When you swipe your credit card at a shopping mall or enter your card number for an online purchase, a range of record-keeping processes come into play. Credit card accounting enables individual and corporate cardholders to track expenses and set effective budgeting policies. Card issuers also keep records about clients’ purchases and periodically evaluate customer receivables.
A credit card is a method of payment that enables a merchant to sell goods or provide services to a client, knowing that the customer has a satisfactory credit rating and that the credit card issuer will honor the customer’s payments. It’s a type of revolving line of credit, because the credit card company replenishes the funds once the customer pays the outstanding balance.
Similar to a home equity line of credit, an untapped credit card is not a liability. Consequently, a bank does not post any journal entry when it issues a card, nor does the customer when receiving the card. A debt arises once the client taps into the cash and makes purchases. Credit card transactions call for three accounts: credit card payable, interest expense and operating expense. To record a credit card purchase, a corporate bookkeeper debits an expense account and credits the credit card payable account. To record an outstanding balance payment, the bookkeeper debits the credit card payable account (to bring the account back to zero) and credits the cash account. Another account to debit is interest expense. In accounting terminology, crediting cash means reducing corporate funds. This is distinct from the banking terminology.
Credit card transactions affect financial statements. Credit card payable is a balance sheet item, whereas interest expense is an income statement component.
The bank approves your credit card application and sends you the plastic, granting you an initial balance of $5,000. Given your stellar credit score, the bank agrees to set your annual percentage rate at 5 percent, which is below market rates and rates charged to other similarly situated consumers. In January, you use the card to make the following purchases: groceries $500; gas, car maintenance and oil change $250; movies and other entertainment $100; car insurance $50; and gift to a local charity $100. The bank advises you that total APR charges for the month amount to $4.17, or $1000 times 5 percent divided by 12. To record the operating costs, you would debit the following accounts: food expense for $500, car-related expense for $250, travel and entertainment expense for $100, insurance expense for $50 and charitable donations for $100. You would credit the credit card payable account for the sum of all these expenses: $1,000. You also would credit the interest expense account for $4.17 and debit the interest payable account for the same amount. If you pay the full amount owed on the card, you would credit the cash account for $1,004.17. You also would debit the credit card payable account and the interest payable account for $1000 and $4.17, respectively.