How to Handle Bookkeeping Double-Entry When Selling on Credit
This is an example of how to handle a double-entry bookkeeping journal entry when selling a product or service on credit where, of course, the customer gets the product or service now and pays later.
A Practical Example
This example is relevant to small businesses who offer credit to their customers:
You are the bookkeeper for XYZ Clothing Store. A customer has just shopped in your store and purchased the following items:
- 3 pair of socks for a total of $12.00
- 2 men's shirts for a total of $55.00
It makes the total sale $67.00. The sales tax in your state is 6% for a total of $4.02 in sales tax. The sales total is $71.02. The customer has an account with your store and plans to buy this merchandise on credit. Here is the bookkeeping entry you would make, hopefully using your computer accounting software, to record the journal transaction.
You would enter this information in two places. First, you would enter the data into your Sales Journal. Second, you would enter the data into the customer's account. The entry into the customer's account should look something like this:
- (Today's Date) Clothing—Sales Receipt # $71.02
The entry into your sales journal would use three figures—the subtotal of sales, total sales, and sales tax. Here is how the entry would look:
Sales Journal Entry—Credit Receipts for (Today's Date)
|Sales Tax Collected||$4.02|
Double-entry accounting is a lot like Newton's Third Law, which states that for every action there is an equal and opposite reaction. With double-entry accounting, every financial transaction has equal and opposite effects in at least two different accounts.
The underlying principle is that Assets = Liabilities + Equity, the books must remain in balance.
Credit sales are thus reported on both the income statement and the company's balance sheet. On the income statement, the sale is recorded as an increase in sales revenue, cost of goods sold, and possibly expenses. The credit sale is reported on the balance sheet as an increase in accounts receivable, with a decrease in inventory. A change is reported to stockholder's equity for the amount of the net income earned. In principle, this transaction should be recorded when the customer takes possession of the goods and assumes ownership.
When companies extend credit to a customer, it carries a certain time period in which the invoice or amount of sale is due, e.g., 30 days. The company may also offer a discount if payment is made within a shorter period of time, e.g., 10 days.
Credit sales carry a certain time period in which the invoice is due. Further, they normally offer a cash discount if the payment is made within a certain period of the actual sale date.
A sale is recorded when the risk and rewards inherent in the product transfer to the buyers, and results in income and assets.
Income must be credited and assets, such as inventory, must be debited. Of course, credit sales always involve the risk that the buyer might not pay what they owe when the amount is due. It results in bad debts expense, which is estimated based on the creditworthiness of the buyer and the company’s previous experience with that customer and credit sales.