Accounting for Credit Sales
Credit sales are sales in which a company expects the buyer to pay the price within a certain period. Unlike cash sales, in which the buyer has to pay the cash on spot, credit sales are flexible in respect of the actual payment of the invoice.
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. The credit terms are expressed as a/b, net z where a is the percentage cash discount offered when the payment is made within the discount period, b is the discount period in days, and z is the credit period i.e. the time period till the due date of the invoice.
A sale is recorded when the risk and rewards inherent in the product transfers to the buyers. This involves creation of account receivable.
When the buyer pays the invoice within the discount period, a cash discount is recorded. Cash discount equals the product of invoice value and the percentage cash discount included in the credit terms. This is journalized as follows:
|Cash (C = A – B)||C|
|Cash discount (discount % × A)||B|
Credit sales involve a risk that the buyer might not eventually pay when the amount is due. This results in bad debts expense, which is estimated based on the creditworthiness of the buyer and the company’s past experience.
On 1 July 2014, Woodworks, Inc. sold 5 office desks, 5 revolving chairs and 10 visitor chairs to A2Z Real Estate Solutions (ARES), for $3,000 with credit terms of 2/10, net 30.
On 10 July 2014, ARES paid $980. On 30 July 2014, it paid $1,800 more. A week late a court ordered the company to be wound up. Woodworks, Inc. wants to write off the uncollected credit sales as bad debts expense.
Required: Journalize the transactions.
The credit sale is recorded as follows:
$980 paid on 10 July 2014 is after adjustment for cash discount equal to $20 [=2% × $1,000]. This payment discharges $1,000 worth of accounts receivable. The payment will be recorded as follows:
|Cash [= $1,000 - $20]||$980|
|Cash discount [= 2% × $1,000]||$20|
$1,800 paid on 30 July 2014 is not entitled to the 2 % discount. It is recorded as follows:
After winding up of ARES, the outstanding balance on ARES account is not recoverable. It is charged to income statement as a direct write off of bad debts expense.
|Bad debts expense [= 3,000 - 1,000 - 1,800]||$200|