Bookkeeping – Debits and Credits in Revenue Accounts (Lesson 6)
The preferred entry for a revenue account is a credit; credits represent sales.
Revenue accounts are the most fun to watch as a bookkeeper. Revenue is the lifeblood of success. Without revenue, the company is doomed to go bankrupt. After all, you are in business to sell your services or products and the revenue accounts are where we get to see the results of activity.
The customary entry in the revenue accounts is a credit entry. The most common journal used is the ‘Sales’ journal. As with any entry there is an offset or in this case a debit side to the credit value. Most businesses simple debit cash as the customer pays for the service or product purchased. Think of a restaurant, each meal sold generates a credit entry to the sales account (revenue account) and a debit to cash for the payment received by the customer.
In some situations, the customer is allowed to purchase on good faith that they will pay in the future. This is pretty common especially when the customer is a governmental authority. It is rare for local governments to pay on the spot for the services received or the products they purchase. They are granted ‘Credit’ (note credit in this sense has a different meaning than the word credit for bookkeeping). The reason is straight forward; the local government will pay their bill. It often takes some time, but they do pay their bills.
In this situation the customer owes the business the money for the ‘Sale’. Now the debit is to the Accounts Receivable account on the balance sheet. A separate log is kept by customer that identifies how much each customer owes the business. With modern technology this is easy to set up and with each sale an entry is made with required customer identification to record to that customer’s account the amount purchased.
Two points are important here:
- There is a difference between revenue and sales. Sales are a subset of revenue. In general revenue accounts include sales, interest earned, penalty fees charged to customers and much more. But all these accounts should have credit balances. I write an in-depth article explaining the difference between revenue and sales.
- There are accounts in the revenue section that customarily have debit balances. These are your returns, discounts and allowance accounts. When a customer returns a product, the entry is a debit to the returns account and a credit to the cash account as the business refunds the money. Notice the entry is not to the primary ‘Sales’ account.
Debits and Credits
This is where a lot of confusion related to debits and credits come into play. You see revenue accounts are on the income statement (most often referred to as the profit and loss statement). A common mistake made by novice business entrepreneurs is that they’ll quote a simple logic concept of ‘Debits are good, credits are bad’. Well this is not even close. The reality is that depending on the type of account (Lesson 1) determines which kind of value is preferred.
For revenue accounts, credit values are preferred and normal. You want as much credit value in the revenue account as possible, the more sales the greater the likelihood of financial success. What you don’t want to see is high debit values in the returns, allowances or discount accounts! This general means something is wrong.
The debits are good and credits are bad statement actually refers to a basic relational comparison between the two primary financial reports. With the balance sheet, debits are preferred as this means more assets. However, over on the income statement, you want credits over debits as this means there is more revenue than costs/expenses which means you have a profit! That profit transfers to the equity section of the balance sheet (explained later in future articles).
There are other revenue accounts that get debit entries (e.g. franchise fees) but for this lesson, it was kept it simple. The end result for the revenue section is a credit balance and is titled ‘NET REVENUE’ or ‘ADJUSTED REVENUE’. Either title is fine. Thus, your typical revenue section will look something like this:
Sub-Total Adjustments (ZZ,ZZZ)
Net Sales ZZZ,ZZZ
Other Revenues Z,ZZZ
Total Adjusted Revenue $ZZZ,ZZZ
You should notice something interesting with this format. The adjustments are in parenthesis. Adjustments are debits and your average person will tell you debits are positive and credits are negative. Well for the income statement, it is the opposite. You want credits! Debits are a bad thing on the income statement thus the parenthesis for debits in the income statement. As explained in Lesson 2 of this series; debits and credits are merely offsetting entries to ensure the books are balanced like an equation. Debits and credits should not be thought of as positives and negatives.
Summary – Revenue Accounts
Debits and Credits are merely values assigned to accounts and offset each other in order for the dual entry system to work effectively. In revenue (income) types of accounts credit balances are the traditional ending balance. Debit entries in revenue accounts refer to returns, discounts and allowances related to sales. In revenue types of accounts credits increase the balance and debits decrease the net revenue via the returns, discounts and allowance accounts. ACT ON KNOWLEDGE.
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