Accounting for Credit Sales

Sales on credit are very common in today’s business environment. This is because each business needs to manage its working capital properly. When a business makes sales on credit, such sales correspondent entry will be on the accounts receivable. In contrast, when the company makes a purchase on credit, the correspondent entry of such purchase will be on accounts payable. The accounts receivable and accounts payable are part of the net working capital that a business needs to pay attention to.

In this article, we cover only the accounting for credit sales. This includes both credit sales with sales tax and without sales tax.

Accounting for Credit Sales without Sales Tax

The accounting for credit sales without sales tax is straightforward. Below is the journal entry to record the credit sales without sales tax:

Account NameDebitCredit
Accounts receivableXXX 
Sales revenue XXX
(To record sales revenue on credit)  

Example

ABC retail grocery store sold its groceries to customers on credit for $150.The journal entry of this credit sales is as follow:

Account NameDebitCredit
Accounts receivable$150 
Sales revenue $150
(To record sales revenue on credit)  

Accounting for Credit Sales with Sales Tax

Sales tax or simply value-added tax (VAT) is an indirect tax that a business needs to collect and pays to the government on behalf of the customer. In some jurisdictions, the sales tax is called Goods and Service Tax (GST) and this shall need to offset against the GST on the purchase before making payment to the GST to tax authority. In addition, in some other jurisdictions, the sales tax is called commercial tax (CT). The mechanism of commercial tax is different from VAT and GST. Unlike VAT or GST, the CT on purchase cannot be claimed as an offset against the CT on sales. Therefore, CT on purchase is recorded inclusive in the expense.

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The journal entry for credit sales with applicable sales tax is as follow:

Account NameDebitCredit
Accounts receivableXXX 
Sales revenue XXX
Sales tax payable XXX
(To record sales revenue with a sales tax on credit)  

When the seller pays the sales tax to the relevant local tax authority, the journal entry is as follow:

Account NameDebitCredit
Sales tax payableXXX 
Cash XXX
(To record sales tax payment to tax authority)  

Example

On 15 January 20X1, XYZ Co sells office supplies to its customer (ABC Co) for $1,500. The applicable VAT is 10% of the total sales. The VAT shall need to be made to the local tax authorize on the 15th of the following month.

From the example above, the VAT is $150 ($1,500 × 10%), thus, the total invoice amount is $1,650 inclusive of VAT of $150.

The journal entry for the cash sales on 15 January 20X1 is as follow:

Account NameDebitCredit
Accounts receivable$1,650 
Sales revenue $1,500
Sales tax payable $150
(To record sales revenue with sales tax on credit)  

When XYZ Co makes payment to the tax authority, the journal entry to record such payment of sales tax is as follow:

Account NameDebitCredit
Sales tax payable$150 
Cash $150
(To record sales tax payment to tax authority)  

As mentioned above, when the company makes sales on credit, the credit function of the company needs to take into account properly. The company needs to ensure that the collection process is carried out within the acceptable level to maintain the day’s sales outstanding (DSO) at a relatively low level.

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The company may consider providing a cash discount on sales to speed up the collection so that it may attract customers to make payment early.

Now let’s assume further that XYZ provides a cash discount of 2% to its customer (ABC Co) if they make payment within 10 days from the sales transaction.

On 20th January 20X1, ABC Co made payment to the company. Thus, ABC Co is eligible for a cash discount of $30 ($1,500 × 2%). Therefore, the company received a payment of only $1,620.

Below is the journal entry for the collection of accounts receivable after cash discount:

Account NameDebitCredit
Cash$1,620 
Sales discount$30 
Accounts receivable $1,650
(To record customer payment with sales discount)  

Conclusion

The accounting for credit sales is straightforward and can with or without sales tax depends on the goods or services delivered or provided for. Typically, to encourage customers to make payment early, the company may consider providing a cash discount. This way can help the company to collect its accounts receivable faster to improve its working capital.

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