What Is the Normal Balance for Accounts Receivable?
Learn the fundamental accounting rules governing Accounts Receivable's normal balance for clear and accurate financial statements.
Understanding the concept of “normal balance” is important for accurate financial record-keeping. This principle dictates how increases and decreases are recorded for every account within a company’s financial system. Accounts Receivable, a key asset account, clearly illustrates this concept. Knowing the normal balance for Accounts Receivable helps in understanding a business’s financial position and transaction flow.
Understanding Normal Balance
In double-entry bookkeeping, every financial transaction impacts at least two accounts, with debits equaling credits. The “normal balance” of an account refers to the side—either debit or credit—where an increase to that account is recorded. This convention helps maintain the accounting equation: Assets equal Liabilities plus Equity. Each account type adheres to a specific normal balance.
Asset and expense accounts have a normal debit balance, meaning a debit entry increases their balance. Conversely, liability, equity, and revenue accounts have a normal credit balance, indicating a credit entry increases their amounts. A debit is recorded on the left side of an account, while a credit is recorded on the right side. An account’s net balance is the difference between its total debits and total credits.
Defining Accounts Receivable
Accounts Receivable (AR) represents money owed to a business by its customers for goods or services delivered on credit. For instance, if a manufacturing company delivers products to a retail store with payment due in 30 days, the manufacturer records this as an account receivable.
Accounts Receivable is classified as a current asset on a company’s balance sheet. It is considered a current asset because these amounts are expected to be collected and converted into cash within one year or the company’s operating cycle. This makes Accounts Receivable an important indicator of a company’s short-term financial health and its ability to generate future cash flow.
Determining the Normal Balance for Accounts Receivable
The normal balance for Accounts Receivable is a debit. When a business increases its Accounts Receivable balance, it records a debit. This rule stems directly from Accounts Receivable’s classification as an asset account. Assets, by accounting convention, increase with debits and decrease with credits.
This aligns with the fundamental accounting equation: Assets = Liabilities + Equity. An increase in an asset account like Accounts Receivable, through a debit entry, expands the asset side of the equation. This debit must be offset by a corresponding credit in another account to keep the equation balanced, such as a credit to a revenue account when a sale is made on credit. A debit balance in Accounts Receivable signifies that customers owe the business money, representing a future economic benefit.
Recording Changes in Accounts Receivable
Transactions involving Accounts Receivable directly reflect its normal debit balance. When a business makes a sale on credit, the Accounts Receivable account is debited. For example, if a business provides $5,000 worth of services on credit, the Accounts Receivable account would be debited for $5,000. This reflects the increase in the asset, indicating money is now due to the company.
Conversely, when a customer pays their outstanding invoice, the Accounts Receivable balance decreases. This reduction is recorded with a credit entry to the Accounts Receivable account. For instance, upon receiving the $5,000 payment for the previously mentioned services, the Accounts Receivable account would be credited for $5,000, while the cash account would be debited. This credit reduces the amount owed by the customer.