Let’s imagine that when we are purchasing some groceries, we queue at the cashier and pay for the groceries. We exchange our cash for the shop’s goods. It is a straightforward transaction.
In the business world, nonetheless, numerous companies are willing to sell their services or products on credit. This is equivalent to the scenario that the grocer transfers the possession of the goods to you, providing a sales billing, and permitting you to pay for the groceries later.
When a seller chooses to sell its products or services on credit, two things occur. First, since numerous consumers appreciate the benefit and effectiveness of purchasing on credit, the seller increases its possibility to boost profits in the profit and loss. Second, the seller exposes itself to potential loses if its clients do not pay the sales invoice quantity when it is due.
The sale on credit under the accounting’s accrual basis will:
1. Increase the quantity due from clients, which is posted as accounts receivable – an asset on the balance sheet
2. Boost sales or revenues, which are stated in the income statement.
The seller will report if the buyer does not pay the quantity it owes:
1. Accounts receivable are reduced on its balance sheet.
2. Bad debts expense or credit loss on its income statement.
In the financial statements, the seller needs to report its forecasted credit losses as quickly as possible through the allowance method. Losses are reported for income tax purposes, using the direct write-off technique.
Recording Goods Sold on Credit
A company sells a product at RM 6,050 to its customers with credit terms up to net thirty days. Offering services with credit terms are also described as offering services on account.
Revenues are earned at the time when the services are offered under the accrual basis of accounting. This suggests that the company should record its income on the day it made the offer, although the revenue is not received yet and that is typically what an accounting firm in Johor Bahru will do.
In this deal, the credit to Service Revenues increases the company’s earnings and net income. These would be reported on the company’s income statement. The debit to Accounts Receivable (Also see Introduction to Interest Receivable) would increase the company’s current assets, total assets, shareholders’ or owner’s equity and working capital (Also see Components of Working Capital); these would be reported on the balance sheet of the company.