Is Accounts Receivable a Debit or Credit?
Understand the fundamental rules governing how your business records money it's owed. Gain essential insights into financial tracking.
Businesses track their financial activities through a systematic method that ensures every transaction is accurately recorded. This organized approach helps in maintaining clear financial records and provides a comprehensive view of a company’s economic health.
The Double-Entry Accounting System
The financial operations of a business are recorded using the double-entry accounting system, a method that requires every transaction to have two equal and opposite effects. This system uses debits and credits as the fundamental building blocks for recording these changes. Debits and credits simply represent the two sides of every financial transaction, not “good” or “bad” outcomes.
For every entry, the total amount of debits must always equal the total amount of credits, ensuring the accounting equation (Assets = Liabilities + Equity) remains balanced. Debits increase asset and expense accounts, while they decrease liability, equity, and revenue accounts. Conversely, credits increase liability, equity, and revenue accounts, and they decrease asset and expense accounts.
What Accounts Receivable Represents
Accounts Receivable (AR) represents the money owed to a business by its customers for goods or services that have been delivered but not yet paid for. This typically occurs when a customer purchases something on terms, such as “Net 30,” meaning payment is due within 30 days.
Accounts Receivable is classified as an asset on a company’s balance sheet. More specifically, it is considered a current asset because these amounts are generally expected to be collected and converted into cash within one year from the balance sheet date.
Why Accounts Receivable is a Debit
Accounts Receivable is recorded as a debit in the double-entry accounting system. This is because Accounts Receivable represents an asset to the business, signifying a future economic benefit—the right to receive cash. Under double-entry accounting rules, asset accounts increase with a debit and decrease with a credit.
Therefore, when a business makes a sale on credit, the amount owed by the customer increases the Accounts Receivable balance. This increase is recorded as a debit to the Accounts Receivable account. Conversely, when a customer pays their outstanding balance, the Accounts Receivable account decreases, which is then recorded as a credit.
Recording Accounts Receivable Transactions
When a business extends credit to a customer, the initial transaction involves recording the sale and the resulting receivable. For instance, if a business sells $500 worth of goods on credit, it would debit Accounts Receivable for $500 and credit Sales Revenue for $500. This entry reflects the increase in the amount owed by customers and the recognition of revenue earned from the sale. It simultaneously increases an asset account (Accounts Receivable) and a revenue account (Sales Revenue), maintaining the balance of the accounting equation.
Subsequently, when the customer pays their outstanding balance, another transaction is recorded to reflect the collection of cash and the reduction of the receivable. If the customer pays the $500 owed, the business would debit Cash for $500 and credit Accounts Receivable for $500. This entry increases the Cash asset account while decreasing the Accounts Receivable asset account. This two-step process demonstrates how the double-entry system meticulously tracks the entire lifecycle of a credit sale, from its creation to its collection, ensuring financial accuracy.