Is an Increase in Accounts Receivable a Debit or Credit?
Decode how common business transactions impact financial records. Learn the foundational accounting rules for managing what customers owe your company.
Accounting tracks a business’s financial activities and records economic events, providing a clear picture of a company’s financial health. At its core, debits and credits form the language of accounting. Understanding these elements is essential for comprehending business finances. This article clarifies the meaning of debits and credits and illustrates their application to accounts receivable.
The Foundation of Debits and Credits
Debits and credits are the two sides of every accounting entry, not indicators of positive or negative value. They are foundational to the double-entry accounting system, which mandates that every financial transaction impacts at least two accounts. Total debits always equal total credits, ensuring the accounting equation (Assets = Liabilities + Equity) remains in balance after every transaction.
The effect of a debit or credit depends on the account type. For asset accounts, such as cash or equipment, a debit increases the balance, while a credit decreases it. Conversely, for liability accounts (like accounts payable) and equity accounts, a credit increases the balance, and a debit decreases it.
Revenue accounts are increased by credits and decreased by debits, reflecting their positive impact on equity. Expense accounts are increased by debits and decreased by credits, as they reduce equity. This consistent framework ensures all financial movements are systematically recorded, providing a complete and balanced view of a business’s financial position.
What Accounts Receivable Represents
Accounts receivable represents money owed to a business by its customers for goods or services delivered but not yet paid for. These amounts typically arise from sales made on credit, signifying a future cash inflow for the company.
Accounts receivable is classified as a current asset on a company’s balance sheet. It is considered an asset because the business has a legal claim to these funds and expects to convert them into cash within one year. This asset status reflects the value these outstanding invoices hold for the business.
How Debits and Credits Affect Accounts Receivable
Accounts receivable is an asset account, following the rules for assets within the double-entry accounting system. An increase in any asset account is recorded as a debit. Therefore, when a business extends credit to a customer and the amount owed increases, Accounts Receivable is debited.
Conversely, a decrease in an asset account is recorded as a credit. When a customer makes a payment, the amount they owe decreases, and Accounts Receivable is credited to reflect this reduction. This ensures the Accounts Receivable balance accurately reflects the total amount customers still owe.
Illustrative Transaction Example
When a business sells goods or services on credit, it creates an accounts receivable. For instance, if a company sells $1,000 worth of products to a customer on credit, the business records this by debiting Accounts Receivable for $1,000. Simultaneously, Sales Revenue is credited for $1,000, as revenue increases from the sale. This entry reflects the increase in the asset (Accounts Receivable) and the increase in revenue.
When the customer pays the $1,000 they owe, the business records another entry. The Cash account is debited for $1,000, indicating an increase in the company’s cash. Accounts Receivable is credited for $1,000, which reduces the outstanding balance owed by the customer.