Revenue: Debit or Credit?

Is revenue debit or credit? Revenue in accounting is the total amount of income realized from the sale of goods and services related to the primary operations of the business. In business, revenue is responsible for an increase in equity and the normal balance for the business’s equity is a credit balance. Therefore, revenue has to be recorded not as a debit but as a credit.

All revenue account credit balances at the accounting year’s end, have to be closed and then transferred to the capital account, thus increasing the business owner’s equity. In this article, we will discuss what credit and debit mean and why revenue is not recorded as a debit but as a credit.

Related: Assets, liability, equity (comparison)

Understanding debit and credit

Business transactions are proceedings that have a monetary impact on a company’s financial statements. When accounting for business transactions, we record numbers in two accounts, the debit and credit columns.

In bookkeeping, knowing the difference between debits and credits will ensure that business owners/ accountants have an easier time balancing their books. One always has to be sure that their entries are correct and accurate because it will go a long way in helping them ensure they are entering the correct data each and every time a transaction is completed in the business.

Debits and credits are necessary for the bookkeeping of a business to balance out correctly. Debits serve to increase asset or expense accounts while reducing equity, liability, or revenue accounts. Credits, on the other hand, increase equity, liability, or revenue accounts while decreasing expense or asset accounts.

In simple terms, debits and credits are used as a way to record any and all transactions within a business’s chart of accounts. This is the business’s income and expenses. All debit entries have to have a credit entry when a transaction is recorded, that corresponds with it while equaling the exact amount.

That is, for accounting purposes, every transaction has to be exchanged for something else that has the exact same value. This means that the total of the debits and credits for any transaction must always equal each other so that an accounting transaction is considered to be in balance. It would not be possible to create financial statements if a transaction were not in balance.

Debit and credit explained

A debit entry is designed to always add a positive number to the journal, while a credit entry adds a negative number. In the actual journal entries, you won’t see written pluses and minuses, so it’s important that you get familiar with the left-side and right-side formats. A debit will always be positioned on the left side of an entry while a credit will always be positioned on the right side of an entry.

The use of debits and credits in a two-column transaction recording format happens to be the most essential of all controls over accounting accuracy. They are used to record transactions in a company’s chart of accounts that classify income and expenses. There are 5 major accounts in a company’s Charts of Accounts (COA). The table below lists and explains these accounts with examples:

In double-entry bookkeeping, credits and debits occur simultaneously in every financial transaction. According to the accounting equation; Assets = Liabilities + Equity, if an asset account increases (a debit), then either a liability or equity account must increase (a credit) or another asset account must decrease (a credit). Revenues increase equity while expenses, costs and dividends decrease equity in the extended equation. So, their difference is the impact on the equation.

For instance, if a company renders a service to a customer that does not pay immediately, the company records an increase in assets, that is Accounts Receivable with a debit entry, with an increase in Revenue, as a credit entry. When the customer pays cash to the company, two accounts again change on the company side, the Accounts Receivable account is now decreased (credited) and the cash account is debited (increased).

Moreso, two things also change, on the bank side when the cash is deposited into the bank account; the bank records an increase in its liability to the customer by recording a credit in the customer’s account (which is not cash) and records an increase in its cash account (debit).

See also: Liabilities vs assets differences and similarities

Understanding Revenue

The money generated from the normal operations of a business is the revenue. This is the money brought into a company by its business activities. It is calculated as the average sales price multiplied by the number of units sold. Revenue is the gross income (top-line figure) from which costs are subtracted to ascertain net income. It is known as the top line because it appears first on the company’s income statement.

On the income statement, revenue is also known as sales and net income, also known as the bottom line, is revenues minus expenses. A company tends to make a profit when revenues exceed expenses. Because revenue can also be referred to as sales, it is used in the price-to-sales (P/S) ratio which is an alternative to the price-to-earnings (P/E) ratio that uses revenue in the denominator.

Revenue, in more formal usage, is a calculation or estimation of periodic income based on the rules established by a government or government agency or based on particular standard accounting practice. Therefore, there are different ways to calculate revenue, depending on the accounting method used. The two common accounting methods, cash basis accounting and accrual basis accounting do not use the same process for measuring revenue.

For accrual accounting, the sales made on credit are included as revenue for goods or services delivered to the customer. Revenue under certain rules is recognized even if payment has not yet been received. On the other hand, cash basis accounting will only count sales as revenue when payment is received. The cash paid to the company is known as a receipt.

Moreso, it is likely for the company to have receipts without revenue. An instance is when a customer pays for a service in advance that has not yet been rendered or pays for undelivered goods in advance. Such an instance would lead to a receipt but not revenue.

Companies increase revenues and/or reduce expenses in order to increase profits and earnings per share (EPS) for their shareholders. When determining the health of a business, investors usually consider the company’s revenue and net income separately. The net income of a company can grow whereas its revenues can remain stagnant due to cost-cutting. Such a situation does not suggest that future developments or events will be good or favorable for the company’s long-term growth.

Therefore, when public companies report their quarterly earnings, revenues and earnings per share are the two figures that receive a lot of attention. They are so relevant that a company beating or missing analysts’ earnings per share and revenue expectations can usually change the price of the company’s stock.

Revenue account

The revenue accounts are financial accounts that contain the receipts of the income or revenue that the business receives through its business transactions. Revenue information is included in all income statements and is a good measure of how well the business is doing on the commercial front. A low revenue turnover would generally indicate that the business has some issues whereas a high revenue turnover would indicate business success.

Revenue accounts in a double-entry bookkeeping system are general ledger accounts that are summarized periodically under the heading Revenue or Revenues on an income statement. Then, the revenue account names describe the kind of revenue, such as Rent revenue earned, Repair service revenue, or Sales. The revenue accounts record all increases in equity such as sales, services rendered, rent income, interest income, recurring receivables, membership fees, interest from investment, donations etc.

There are basically two types of revenue accounts that are included in an income statement. They are operating revenues and non-operating revenues.

Operating revenues are the revenue that the business earns from its principal business operations. This generally forms a greater part of the total income of a company. Revenue is earned for the company when the business makes a sale to a customer, either from a product or a service rendered. Such kind of revenue from sales is an operating revenue, other examples include rental income and payment from professional services (professional income). Service and sales are usually the most common ways that a company earns revenue.

Additionally, revenue can be made from the interest that the business receives from investments. Such an interest income is an example of a non-operating revenue. Non-operating revenues are the income that the company earns from business activities aside from its main business operations. Typical examples of nonoperating revenues include interest revenue, dividend income and asset sales.

Generally, the subgroups that are found within revenue accounts include the following:

1. Investment Income
2. Service revenue
3. Rent Income
4. Interest income
5. Sales revenue
6. Dividend Income

See also: Accumulated depreciation on the balance sheet

Remember that credits increase equity, liability, or revenue accounts while decreasing expense or asset accounts. Therefore, since revenues cause owner’s equity to increase, it is credited and not debited. The credit balances in the revenue accounts will be closed at the end of the accounting year and transferred to the owner’s capital account, thus increasing the owner’s equity. While the credit balances in the revenue accounts at a corporation will be closed and transferred to Retained Earnings, which is a stockholders’ equity account.

The bottom line is revenue is not posted as a debit but as a credit because it represents a company’s income during an accounting period and this income has an impact on the company’s equity. Hence, equity increases as a company generate revenue. The fact is the increase in income and equity accounts is a credit, so revenues will definitely also be a credit entry.

Furthermore, having the accounting equation, Assets = Liabilities + Owner’s Equity, in mind can help you understand why an asset (that is on the left side of the accounting equation) will usually have its account balance on the left side (debit side) whereas, liabilities and owner’s equity accounts (that is on the right side of the accounting equation) will usually have their account balances on the right side (credit side).

Why revenue is not recorded as a debit but as a credit

The reason why revenues are credited all fall back to the accounting equation. Revenue is not posted as a debit but as credit, because it increases the shareholders’ equity of a business, and shareholders’ equity has a natural credit balance. Therefore, an increase in equity can only result from transactions that are credited. As earlier said, the foundation of this reasoning is the accounting equation:

Assets = Liabilities + Shareholders’ equity

The above accounting equation appears in the structure of a balance sheet, where assets (with normal debit balances) offset liabilities and shareholders’ equity (with normal credit balances). When a company makes a sale, the revenue (in the absence of any offsetting expenses) automatically increases profits and the profits increase shareholders’ equity.

Read also: Equity ratio formula and calculation

Examples: revenue debit or credit?

In order to explain why revenue is not recorded as a debit but as a credit, let’s take a look at some examples.

Sales revenue

Assume that a company at the time that it makes a sale receives $1500 and is therefore earning the $1500. The company will increase its asset account, Cash with a debit of $1500. Moreso, because every entry must have debits equal to credits, a credit of $1500 will be recorded in the account, Sales Revenues. This credit entry in Sales Revenues will cause an increase in the owner’s equity.

Now, if the company earns an additional $500 of revenue but allows the customer to pay in 30 days, the increase in the company’s assets will be recorded with a debit of $500 to Accounts Receivable. Because the revenue was earned, this must also record a credit of $500 in Sales Revenues. The credit entry in Sales Revenues also means that the owner’s equity will be increasing.

Let’s look at another example for a better understanding. Let’s assume you run a grocery store business and you sell some food items to a customer for $700. You then deposit the $700 into your business’s bank account right away without delay. With that $700 already on record, you will need to ensure you update your business’s accounting data.

You will first need to record this sale as a debit entry in the cash account and the $700 will need to be entered into the left side of the assets chart. Then, the sales part of your accounting will be listed under Revenue as a credited amount of $700, therefore balancing everything out in your books.

Service revenue

Let’s say that Company A gets $1,000 for a service that it rendered, therefore earning that $1,000. The business’s assets will then increase, and as such, the increase in the company’s assets will be recorded with a debit of $1000 to Cash. In accounting, It is a must for all entries that are debited to equal out as credits. As a result, the business will get a $1,000 credit that gets recorded in Service Revenues. And since a credit entry is now present in the Service Revenues, the equity will effectively increase due to the credit entry.

Assume, Company A has a customer that purchases its services for, $700 but is allowed to pay the company over the course of 30 days, the business’s Accounts Receivable will receive a $700 debit. Since the revenue was earned, it must be recorded as such. This means that the business will record a $700 credit in the Service Revenues. Therefore, the owner’s equity increases as a result.

Related: Return on assets formula and calculation

Does revenue increase with debit or credit?

Revenues and gains are usually recorded in accounts such as Sales, Interest Revenues (or Interest Income), Service Revenues, and Gain on sale of assets. These accounts usually have credit balances that are increased with a credit entry. Therefore, their balances in a T-account will be on the right side.

However, the exceptions to this rule are the accounts such as Sales Allowances, Sales Returns, and Sales Discounts. These accounts are reductions to sales and therefore have debit balances. The accounts with balances that are the opposite of the normal balance are called contra accounts. Therefore, contra revenue accounts will have debit balances, not credit balances.

In order to record revenue from the sale of goods or services, one would need to credit the revenue account. This means that credit to revenue would increase the account, whereas a debit would decrease the account. An increase in debits will decrease the balance of a revenue account. This is because when revenue is earned, it is recorded as a debit in accounts receivable (or the bank account) and as a credit to the revenue account.

Conversely, in a revenue account, an increase in credits will increase the balance. Therefore, revenue increase with credit and not debit. This means that if a company has more expenses than revenue, the balance in the revenue account will be lower and the debit side of the profit and loss will be higher. Conclusively, credits would increase the balance in a revenue account whereas debits decrease the balance.

See also: Equity options types and examples

Conclusion

Debits and credits are necessary for the bookkeeping of a business to balance out correctly. Debits serve to increase asset or expense accounts while reducing equity, liability, or revenue accounts. Whereas credits increase equity, liability, or revenue accounts while decreasing expense or asset accounts.

Debits and credits are just values that are assigned to accounts. In order for the double entry system to work effectively, debit and credit have to offset each other. So, in double-entry bookkeeping, credits and debits occur simultaneously in every financial transaction, according to the accounting equation:

Assets = Liabilities + Equity.

Therefore, if an asset account increases (a debit), then either a liability or equity account must increase (a credit) or another asset account must decrease (a credit). Revenues increase equity while expenses, costs, and dividends decrease equity in the extended equation. Revenue is the money generated from the normal operations of a business. Therefore, the traditional ending balances in the revenue type of account are credit balances. That is revenue is recorded not as a debit but as a credit.

The only debit entries in revenue accounts refer to discounts, returns and allowances related to sales. Conclusively, credits increase the balance of revenue accounts, while debits decrease the net revenue through the returns, discounts and allowance accounts.