Why are Sales a Credit
The reason sales are credited in accounting is grounded in the principles of the double-entry accounting system. This system maintains that for every transaction, there must be an equal and opposite entry to keep the accounting equation balanced:
Assets = Liabilities + Equity
Role of Sales in Accounting Equation:
When a sale is made, it usually results in an increase in assets (typically either cash or accounts receivable). According to the double-entry system, this increase in assets must be balanced by an equal increase on the other side of the equation. The other side often involves an increase in equity, specifically the revenue or sales account.
Debit and Credit Rules:
- Increases in assets are recorded as debits.
- Increases in liabilities or equity (which includes revenue or sales) are recorded as credits.
Why Sales are Credited:
- Recognition of Earnings: A sale represents earned revenue and an increase in equity. In double-entry accounting, increases in equity are credited.
- Balancing the Equation: Crediting sales helps in keeping the accounting equation balanced by offsetting the debit made to an asset account (like cash or accounts receivable).
- Compliance and Consistency: Crediting sales is consistent with accounting standards like Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS), which mandate such treatment for accurate and comparable financial reporting.
Example of Why are Sales a Credit
Let’s consider a simple example involving a fictional bookstore named “ReadMore Books.”
ReadMore Books sells a collection of books to a customer for $200. The customer pays in cash at the time of the sale.
The accounting equation is Assets = Liabilities + Equity
To record this cash sale, ReadMore Books would make the following journal entry:
- Debit Cash $200 (to record an increase in assets)
- Credit Sales Revenue $200 (to record an increase in equity)
Here’s the breakdown of how this entry fits into the accounting equation:
- Assets Increase: The cash account, an asset, increases by $200. According to the double-entry accounting system, increases in assets are recorded as debits. So, the Cash account is debited by $200.
- Equity Increase: The sale represents revenue earned, increasing the store’s equity. Increases in equity are recorded as credits. Therefore, Sales Revenue is credited by $200.
Why This Matters:
- Balanced Books: This transaction keeps the accounting equation balanced. Both sides of the equation increase by $200:
Assets (Cash) = Liabilities + Equity (SalesRevenue)
- Income Statement: The $200 credit to Sales Revenue will appear on the income statement, reflecting the revenue earned during the period.
- Cash Flow Statement: The $200 debit to Cash will appear on the cash flow statement under operating activities, indicating an inflow of cash.
- Business Decisions: Proper accounting of sales allows ReadMore Books to make informed decisions about inventory management, sales strategies, and business growth.
In summary, in this example, the sales are credited to accurately reflect the increase in equity resulting from the revenue earned by ReadMore Books, ensuring that the accounting equation stays balanced and that the financial statements are accurate.