For any company to remain in business, making sales is vital as this is what every company should be thinking of. It is for this reason that one should try to figure out what customers want as well as study consumer behaviors. As a company, whether you are selling physical goods, rendering services, or maintaining a corporate image, you are involved in sales. This implies that “sales” is a determinant of the survival of any business.
Have you wondered why many firms hire sales representatives and associates? This shows how vital making sales is to an entity. Therefore, it is important to keep a record of every sale made by a company, whether cash or credit, in the company’s financial records. This has brought about questions regarding whether the item, sales is a debit or credit. In this article, we see what sales mean as well as how the sales account works, sales debit or credit, the journal entries, and examples that will aid a better understanding.
See also: Income Statement Ratios Formulas and Examples
What are sales?
Sales in accounting refer to the revenue a company earns from selling its goods, products, merchandise, etc. In other words, the term is defined as the volume of goods and services sold by a company or a business during a reporting period. Sales do not include the income received by a company when it sells noncurrent assets that have been used in its business such as old delivery trucks, company cars, display counters, etc. This transaction will rather be recorded on its income statement as a gain or loss on the disposal of an asset.
Note that in accounting, sales and revenue are used interchangeably to mean the same thing. When a sale is quantified into a monetary amount, it is positioned at the top of the income statement. Sales are recorded at the top of the income statement for two important reasons. The first reason is that it marks the starting point for arriving at the net income. It is then that operating and other expenses are subtracted in order to arrive at the profit or loss figure.
Secondly, as the first item that is listed on the income statement, sales revenue is important for the top-down approach to forecasting the income statement. Sales may be recorded on the income statement as gross sales; and after sales returns and allowances are deducted from it, the result shows the net sales figure.
Having said this, sales can also refer to a business’s selling organization and the activities it engages in to secure orders from customers, that is, an exchange of money for goods, services, or other property. In essence, sales refer to any transactions where there is an exchange of money or value for the ownership of goods or entitlement to service. Sales are also referred to as revenue in a company’s income statement.
As stated above, the amounts recorded at the time the sales transaction took place are known as gross sales. However, situations may arise whereby some customers are not satisfied with the products sold by the company to them due to product defects, wrong size, damages, etc. This may give rise to sales returns and allowances. Also, the company may provide sales discounts to customers for early payment. These factors bring about a decrease in the initial amount of sales. In such cases, sales returns and allowances, and sales discounts are subtracted from the gross sales to result in net sales.
Under the accrual basis of accounting, a company reports goods sold on credit as sales (revenue) as soon as they are transferred to the buyer. This usually happens before the seller receives payment from the buyer. The sales on credit are recorded by debiting accounts receivable and crediting the sales account. In cash accounting, on the other hand, sales revenue is recorded only if the money has been received by the company for the delivery of goods or services. It is important to note that sales are operating revenues as they are earned by a company through its business activities.
With this, one can note that revenue does not necessarily imply cash received as a portion of sales may be paid in cash and a portion may be paid on credit, here, account receivables come in.
Sales account
A sales account is the record of all sales transactions in the business. This includes both cash and credit sales. As previously stated, the account total is then paired with the sales returns and allowances account in order to derive the net sales figure which is listed at the top of the income statement.
It is required to keep a proper account because every business is faced with multiple transactions daily. This brings about the need to have a consolidated ledger that will hold the record of all transactions that take place in the company. These transactions may be large or small, cash or credit. It is here that the concept of a sales account was established.
The basic application of a sales ledger is to act as a record-keeping ledger which would contain the data of all transactions carried out in the business for a given accounting period. It has a provision for credit as well as debit transactions and there are cases whereby separate space is allocated to distinguish both transactions. Some businesses make use of a new ledger for the new year and keep the transactions consolidated in accordance with the day and month.
For instance, every day, a company starts its transaction on a new page, and similarly, every new transaction happening every new month is initiated on a different page which will keep all the transactions consolidated in accordance with the day as well as in accordance with the month. This will give the accountant ease in finding a particular deal at a given point in time.
One major factor that makes sales accounting important for a business is the fact that it brings about an increase in credibility in business transactions as it births reliability. Another fact is that keeping a record of all transactions helps in calculating the net profit/loss of a business. Keeping records helps companies to present proof of transactions during taxation which brings about accountability and transparency. Also, the presence of past transaction records will help a new leader to study the organization and strategize in the future accordingly.
See also: Is Sales Discount Debit or Credit?
Debit and credit explained
Debits and credits are bookkeeping entries that balance out each other. It is critical to consider that for accounting purposes, there must be an exchange of every transaction for something else of the exact same value.
Simply put, consider that a debit always adds a positive number while a credit entry always adds a negative number although, in an actual journal entry, positives and negatives are not used. For placement, a debit is always placed at the left side of an entry, it increases asset or expense accounts and brings about a decrease in liability, equity, and sales (revenue) accounts. A credit, on the other hand, is usually positioned at the right side of an entry, it brings about an increase in liability, equity, and sales accounts and brings about a decrease in asset or expense accounts.
Having said this, debits and credits are used to record transactions in a company’s chart of accounts which classifies income and expenses. The five major accounts involved are asset account, liability account, equity account, revenue (or sales) account, and expense account.
It is evident that whenever an accounting transaction is created, it has an impact on at least two accounts. This comes with a debit entry recorded against one account and a corresponding credit entry recorded against the other account. Here, there is no upper limit to the number of accounts involved in a transaction, but the minimum is not less than two accounts.
It is required for the totals of the debits and credits for any transaction to always be equal to each other in order for the transaction to be “in balance”. If a transaction fails to be in balance, then it will not be possible to create financial statements. With this, making use of debits and credits in a two-column transaction format of the recording is the most essential of all controls over accounting accuracy.
It can be confusing when it comes to getting the inherent meaning of debit and credit as they have different impacts across the five broad types of accounts as highlighted above. The reason behind this seeming reversal of making use of debits and credits comes as a result of the underlying accounting equation. It is upon this that the entire structure of accounting transactions is built. The accounting equation is as follows:
In this sense, one can only have assets if he paid for them with liabilities or equity, therefore, one has to have one in order to have the other. Consequently, if a transaction is created with debit and credit, one is usually increasing an asset while also increasing liability or equity account or vice-versa. Though some exceptions may be in place such as an increase in one asset account while decreasing another asset account. If one’s area of concern is basically with regard to accounts that appear on the income statement such as sales/revenue, then these rules will apply.
So we can say that all accounts that usually contain a debit balance will increase in amount when a debit that is in the left column is added to them and decreased when a credit that is in the right column is added to them. On the other hand, all accounts that contain credit balances will increase when credit is added .to them and decrease when a debit is added to them and this is applicable to sales, liability, and equity accounts.
See also: Is Sales Discount Debit or Credit?
Is sales a debit or credit?
Sales are recorded as a credit, this is because the offsetting side of the journal entry is a debit, usually to either the cash account or accounts receivable account. In essence, a debit brings about an increase in asset accounts, while credit on the other hand brings about an increase in the shareholders’ equity account. As earlier stated while explaining debits and credits, these offsetting entries are explained by the accounting equation where assets must be equal to the sum of liabilities and equity. In other words, sales are a credit balance in the books of accounts because they increase the equity of the owners. In essence, sales are credited because a cash or credit account is simultaneously debited.
In explaining the sales account, we say that it accumulates the detail of all sales transactions during an accounting period or over the course of a company’s fiscal year. After this, the account balance is then flushed out with closing entries and transferred in aggregate into the retained earnings account, which is an equity account.
There are sometimes cases of reversal of a sale probably due to a product return or reduced probably due to the application of a volume discount. When this happens, then the sales account will be debited which brings about a decrease in its balance.
Why sales are not recorded as a debit but a credit
We said that sales in accounting refer to the revenues earned when a company transfers its ownership of goods to its customers. Also, we saw that under the accrual basis of accounting, the sale occurs when the required tasks have been completed by the company. In cases whereby customers are allowed to pay at a later date, the sale will be debited to accounts receivable and credited to the sales/revenue account.
The sales account is a temporary account used in keeping a tally of sales that took place during an accounting period which, in turn, will be used in preparing the company’s income statement. Sales, however, have the effect of bringing about an increase in the credit balance of a sole proprietorship in the owner’s equity section of the balance sheet or the corporation’s shareholders’ equity. At the completion of the accounting year, the credit balance will be moved via closing entries to the corporation’s retained earnings account as stated previously, or the sole proprietorship’s owner’s capital account.
In essence, the reason why sales are not recorded as a debit but as a credit is that an increase in debit will bring about a decrease in its balance. This happens so because when a sales revenue is earned, it is recorded as a debit in the bank account or accounts receivable and as a credit to the revenue account. If a company’s expenses are more than its revenue, the debit side of the profit and loss account will be higher and the balance in the revenue account will be lower.
In order to confirm that crediting sales is logical, let us look at this brief example of a $100 cash sale. In the asset account, cash will be debited for $100 and sales will be credited for the same amount, $100 correspondingly. Another thing is that the accounting equation will remain in balance because the asset cash has been increased by $100 with debit and through the closing entries, there will be an increase in the owner’s or shareholders’ equity with a credit of $100.
See also: Unearned Revenue is What Type of Account?
Debit and credit journal entries for sales
Businesses sell products and services and when sales take place, there is a need to record the transaction in the books of accounts. Making a sales journal entry is critical. How the transaction is recorded is dependent on whether the customer pays with cash or uses credit.
A sales journal entry records a cash or credit sale to a customer, it goes beyond recording the total money received by the business from the transaction. Sales journal entries are to also reflect the changes to accounts such as cost of goods sold, inventory, and sales tax payable accounts.
In creating journal entries for sales, there is a need to debit and credit the appropriate accounts and the end debit should be equal to the end credit balance.
Debit and credit journal entry for cash sales
When a company sells goods or services to a customer who pays in cash, a journal entry will be made by debiting the cash account and crediting the revenue account. This entry reflects the increase in cash and business revenue. The journal entry is illustrated below:
| Account | Debit | Credit |
|---|---|---|
| Cash | 00 | |
| Revenue | 00 |
In realistic terms, the total of the transaction will not all be the company’s revenue as it will also involve sales tax which is a liability. Therefore, a company must credit its sales tax payable account in order to reflect the increase in sales tax liability as follows:
| Account | Debit | Credit |
|---|---|---|
| Cash | 00 | |
| Sales tax payable | 00 | |
| Revenue | 00 |
Note that the debit and credit columns should be equal to each other.
Debit and credit journal entry example for cash sales
Assuming a company receives $100 from a company for goods sold, the cash account will be debited by $100, and the revenue account credited with the same amount as shown in the journal entry below:
| Account | Debit | Credit |
|---|---|---|
| Cash | 100 | |
| Revenue | 100 |
If the customer’s $100 purchase is subject to a 5% sales tax, the customer will have to pay $5 in sales tax which makes the total amount $105.
| Account | Debit | Credit |
|---|---|---|
| Cash | 105 | |
| sales tax payable | 5 | |
| Revenue | 100 |
Debit and credit journal entry for credit sales
When a company offers credit sales to customers, they will not pay for the goods or services immediately. As a result of this, the accounts receivable account will be increased instead of the cash account. The accounts receivable account shows the total amount a customer owes to a company. When the customer later pays, the entry can be reversed to decrease the accounts receivable account and increase the cash account. There will also be a need to increase the revenue account to reflect that the company is bringing in the amount owed by the customer. The journal entry looks like this:
| Account | Debit | Credit |
|---|---|---|
| Accounts receivable | 00 | |
| Revenue | 00 |
As it is in cash sales journal entry, one is likely to deal with sales tax. The accounts receivable total should be equal to the sum of sales tax payable and revenue accounts.
| Account | Debit | Credit |
|---|---|---|
| Accounts receivable | 00 | |
| Sales tax payable | 00 | |
| Revenue | 00 |
Remember that debits and credits must be equal to each other. Also, when the customer pays their bill, there will be a need to create another journal entry. The accounts that are affected when the customer pays are cash and accounts receivable accounts.
| Account | Debit | Credit |
|---|---|---|
| Cash | 00 | |
| Accounts receivable | 00 |
Debit and credit journal entry example for credit sales
If for example, a company makes a credit sale of $240, accounts receivable will be debited for $240 while the revenue account will be credited for $240.
| Account | Debit | Credit |
|---|---|---|
| Accounts receivable | 240 | |
| Revenue | 240 |
When the customer makes the payment, the original entry can be reversed by debiting the cash account and crediting the accounts receivable account for the amount of the payment as follows:
| Account | Debit | Credit |
|---|---|---|
| Cash | 240 | |
| Accounts receivable | 240 |
Making journal entries for the same transaction with sales tax. If the sales tax on the total bill of $240 is 5% ($12), the total charge on credit will be $252. The credit sales journal entry will therefore be made by debiting the accounts receivable account and crediting the sales tax payable and revenue accounts. The journal entry will look like this:
| Account | Debit | Credit |
|---|---|---|
| Accounts receivable | 252 | |
| Sales tax payable | 12 | |
| Revenue | 240 |
Debit and credit journal entries for sales of inventory
If the company is dealing with inventory, the journal entries will be a little more complex because two additional accounts will need to be added in order to reflect the changes in inventory.
When a company sells goods to customers, it is getting rid of inventory and the cost of goods sold expense account is increased as a result. The cost of goods sold represents how much it costs a company to produce the item. The accounts involved in the sale of inventory journal entries are cash (or accounts receivable), sales tax payable (if applicable), revenue, and cost of goods sold. The journal entry in this context looks like this:
| Account | Debit | Credit |
|---|---|---|
| Cash | 00 | |
| Sales tax payable | 00 | |
| Revenue | 00 | |
| Cost of goods sold | 00 | |
| Inventory | 00 |
Journal entries examples for sales of inventory
Assuming a customer purchases a chair for $500 with cash and there is a 5% sales tax rate, it means that the company will receive $25 in sales tax. Therefore, the customer’s bill is $525. The chair cost the company $400. To reflect this, the cost of goods sold account will be debited by $400 and the inventory account will be credited by $400. The journal entry for this is shown below.
| Account | Debit | Credit |
|---|---|---|
| Cash | 525 | |
| Sales tax payable | 25 | |
| Revenue | 500 | |
| Cost of goods sold | 400 | |
| Inventory | 400 |
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