Business-to-business transactions are mostly conducted through credit. One company delivers its goods or services to another company and considers it their accounts receivable. But how should you report accounts receivable? Are accounts receivable a debit or credit?
Basically, when you purchased a company’s goods or services through a credit, then this is the accounts receivable. From the company’s perspective, they count this on the debit side and deduct it on the credit side. When the debtor paid the company, then there is a reduction in the company’s accounts receivable.
In recording the transaction, accounts receivables are credited, and cash is debited. Accounts receivables are classified as asset accounts. If the performance of the service or delivery of goods is done simultaneously as the company receives the payment (in cash), the revenue account is credited. So, it increases the account balance.
Read on to learn more about accounts receivables, and whether they are debits or credits.
Is Accounts Receivable a Debit or Credit?
Essentially, when a customer purchased a product or service through credit, then the money is accounts receivable. Then, the company will add this money to the debit side and deduct it on the credit side.
Once the debtor paid the company, then there’s a reduction in the accounts receivable. To record the transaction, cash is debited, and accounts receivable is credited.
If the service was performed at the same time it was paid by cash, the revenue account ‘Service Revenues’ is credited. So, it will increase the account balance. Thus, the accounts receivable is an asset account. Its amount is increased with a debit.
Accounts receivable represents money due or owed to a company in the short term on the balance sheet. That is why it is regarded as an asset account.
In short, accounts receivable is an individual’s debt to a company. So, the customer still has not paid. Therefore, the company lists this money on the company’s balance sheet as a current asset.
Understanding Accounts Receivable
If you own a company, especially if it has huge commercial interests, you can’t force your customers to always pay in cash. In our modern world, dealing with cash always has many disadvantages. Thus, the invention of credit purchasing.
As you allow your customers to buy your goods or services on credit, you need to know how much money they owe you at any one time of your business operations. This is one of the primary reasons why there is such a thing as accounts receivable.
Accounts Receivable Is the Sum of Money Your Clients Owe You for the Goods or Services
Accounts receivable is the sum of money your clients owe you for the goods or services that they bought from you in the past. You still have to collect the money according to the terms that you both have agreed to. Usually, it is a 30-day or a 60-day term.
You should record this amount and the term period in your company ledger. And this accounts receivable is one of your company’s assets. Therefore, you should record it as such in your company’s balance sheet. In accounting lingo, this AR is part of your accrual basis accounting.
Another account receivable is the outstanding or unpaid invoices or the accounts or money a business has the right to receive because it has already provided the services or has already delivered the goods.
A Company’s Line of Credit Extended to Its Customers
It can also be regarded as the company’s line of credit that it extends to its customers. As a form of credit, it naturally has terms that require payment to be made within a prescribed period, usually only on a short-term basis. The term could be 7 days, one month, 60 days, and at most one year.
Accounts Receivable Is Under Current Asset
Usually, a company records the accounts receivable on the balance sheet under assets because the customer has the legal obligation to pay their debt. Specifically, the company lists it as a current asset because customers have to pay their debt in less than one year.
If you have some receivables on your balance sheet, it means you still have money to collect because of the goods or services that your customers bought from you on credit. Basically, your company has accepted the short-term IOUs of your clients.
Since not all your IOUs are payable simultaneously, you have to use accounts receivable aging schedules. This system will enable you to keep tabs on the well-being and status of all your accounts receivables.
Keep Track of Your Company’s Receivables
Keeping track of all your accounts receivables is very important for your business operations. It will help your company prevent credit over-exposure. You should be able to set a limit on how much your customers can borrow from you.
You should be concerned about the amount of your accounts receivables because next to cold cash, they are your company’s most liquid asset. Take note that there is a connection between ARs and company invoices.
For instance, companies usually record their invoices with specific terms like ‘net 60 days.’ This term means that your company sold the item or service on credit instead of cash. The phrase ‘net 60 days’ means the total amount of that invoice is due for payment at the end of the invoice’s 60 day period.
Recording Accounts Receivables
Again, you should put your company’s accounts receivable under the assets section (on the balance sheet). Specifically, ARs are current assets because it adds value to your company. They are actually future cash payments that your company is expecting.
You should add ARs on the debit side and deduct them on the credit side. When you receive the cash payment from a debtor, you need to erase the corresponding amount on your accounts receivables. So, the total amount of your ARs will decrease. In other words, when you record a transaction, you should debit the cash while crediting the ARs.
Your company also has its own Accounts Payable (AP). You should also record these APs but in reverse. If your company buys goods or services through credit, it increases its accounts payables.
To help you better understand the concept, here is an example.
John’s company sold $1,000 worth of jewelry to a retail store that buys it on credit. The type of transaction is ‘net 45 days.’ Upon confirmation of the order, John reduces his inventory of jewelry by $1,000. He also increases his company’s accounts receivables by the same amount of $1,000.
After 45 days, the retail store paid the $1,000 to John’s company. John then adds the $1,000 to his company’s cash amount, and at the same time, deducts $1,000 from his accounts receivables. There is an adjustment to his company’s balance sheet on paper, and his assets and liabilities remain balanced.
What If a Client Borrowed a Service and Not Physical Goods?
What if a client borrowed a service and not physical goods? Below is an illustration of such a case.
If the client pays for the service in cash immediately, say $100, the debit and the credit will be usually presented in the following format in the general journal:
So, if the debtor paid the company in cash, the Cash goes to the debit. But another account needs to be credited. This is the Service Revenues account name. Because the company provided its customer the service while its customer paid in cash, its account balance will increase.
When a customer pays the company through credit, the company considers it revenue earned. The company then records this in the Service Revenues account name with a credit.
It is in the account name Accounts Receivable where the amount is debited and in the Service Revenues account name where the amount is credited. If the amount of the transaction is $200, it will be recorded in the following format.
Example of Accounts Receivable
One example of an account receivable is the cost of the amount of electricity generated by an electric company consumed by one of its customers.
The electric company bills the consumer, and the exact amount owed by the customer is recorded as an account receivable for unpaid invoices. The electric company considers it as an account receivable until the customer pays the amount.
The majority of businesses today operate by allowing part of their sales to be on credit. There are times when companies offer credit to loyal or frequent customers that regularly receive their invoices.
This arrangement offers convenience to customers since they can avoid the trouble of making physical payments for every transaction they make. Some businesses even offer credit to their customers in a routine manner after getting their services.
Accounts receivables are always created when a customer receives goods or services from a company without paying in cash for what has already been provided by the company. The debt could be in the form of a sale on store credit, an installment payment due after the services or goods have been received, or a subscription to a periodical.
Are Accounts Receivables Considered as Revenue?
An account receivable is considered an asset account and not a revenue account. However, you can record it as revenue at the same time that you record it as an account receivable.
For instance, Company A buys $400 worth of goods from your store. You should record the transaction in your accounting books at the same time you issue an invoice to this company in the following way:
Always remember that cash is cash, and credit is credit. Under the cash basis accounting system, accounts receivables do not exist. There is no transaction under the cash accounting system until the customer pays cash for the goods or services they received.
Benefits of Accounts Receivable
Accounts receivable is an essential part of the fundamental analysis of the health of a commercial enterprise. It is a measure of a company’s liquidity since it is regarded as a current asset. It shows the capability of the business to cover its short-term obligations without requiring additional cash flows.
Fundamental analysis usually evaluates a company’s accounts receivables in the context of turnover. This is also called the accounts receivable turnover ratio. It measures the number of times or frequency by which the company has collected its accounts receivable balance in an accounting period.
Accounts Receivables FAQs
To increase your accounts receivable fund of knowledge, here are some Q&A about ARs:
What Is a Credit Balance on Accounts Receivable?
A credit balance on accounts receivable refers to the amount that a debtor owes to a business. It is the amount that a debtor has paid more than the amount indicated in their current invoice.
Are Accounts Receivables Positive or Negative?
If the debtor overpays what they owe, it is considered an overpayment, resulting in a credit. Then, the customer will see the credit balance in their account. But on the balance sheet, it will show as negative accounts receivable.
How Do Accounts Receivables Affect a Company’s Balance Sheet?
The total amount of the accounts receivables compared to the total amount of assets, cash, and inventory can tip the accounts on a balance sheet in favor of non-liquid assets that are difficult to sell. But since they are considered current assets and contribute to current-period revenue, increased receivables can also positively affect income statements.
Conclusion: Is Accounts Receivable a Credit or Debit?
In basic terms, accounts receivable is money owed to a company by a client who bought its goods or services on credit. The amount is added on the debit side and deducted on the credit side to record the credit transaction.
The total amount of accounts receivable of a company is reduced when it receives a cash payment from one of its debtors.