Double-entry bookkeeping: credit transaction (AS Level) Financial accounting

 

1. Defining Credit Transactions and Key Parties

A credit transaction is a business transaction where no money changes hands at the time the transaction occurs. Although no money is exchanged immediately, the sale or purchase must be recorded in the books of account on the date it takes place.

The key parties involved are identified based on whether money is owed to or by the business:

• Debtor (Trade Receivable): A customer (or other party) who owes the business money. Accounts for trade receivables usually have debit balances.
• Creditor (Trade Payable): A supplier (or other party) to whom the business owes money. Accounts for trade payables usually have credit balances.

2. Recording Initial Credit Sales and Purchases

All transactions must be recorded from the perspective of the business.

Transaction Aspect	In the Seller's Books (The Business)	In the Customer's Books (The Debtor)
Sale on Credit	Credit the Sales account.	Debit the Purchases account.
	Debit the customer's personal account (now a debtor).	Credit the supplier's personal account (now a creditor).
Purchase on Credit	Debit the Purchases account.	Credit the Sales account.
	Credit the supplier's personal account (now a creditor).	Debit the customer's personal account (now a debtor).

When the actual payment occurs later:

• When the Debtor Pays: The debtor’s account is credited (since the debt is reduced/cleared), and the bank account is debited (since the business receives cash).
• When the Creditor is Paid: The creditor’s account is debited (since the liability is reduced/cleared), and the bank account is credited (since the business pays cash).

3. Recording Goods Returned on Credit

When goods previously bought or sold on credit are returned, specific returns accounts are used:

Situation	In the Seller's Books (Original Seller)	In the Buyer's Books (Original Purchaser)
Customer Returns Goods	Debit the Sales Returns account.	Credit the Purchases Returns account.
(Sales Returns)	Credit the customer’s personal account.	Debit the supplier’s personal account.
Business Returns Goods	(No entry in Sales Returns for seller)	Credit the Purchases Returns account.
(Purchases Returns)	(No entry in Purchases Returns for buyer)	Debit the supplier’s personal account.

Goods returned are generally not debited to the Sales account or credited to the Purchases account; dedicated returns accounts are used.

4. Treatment of Discounts in Credit Transactions

There are two main types of discounts, and their treatment differs significantly:

A. Trade Discount

• Definition: An allowance made by one trader to another, typically to ensure the buyer can make a profit when they resell the goods.
• Recording Rule: Trade discount is never recorded in ledger accounts.
• Application: Trade discount is deducted before the invoice amount is recorded in the books. For instance, entries in the books of prime entry (like the sales journal) should be made net of the trade discount.

B. Cash (or Settlement) Discount

• Definition: An allowance given by the seller to a customer to encourage the customer to pay the invoice promptly, usually before its due date.
• Recording Rule: Cash discounts are always recorded in ledger accounts.

The accounts used depend on whose perspective the discount is viewed from:

Perspective	Account Used	Type of Account	Double Entry Rule
Seller	Discounts Allowed	Expense account	Debited to the Discounts Allowed account. Credited to the customer's (debtor's) account.
Buyer	Discounts Received	Revenue/Income account	Credited to the Discounts Received account. Debited to the supplier's (creditor's) account.

The cash book is used as the book of prime entry for cash discounts, featuring a 'discounts allowed' column on the debit side and a 'discounts received' column on the credit side. When settlement occurs, the individual discount amounts are posted to the customer/supplier account, but the totals of the discount columns are posted to the respective main Discounts Allowed/Received accounts in the general ledger.

For example, when a debtor pays and takes a cash discount:

1. The debtor account is credited with the cash paid (bank column) and the discount taken (discounts allowed column).
2. The Discounts Allowed account is later debited with the total from the cash book's discounts allowed column.