Cash sales vs credit sales

Cash sales refer to the sales for which customers pay the consideration at the time of sale of goods or services. Whether the customers pay cash, pay through a credit or debit card, or make payment in any other form, if the payment is made at the time of sale, that sale will be termed as cash sale.

On the other hand, businesses tend to sell their goods and services on credit as well. It means that they transfer the goods and services to the customers and allow the customers to pay for the goods and services later. Such sales are termed as credit sales.

Accounting of cash sales and credit sales

As far as accounting of income is concerned, amount and timing of income recognition is not affected by the type of sale. Regardless of whether it is a cash sale or a credit sale, income is recognized when the entity transfers control of the goods or services to the customer. The difference arises in the second effect of recording the double entry of income.

Cash sales

Accounting of cash sales is rather simple. As the entity receives cash at the time of sale, sales income is credited with a corresponding debit entry in the cash or bank account. Following is the journal entry for cash sales:

Dr. Cash Account — XX
Cr. Sales Account — XX

However, sales proceeds must be carefully evaluated. In jurisdictions where there is indirect taxation, for e.g., value added tax on the sale of goods or services, the cash received by the entity will be made up of two parts:

  • Payment of the good or service sold.
  • Value added tax

Let’s recall the definition of income. Income or revenue is the gross economic benefits earned by an entity from its main business activities. Value added tax is not an economic benefit of the entity. It is just collected from the customer and will be paid to the revenue authorities of the government. So, it should not be a part of the income. Similarly, any other payments collected on behalf of third parties should not be included in sales income, for e.g., an agent collecting cash on behalf of principal.

Following is the journal entry for cash sales where indirect tax is applicable:

Dr. Cash Account — XX
Cr. Sales Account — XX
Cr. Value Added Tax Payable Account — XX

Credit sales

Why do entities opt for credit sales, even though cash sales are simpler with no credit risks involved? They do so to increase their sales income. The entities sell the goods or services on credit as they believe that the benefits of increased sales outweigh the credit risks involved.

As per accrual basis of accounting, credit sales are recorded by crediting the sales income account with a corresponding debit entry in a current asset account known as accounts receivable or trade receivables. Following is the journal entry for credits sales:

Dr. Accounts receivable — XX
Cr. Sales Account — XX

Where there is indirect taxation applicable, following journal entry is made to record the credit sale:

Dr. Accounts Receivable — XX
Cr. Sales Account — XX
Cr. Value Added Tax Payable Account — XX

When the customer pays for the goods or services, cash or bank balance is increased by recording a debit entry with a corresponding credit entry in accounts receivable, as the receivable has been realized.

Following journal entry is made to record the receipt of payment from a customer:

Dr. Cash or Bank Account — XX
Cr. Accounts Receivable — XX

However, there can be situations where the customer defaults and does not pay for the goods or services bought. In such cases, credit loss known as bad debt expense is recorded with a corresponding credit entry in accounts receivable, as the receivable will not be realized now.

Following journal entry is made to record the bad debt expense:

Dr. Bad Debt Expense Account — XX
Cr. Accounts Receivable — XX