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Lesson 5 of 7The World of Accounting
Unit 1 · Lesson 5 of 7

Accounts Receivable and Accounts Payable

Accounts receivable and accounts payable are the two everyday balances created when a business buys or sells on credit instead of for cash.

2 min read6 practice questionsAsk AI about this →

Key things to remember

  1. 1Accounts receivable: total amount due from debtors (customers), usually within 30 days — an asset.
  2. 2Accounts payable: total amount owed to creditors for goods/services purchased — a liability.
  3. 3A debtor owes the business money; a creditor is owed money by the business.
  4. 4Equities = claims by creditors (liabilities) and owners (owner's equity) against a business's assets.
  5. 5Selling on credit increases accounts receivable; buying on credit increases accounts payable.

Very few businesses insist on being paid in cash on the spot every single time, and very few businesses pay every bill the moment it arrives. Instead, businesses routinely buy and sell on credit — the goods or service moves now, and the money follows later. Two accounts exist specifically to track that gap between "now" and "later": accounts receivable and accounts payable.

Accounts Receivable

Accounts receivable refers to the total amount due from debtors, usually within 30 days. A debtor is a customer who owes the business money — the business sold something (goods or a service) but hasn't collected the cash yet. Accounts receivable is an asset: it represents value the business is owed and will likely turn into cash soon, so it sits high up in liquidity order on the balance sheet, right after cash.

Accounts Payable

Accounts payable refers to the total amount owed to creditors for the purchase of goods or services by the business. A creditor is a person or business that has extended credit or loaned money to another individual or business — in other words, whoever the business owes money to. Accounts payable is a liability: the business received something of value but hasn't paid for it yet.

AAccounts receivable (asset)
  • Money owed TO the business
  • Customers (debtors) owe this to us
  • Increases when we sell on credit
  • Decreases when the customer pays
BAccounts payable (liability)
  • Money owed BY the business
  • We owe this to suppliers (creditors)
  • Increases when we buy on credit
  • Decreases when we pay the supplier
A trick for keeping them straight
"Receivable" sounds like "receive" — money we will receive. "Payable" sounds like "pay" — money we must pay. If you're still not sure, ask: did the business already deliver value and is now waiting to be paid (receivable), or did the business already receive value and now owes payment (payable)?

Equities: Claims Against the Business

Equities are claims by both creditors and owners against the assets of a company. Liabilities like accounts payable are the creditors' claims — legally, creditors get paid first if a business is wound down. Owner's equity is the owner's claim, and it's what's left over after every creditor's claim is satisfied. That's exactly why the balance sheet equation places liabilities before owner's equity: lists the claims in the order they'd be paid.

Assets=Liabilities+Owner'sEquityA = L + OEBuy $500 supplies on account: Assets +$500 (supplies), Liabilities +$500 (A/P) — both sides rise by $500, still equal.
Fig 1Accounts receivable adds to assets; accounts payable adds to liabilities — the equation stays balanced.

Worked examples

Reveal one step at a time and try to beat it to the next line.

Example 1
A bookstore sells $340 of textbooks to a school on account (on credit). How does this affect the bookstore's accounts, and is the school a debtor or a creditor of the bookstore?
Example 2
A café buys $210 of coffee beans on account from a supplier. How does this affect the café's accounts, and is the supplier a debtor or a creditor of the café?

Where marks get lost

  • Mixing up debtor and creditor — a debtor owes money (linked to our accounts receivable); a creditor is owed money (linked to our accounts payable).
  • Treating accounts receivable as if it were cash already in hand — it's a promise of future cash, not cash itself, and carries the risk the customer won't pay (bad debts).
  • Recording accounts payable as an asset because it feels like it's "about supplies we got" — the supplies became an asset, but the unpaid amount is a liability.
  • Forgetting that accounts receivable and accounts payable are usually short-term (often due within 30 days), not long-term debts.

Flashcards 5

Accounts receivable
Accounts payable
Creditor
Debtor
+ 1 more

Practice

1
A business sells services on credit to a client. This transaction increases the business's...
2
Which of these is a creditor of a business?
3
What type of account is accounts payable, and why?
4
Match each term to its correct side of the balance sheet equation.
Accounts receivable
Accounts payable
Owner's equity
Equities
5
A business has accounts receivable of $1,200 and accounts payable of $850. If it collects $400 of the receivable in cash, what is the new accounts receivable balance?
$
6
In your own words, distinguish a debtor from a creditor.

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