Income statement and sales ledger

Hello, this is Huw Morgan from the Alliance Manchester Business School. This is the fourth talk in the series of lectures on Accounting Records. In this lecture, we see the typical format of the income statement and then focus on the ways in which sales on credit terms are recorded, managed and controlled in the accounting records.

This section outlines the typical presentation of the income statement, that summarises the trading and operating transactions arising in an accounting period. We shall then focus on the impacts that credit transactions, specifically selling to customers on credit, will have on the accounting records. The more sales made on credit, the closer a business will need to monitor what it is owed and received through the use of the Sales Ledger and Sales Day Book.

Income is defined as increases in economic benefit from revenue, or gains during the accounting period, that increase equity other than contributions from the owners. There are two elements to income: Revenue, or sales income from trading, and non-operating income - gains from transactions other than normal trading activity. Both types result in an increase in economic benefit to the business, which results in an increase in equity.

A current issue in financial accounting is the question of when to recognise a sale. Income should be recognised when a business has completed its part of a contract, or, satisfied a performance obligation, for example, when ownership and control of goods has passed to the customer. The value of the income should be measured reliably, normally straightforward if a cash or credit agreement, and it's probable that the economic benefit will be received. The simplest way in which a business generates income is by selling inventory for cash. Cash, an asset, increases, resulting in the generation of income, or revenue, earned by the business for the owners. Most businesses will also trade on credit, meaning they allow their customers to delay in paying them for, say, a month. According to the income recognition requirements, the sale should be recorded as soon as the goods are traded and obligations met, rather than when the cash is received. In this case, the transaction will result in an increase in another asset, trade receivables, the right to receive cash in the future as a result of the sale. This increase in assets results in an increase in equity shown once more as revenue income in the income statement. The reason why we recognise a sale on credit before cash is received, is because we've met our side of the transaction by selling goods and can reasonably expect the customer to pay us later. However, we should be aware, that there's a risk that customers may go bankrupt before paying us, and we shall discuss the implications of this further in a later session.