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You are here: Experts > Real Estate > Banking: U.S. > Using Banks and Bank Accounts > Credit Sales
Expert: Jim Meadows - 10/13/2009
Question
QUESTION: Jim,
I would just like to ask about credit card sales from the perspective of the business and was wondering if you could help me understand how it works. If I go to a shop, buy something and pay with credit, that business will not receive any money at that point, is that right? In the account books of that business, it will have accounts receivable at $x amount. It doesn't work as say at the point of transaction, the bank pays the business and then the consumer pays the bank.
So eventually when the consumer pays the bank the amount on the statement, this is when the business will receive its money. Is that right? I think this is right because I have done some studies in accounting and they talk about a figure called bad debts, and if the bank pays the money straight away, then there would be no need for this account. Would appreciate if you could help me in simple terms because it would help my understanding quite a lot.
Thanks
ANSWER: Johann, the merchant will receive the charged funds typically within a day or so of the transaction whether or not the card holder repays the card issuer. The card issuer has basically made a loan to the cardholder. The payment risk is the card issuer not the merchant.
---------- FOLLOW-UP ----------
QUESTION: Jim,
Thanks for the response. But there must be another "credit" sale that I must be talking about in relation to the bad or doubtful debts that turn up in the accounts of businesses. I know you do not have a degree in accounting but you do have one in economics. Is there a sale that can take place where the customer signs an invoice and promises to pay in a certain amount of time, for example if they pay within 10 days they get a discount and the whole amount is due in 30 days? I have read this in my textbook but I have not seen this happen in real life.
Is this something that can only happen in transactions between businesses? For example a steel manufacturer sells steel to a table manufacturer, is this an occasion where the above happens? I am doing accounting studies so it relates to me and was hoping you could provide a response or some more information.
Cheers
Answer
Johann, I read your original question as relating to consumer credit card sales. The example you pose in your follow up can theoretically be used for consumer transactions but almost always is a commercial transaction.
Cash accounting would allow the sale to flow to the income statement only when collected. Accrual accounting would credit the sale to income when the sale occurred. High volume businesses use an experience method to build a loss reserve (a contra asset account to receivables. Small businesses typically operate without a balance sheet reserve and take the charge to income when the receivable is deemed uncollectible. Jim
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