Chapter 6Reporting and Interpreting Sales

Revenue and Accounts Receivable

Acct 2301

Zining Li

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Key Terms• Sales revenues

– Sales returns– Sales discount ( 2/10, n/30)– Credit card discount– All of these three are contra-revenue accounts

• Accounts receivable– Allowance for doubtful account (contra-asset account)– Net realizable value of A/R– Bad debt expense

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Accounting for Sales Revenue

Sales RevenueLess: Credit card discounts (a contra-revenue account) Sales discounts (a contra-revenue account) Sales returns and allowances (a contra-revenue account)Net Sales (reported on the income statement)

Sales (revenue) reported on the Income Statement are net of credit card sales discount, sales discount, and sale returns.

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Accounting for Credit Card Discount

Assume the credit card company charges a fee of 3%

When sales of $1,000 are made by credit card purchases:

Dr. Cash $970

Dr. Credit-card discount 30

Cr: Sales Revenue $1,000

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Accounting for Sales Discount

Suppose the credit term is 2/10, n/30 When sales of $1,000 are made on account

Dr. Accounts Receivable $1,000 Cr: Sales Revenue $1,000

When customers pay within 10 days, they enjoy 2% discountDr. Cash $980Dr. Sales Discount 20 Cr. Accounts Receivable $1,000

When customers pay after 10 days, they have to pay the full amountDr. Cash $1,000 Cr. Accounts Receivable $1,000

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Accounting for Sales Returns

When sales of $1,000 are made on account Dr. Accounts Receivable $1,000 Cr: Sales Revenue $1,000

When returns of $150 are made Dr. Sales Return $150 Cr. Accounts Receivable $150

When customers pay off the restDr. Cash $850 Cr. Accounts Receivable $850

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E6-3: Clem Retailers

• Nov 20: sold two items of merchandise to Customer B, who charged the $350 sales price on her visa card. Visa charges Clem a 2% credit card fee

• Nov 25: sold 20 items of merchandise to Customer C at an invoice price of $4,500 (total); terms 3/10, n/30.

• Nov 28: sold 10 identical items of merchandise to Customer D at an invoice price of $9,000 (total); terms 3/10, n/30.

• Nov 29: Customer D returned one of the items purchased on Nov 28th; the item was defective and credit was given to the customer

• Dec 06: Customer D paid the account balance in full• Dec 20: Customer C paid in full for the invoice of Nov 25

Required:1. Provide journal entries for above transactions when necessary.2. Assume that Sales Returns and Allowances, Sales Discounts, and Credit Card Discounts are treated as contra-revenues, determine the net sales for the two months ended December 31, 2011

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Nov 20--- Dr. Cash $343

Dr. Credit-card discount 7

Cr: Sales Revenue 350

Note: COGS will also be recorded at the time of sales.

Nov 25--- Dr. Acct. Receivable $4,500

Cr: Sales Revenue 4,500

Nov 28--- Dr. Acct. Receivable $9,000

Cr: Sales Revenue 9,000

Nov 29--- Dr. Sales returns and allowance $900

Cr: Acct. Receivable 900

Note: COGS will also be adjusted at the time of sales returns.

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Sales revenue ($350 + $4,500 + $9,000) $13,850Less: Sales returns and allowances (1/10 x $9,000 from D) 900Less: Sales discounts (9/10 x $9,000 from D x 3%) 243Less: Credit card discounts ($350 from B x 2%) 7Net sales $12,700

Dec 06--- Dr. Cash $7,857

Dr. Sales discount 243

Cr: Acct. Receivable 8,100

Dec 20--- Dr. Cash $4,500

Cr: Acct. Receivable 4,500

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Measuring and Reporting Accounts Receivable

• Accounts receivable vs. Notes receivable

• Net Realizable Value of A/RAccounts Receivable

Less: Allowance for doubtful accounts (a contra-asset account)

= Net Realizable Value of Accounts Receivable

• Allowance for doubtful accounts – contra-asset account – the estimated amount of uncollectible A/R

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Accounting for Bad Debt Expenses

• An adjustment to account for expenses for potential default accounts receivable

• Bad debt expenses are estimated and recorded in the same accounting period when credit sales are made;

• NOT at the time when some accounts receivable are determined to be uncollectible.

• Matching Principle

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Accounting for Bad Debt Expenses

• Journal entry to record Bad Debt Expense:

Dr. Bad Debt Expense $XX

Cr. Allowance for doubtful accounts $XX

• Effects on financial statements: – Net income is decreased; – Assets are decreased, – Shareholders’ Equity is decreased

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Methods for Estimating the Amount of Bad Debt Expense

• Sales Method– The amount of bad debt expense is a percentage of

credit sales generated in current accounting period

• Accounts Receivable Method

– The amount of doubtful accounts is estimated based on the balance and age of accounts receivable at the end of the accounting period

– The amount of bad debt expense is then a plug-in number

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Sales Method

Example: During Oct. 2006, total credit sales revenue was $20,000. The company estimates 1% of this credit sale to be uncollectible. On Dec 2nd, the account receivable of $3,000 for Oct 2006 credit sales was determined to be uncollectible.

• Assuming the company prepares its financial statement at Oct. 30st, provide the journal entry to record the bad debt expense.

• What is the effect on the financial statements of recording bad debt expense?

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Accounts Receivable Method

• The amount of doubtful accounts is estimated as a percentage of the balance of accounts receivable at the end of the accounting period.

• The amount of bad debt expense is then a plug-in number.

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Steps in Accounts Receivable Method

• Estimate the dollar amount of uncollectible accounts based on a percentage of the ending balance of accounts receivable;

• The estimated uncollectible accounts (from step1) is the (desired) ending balance of allowance for doubtful accounts;

• Bad Debt Expense

= Ending balance of allowance for doubtful accounts

– the pre-adjustment balance of allowance for doubtful accounts.

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Example: Accounts Receivable Method

• Following is the summary of transactions that Cart Corp. had in year 2005 and year 2006. Year 2005 was the first year of operations. Please determine and record the bad debt expense for both years.

• In Year 2005:– Provided $5,000 services on account;

– Collected $4,000 cash from accounts receivables;

– Adjusting entry booked to reflect the estimate of 5% of ending A/R balance to be uncollectible.

• In Year 2006:– Provided $6,000 services on account.

– Collected $4,500 cash from accounts receivables.

– Adjusting entry booked to reflect the estimate of 5% of ending A/R balance to be uncollectible.

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Aging Schedule of A/R

• In estimating the percentage of uncollectible accounts receivable, the age of each account receivable is taken into consideration;

• A higher percentage is used to estimate the uncollectible amount for an older accounts receivable;

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Example: Aging Schedule of A/RAge of Accounts

Balance of Accounts

Receivable

Estimate of Percentage that

will Prove Uncollectible

Estimated Uncollectible

Accounts

0 - 30 days

500,000

0.5%

31 - 60 days

120,000

1.0%

61 - 90 days

40,000

5.0%

More than 90 days

30,000

10.0%

At the beginning of the year, the company had a credit balance in the Allowance for Doubtful accounts of $4,000. Prepare the adjusting journal entry to recognize the company's bad debt expense for the year.

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Write-off of Uncollectible Accounts

• No expenses are recorded when certain A/R are found to be uncollectible (why ?)

• Rather, the balance of A/R is reduced by the amount of uncollectible accounts (why?)

• Allowance for doubtful accounts is also reduced by the same amount (why?)

Dr. Allowance for doubtful accounts $$ Cr. Accounts Receivable $$

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Example of writing off A/RSuppose Dart Corp. had a beginning balance of A/R of $20,000 and allowance of $1,500. During a period, it had credit sale of $5,000, collections of A/R of $8,000. It estimates its bad debt expense based on 2% of credit sales. During the period, a customer failed to pay off the account of $980 he owed and the company wrote the account off.

• Please provide the journal entry to record the write-off

• Provide the T-accounts of A/R and the Allowance account.

Determine the bad debt expense for year 2006 and net realizable value of A/R at 12/31/2006

In Year 2005:• Provided $5,000 services on account;• Collected $4,000 cash from accounts receivables;• Adjusting entry booked to reflect the estimate of 5% of

ending A/R balance to be uncollectible.

In Year 2006:• Wrote off $120 of accounts receivable• Provided $6,000 services on account.• Collected $4,500 cash from accounts receivables.• Adjusting entry booked to reflect the estimate of 5% of

ending A/R balance to be uncollectible.

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One more exercise …During the period, a company had $2,000,000 in

credit sales. The Company assumes that approximately 1% of total sales on account will prove uncollectible. At the beginning of the year, the company had a credit balance in the Allowance for Doubtful accounts of $4,000. During the year, the company wrote-off $2,300 of identified uncollectible accounts.

• Prepare the adjusting journal entry to recognize the company's bad debt expense for the year;

• Determine the ending balance of accounts receivable and the allowance for doubtful accounts.

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Effect of Change in A/R on Cash vs. Net Income

Accounts Receivable

Sales Revenue

Cash collected

from customers

Net Income

Cash from operations

Cash Sale N/A Increase Increase Increase Increase

Credit Sale Increase Increase N/A Increase N/A

Cash collection form A/R

Decrease N/A Increase N/A Increase

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How to infer Cash Flows from Sales Revenue and Changes in A/R

• Cash collected from customers = Sales revenue – increase in A/R

• Cash collected from customers = Sales revenue + decrease in A/R

• Cash from operations = Net Income – increase in A/R

• Cash from operations = Net Income + decrease in A/R

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Accounts Receivable Turnover

Net Sales

Average Net Accounts Receivable

• How many times accounts receivable was created and collected during the period

• Efficiency of accounts receivable management