Chapter 4: Credit Sales and Purchases Flashcards
Recording credit sales transactions
** A credit sale arises from a sale of goods or services to customers for FUTURE PAYMENT
A financial document accompanies each credit sale transaction
- Credit sale is recorded in a SALES INVOICE
- Sales return is recorded in a CREDIT NOTE
- A REMITTANCE ADVICE evidences customer payments
These above transactions are reflected in a business’s accounting system by transferring information from the financial documents into the relevant credit sales ledger accounts using double entries.
The sales system is integrated into the business’s computerised accounting system. As sales transactions occur, the relevant general ledgers and the individual customer account are updated automatically.
For example, when Sunrise Lighting raises a sales invoice to customer ABC Ltd, the general ledger accounts (Trade Receivables and Sales) and the individual customer account (ABC Ltd Account) are updated simultaneously.
Sales transaction (eg. credit sale) -> Sales document (eg. sales invoice) -> a) general ledger (trade receivables account or sales account or b) Individual Customer account
Sales Invoice
A sale invoice is a financial document sent from a business to the customer, highlighting details of the credit sales transaction.
It includes information such as the name and address of the buyer and seller, the items sold, and the price of the items. The sales invoice also contains details of any sales tax and discounts given.
Credit Note
A credit note is a financial document issued to customers from a business due to SALES RETURNS. The credit note REDUCES THE VALUE OF AN INVOICE previously issued.
The credit note (negative invoice) is issued due to problems with goods delivered already invoiced. Examples of issues are:
- Damaged or faulty goods
- Wrong item delivered
- Incorrect units delivered
- Overcharge on invoice
For example, faulty goods in Sunrise Lighting, such as damaged or broken light bulbs, are returned by customers in exchange for a credit note.
- If a trade discount was offered, it also needs to be considered in the credit note, or the refund will be overstated.
- Settlement discounts are not considered in a credit note because it is unlikely that the customer will pay for a faulty sales invoice.
Types of Discounts
IFRS 15 Revenue from Contracts with Customers provides the principles of recording sale transactions. Per IFRS 15, the framework requires the business to determine the transaction price of a sale.
The transaction price is the amount a business expects to be entitled to in exchange for the transfer of goods or services. Accounting for trade and settlement discounts is considered in determining the transaction price.
Trade Discounts
Definition - a trade discount reduces the cost of goods or services bought or sold. Trade discounts reduce the goods total (list price)
The business can choose to offer a trade discount to customers for two reasons:
- They are valued customers who regularly buy goods from the business.
- The discount offers customers an incentive to order in larger quantities.
Trade discounts offered are guaranteed discounts that customers are expected to take advantage of. Therefore, trade discounts offered are always included when recognising sales.
Settlement discount
Definition - a settlement discount or prompt payment discount is a discount offered to customers or given by suppliers for payment made within a specific TIMEFRAME
A settlement discount encourages credit customers to pay outstanding balances to the business earlier than the standard credit agreement term (credit period).
For example, a business can offer a 2% settlement discount if payment is made within seven days, although the standard credit period is 30 days.
** Per IRFS 15, settlement discounts are recognised only when a business expects that customers will accept the discount by making the payment within the settlement window
The business must determine the amount of consideration (money) it expects from the sale per the criteria of IRFS 15.
Settlement discounts are offered to credit customers to encourage prompt payment, which can help a business’s cash flow.
It is uncertain if a customer will take advantage of the discount at the point of sale.
When recording the initial credit sale, the business must consider the probability of the discount being taken using JUDGEMENT and considering the PAST ACTIONS of each customer.
If the business expects the customer to take advantage of the discount, the recognised revenue should be the amount after the settlement discount has been deducted.
Credit Sale Transactions and their Double Entries
Transactions that may impact the trade Receivables account are:
- Credit sales
- Sales returns
- Receipts from customers
Credit Sales
A credit sale arises from a sale to a customer for future payment. At the point of sale, the customer owes the business the sale amount. The amount is classified as Trade Receivables.
In a credit sale, two ledger accounts are affected.
- Trade Receivables account
- Sales account
Dr, trade receivables, asset, receivables (asset) increased
Cr, Sales, Income, Sales (income) increased
The amount entered into these accounts is the NET AMOUNT (price after trade discount)
The business will determine whether the customer is expected to take up the prompt payment discount for credit sales with settlement discounts.
If it is likely that the customer will take up the discount, the business will enter the amount inclusive of the settlement discount into the individual ledgers. The settlement discount can be ignored if the customer is not likely to take up the discount.
Sales Return
Sale returns are goods returned to the business by the customers due to an error on the business’s part, such as delivering damaged or incorrect items. Credit notes are issued by the business to reduce the value of the previously issued sales invoice.
A sale return transaction will impact two ledger accounts.
- Sales Return account
- Trade Receivables account
Dr, Sales return, expense, sales returns (expenses) increased
Cr, Trade Receivables, Asset, Receivables (asset) decreased
Receipts from Customer
At the end of the credit term, the customers should pay the business for the outstanding balance for purchases.
Payments made by customers will be recorded into two ledger accounts.
- Bank account
- Trade Receivables account
Dr, Bank/cash, asset, bank/cash (asset) increased
Cr, Trade Receivables, asset, receivables (asset) decreased
Each credit sale, sale return and customer payment is transferred to the ledger accounts in the general ledger. Each ledger account is represented in a “T-Account”.
(see examples)
Individual Customer Accounts
As the sales transactions take place, the INDIVIDUAL CUSTOMER ACCOUNTS are also updated. Entry into the individual customer accounts does not form part of the double entry.
It allows the business to identify specific information relating to each customer, such as:
- Amount the customer owes (the customer accounts
- Invoices the customer has paid
- Invoices still outstanding from the customer
The Trade Receivables ledger account summarises the total receivables amount in a period. Therefore, the business cannot analyse the position of each individual customer from that ledger.
Recording Credit Purchases Transactions
*A credit purchase arises from purchasing goods or services from a supplier for FUTURE PAYMENT
A financial document accompanies each credit purchase transaction
- Credit purchases are recorded in a PURCHASE INVOICE
- Any purchase return is recorded in a CREDIT NOTE
- a REMITTANCE ADVICE evidences payment to a supplier
Credit purchase transactions are reflected in a business’s accounting system by transferring information from the financial documents into the relevant credit purchase ledger accounts using double entries.
The purchase system is integrated with the business’s computerised accounting system. As purchase transactions occur, the general ledger accounts and the individual supplier account is updated automatically.
For example, when a business receives and keys the details of a purchase invoice from supplier XYZ Ltd. into their accounting system, the general ledger accounts (Trade Payables account and Purchases account) and the individual supplier account (XYZ Ltd. account) are updated simultaneously.
[see diagram]
Since the same transaction information is used to update the Trade Payables ledger account and the individual supplier account, the total of the individual suppliers accounts should agree to the total balance on the Trade Payable ledger account. This should be checked periodically to ensure that all transactions have been correctly processed.
Credit Purchase Transactions and their Double Entries
Credit Purchase
A credit purchase arises from a purchase from suppliers for future payment. At the point of purchase, the business owes the business to the seller. The purchase amount is classified as Trade Payables.
Purchases can be categorised as ASSET purchases or EXPENSE purchases.
Asset purchases include acquiring inventory (current assets) or property and vehicles (non-current assets). Expense purchases include amounts paid for rent, heating, and lighting.
In a typical credit purchase transaction, two ledger accounts are affected.
- Purchases (Asset or Expenses) Account
- Trade Payables Account
Dr 1. purchases (inventory) 2. non current asset 3. Individual expense
Cr, Trade Payables - payables (liability) increased
[see table]
The amount to be entered into the Purchase account is the Net Amount (Price after Trade Discount)
Purchase Returns
Purchase returns are goods returned to the seller by the business due to an error, such as delivering damaged or incorrect items. The seller issues credit notes to reduce the value of the previously issued purchase invoice.
A purchase return transaction will impact two ledger accounts.
- Trade Payables: Dr, Payables (liability) decreased
- Purchase Return: Cr, Purchase Refunds (Income) increased
If a trade discount was offered, the amount to record in the purchase return ledger should be net of the trade discount, or the refunds recorded may be overstated.
