Recording Sales of Goods on Credit

When a company sells goods on credit, it reports the transaction on both its income statement and its balance sheet. On the income statement, increases are reported in sales revenues, cost of goods sold, and (possibly) expenses. On the balance sheet, an increase is reported in accounts receivable, a decrease is reported in inventory, and a change is reported in stockholders' equity for the amount of the net income earned on the sale.

If the sale is made with the terms FOB Shipping Point, the ownership of the goods is transferred at the seller's dock. If the sale is made with the terms FOB Destination, the ownership of the goods is transferred at the buyer's dock.

In principle, the seller should record the sales transaction when the ownership of the goods is transferred to the buyer. Practically speaking, however, accountants typically record the transaction at the time the sales invoice is prepared and the goods are shipped.



FOB Shipping Point
Quality Products Co. just sold and shipped $1,000 worth of goods using the terms FOB Shipping Point. With its cost of goods at 80% of sales value, Quality makes the following entries in its general ledger:

Account Name Debit Credit
Accounts Receivable 1,000
Sales 1,000


Cost of Goods Sold 800
Inventory 800


(While there may be additional expenses with this transaction—such as commission expense—we are not considering them in our example.)

FOB Shipping Point means the ownership of the goods is transferred to the buyer at the seller's dock. This means that the buyer is responsible for transporting the goods from Quality Product's shipping dock. Therefore, all shipping costs (as well as any damage that might be incurred during transit) are the responsibility of the buyer



FOB Destination
FOB Destination means the ownership of the goods is transferred at the buyer's dock. This means the seller is responsible for transporting the goods to the customer's dock, and will factor in the cost of shipping when it sets its price for the goods.

Let's assume that Gem Merchandise Co. makes a sale to a customer that has a sales value of $1,050 and a cost of goods sold at $800. This transaction affects the following accounts in Gem's general ledger:

Account Name Debit Credit
Accounts Receivable 1,050
Sales 1,050


Cost of Goods Sold 800
Inventory 800


Because Gem chooses to ship its goods FOB Destination, the ownership of the goods transfers at the buyer's dock. Therefore, Gem Merchandise assumes all the risks and costs associated with transporting the goods.

Now let's assume that Gem pays an independent shipping company $50 to transport the goods from its warehouse to the buyer's dock. Gem records the $50 as an operating expense or selling expense (in an account such as Delivery Expense, Freight-Out Expense, or Transportation-Out Expense). If the shipping company allows Gem to pay in 7 days, Gem will make the following entry in its general ledger:

Account Name Debit Credit
Freight-Out Expense 50
Accounts Payable 50