Updated July 7, 2023
Definition of Credit Sales
A credit sale is a transaction where goods and services are sold to the customer, and the business and customer agree to settle the payment at a future date. In simple words, goods are transferred, or the seller renders services to the buyer, but the payment is promised to be done at a later date.
Explanation
The buyer in any sales transaction is not required to make an upfront payment to the seller. Instead, the seller offers a certain credit period to the buyer for making the payment. It is a prevalent form of sales transaction these days. In accounting, a credit sales transaction creates a receivable in the books of accounts of the seller.
For example, A Ltd sells an Air Conditioner worth $5,000 to Mr. B and agrees to settle the payment after 30 days. This is a form of credit sales transaction.
How to Record Credit Sales?
A credit sales transaction is recorded as a typical sales transaction in the books of accounts, but instead of recording cash, an account receivable against the customer is booked.
Once the cash is received, the account receivable created is reversed in the books of accounts of the seller.
Below are the Journal entries recorded in the books of accounts of the seller:
Journal Entry
Date | Account title & explanation | Post. | Debit($) | Credit($) |
31-Dec | Account Receivable A/c | XXX | ||
To Sales A/c | XXX | |||
(To book credit sales transaction) |
Date | Account title & explanation | Post. | Debit($) | Credit($) |
31-Jan | Cash A/c | XXX | ||
To Account Receivable A/c | XXX | |||
(To book settlement of credit sales) |
Sometimes, the seller offers a cash discount to the buyer on early payment of its dues. This cash discount is a loss for the seller and is recorded as follows:
Date | Account title & explanation | Post. | Debit($) | Credit($) |
15-Jan | Cash A/c | XXX | ||
Cash Discount A/c | XXX | |||
To Account Receivable A/c | XXX | |||
(To book early settlement of credit sale) |
Example
On 15th May 2019, Apple Ltd offered to sell a laptop to Mr. Jack for $20,000 on credit. Jack is required to make the payment by 31st May 2019. Apple Ltd also provides a 5% discount if Jack makes payment by 20th May 2019. Journalize the transaction considering the following:
- Case 1 – Mr. Jack settled the full payment on 31st May 2019
- Case 2 – Mr. Jack agrees to receive the cash discount and settle the payment on 20th May 2019
Journal entries in the books of Apple Ltd if Mr. Jack makes payment as per Case 1:
Journal Entry | ||||
Date | Account title & explanation | Post. | Debit | Credit |
Ref. | ($) | ($) | ||
May-15 | Account Receivable A/c | 20,000 | ||
To Sales A/c | 20,000 | |||
(To book credit sales transaction) | ||||
Date | Account title & explanation | Post. | Debit | Credit |
Ref. | ($) | ($) | ||
May-31 | Cash A/c | 20,000 | ||
To Account Receivable A/c | 20,000 | |||
(To book settlement of credit sales) | ||||
Journal entries in the books of Apple Ltd if Mr. Jack makes payment as per Case 2:
Date | Account title & explanation | Post. | Debit($) | Credit($) |
15-May | Account Receivable A/c | 20,000 | ||
To Sales A/c | 20,000 | |||
(To book credit sales transaction) |
Date | Account title & explanation | Post. | Debit($) | Credit($) |
31-May | Cash A/c | 20,000 | ||
To Account Receivable A/c | 20,000 | |||
(To book settlement of credit sale) |
Types of Sales Transactions
There are three types of Sales transactions between a buyer and a seller. These are Cash Sales, Credit Sales, and Advance Payment Sales. The primary difference between all three sales types is the payment timing.
- Cash Sales: A sales transaction in which the seller sells goods/services to the buyer in exchange for immediate cash payment.
- Credit Sales: A sales transaction under which goods are delivered, or services are rendered to the buyer by the seller, but the payment is made on an agreed future date.
- Advance Payment Sales: In this type of sales transaction, the buyer has to pay in advance for the goods the seller sells. For example, you book your movie ticket and pay for it before the actual date of watching the movie.
Credit Sales and Credit Terms
It is finalized on some agreed credit terms. Credit Terms indicate the payment terms of a sales transaction, like when the payment is due, any discounts offered, and any interest or fees charged in case of late payment.
Credit Period: The number of days the customer has to pay the seller.
Example: Credit terms in a sale transaction can be 5/10, net 30. This means a customer has to make payment within 30 days of the sale; if the customer settles the payment within ten days, he will be given a discount of 5% on the total amount due.
How to Manage Credit Sales?
Managing it is one of the biggest concerns of the seller. An effective credit control policy needs to maximize sales and minimize bad debts.
Advantages
Some of the advantages are mentioned below:
- Selling the goods on credit helps to boost the sales of the business. Mostly Customers prefer to buy goods on credit than in cash.
- It helps the customer purchase if he does not have readily available cash to buy something.
- It increases trust and loyalty between customer and seller.
Disadvantages
Some of the disadvantages are mentioned below:
- There is always a risk of bad debt in case of it.
- Higher credit sales affect the company’s liquidity as creditors block most funds.
- The seller must incur extra costs on follow-up and collection of its dues.
Conclusion
It is one of the most common types of sales under which the seller sells goods to the buyer on credit. This type of sales transaction helps increase the business of the seller. However, it can be a costly affair also. The customer can refuse to make a payment or be bankrupt. So, the business has to be careful while making such sales transactions.
Recommended Articles
This is a guide to Credit Sales. Here we also discuss the definition, how to record credit sales, and advantages and disadvantages. You may also have a look at the following articles to learn more –