered to customers who pay their invoices within a specified, shorter timeframe. These discounts reduce the amount the customer needs to pay. When a customer takes advantage of an early payment discount, the journal entry involves debiting “Cash” for the net amount received, debiting a “Sales Discounts” contra-revenue account for the discount amount, and crediting Accounts Receivable for the full original amount of the invoice. For example, if a $1,000 invoice with terms allowing a 2% discount for early payment is settled, the customer pays $980. The entry would be a debit to Cash for $980, a debit to Sales Discounts for $20, and a credit to Accounts Receivable for $1,000.