Chapter 6 (Student) Accounting UMN

8/12/2019 Chapter 6 (Student) Accounting UMN

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Chapter 6Reporting and Interpreting Sales

Revenue, Receivables, andCash


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What are we going to learn?

How to apply revenue principle

How to analyze credit card sales, sales

discount and sales return (net sales)?

Bad debts and write-offs

Ratios Gross Profit Percentage and Receivable

Turnover

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Revenue and Net Sales

Revenue Recognition Principle: revenues arerecognized as earned when

Delivery is occurred or services have been rendered There is a persuasive evidence of an arrangement for

customer payment

The price is fixed or determinable

Collection is reasonably assured

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Review of Recognition Principle

For sellers of goods: the criteria for revenuerecognition often meet when title and risks of

ownership transfer to buyer. FOB (free on board) shipping

FOB destination

For service companies: when they have provided

services to the buyer, they recognize revenues.

Revenue Recognition Rule : in the footnote to the

financial statements

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Reporting Net Sales5

Companies record credit card discounts,sales discounts, and sales returns andallowances separately to allow management

to monitor these transactions.

(Gross) Sales revenueLess: Credit card discounts

Sales discountsSales returns and allowances

Net Sales Revenue


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Credit Card Sales6

Companies accept credit cards for several reasons:

1. To increase sales.

2. To avoid providing creditdirectly to customers.

-To avoid losses due tofraudulent credit card sales.

-To receive payment quickly.

3. To avoid losses due to badchecks.


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Credit Sales

When credit card sales are made, the company mustpay the credit card company a fee for the service itprovides .

Example: Sears sold a washer and the customercharged the $1,000 sales price on her Master card.Master card charges a 2% credit card fee.Cash 980Credit card discount 20

Sales Revenue 1,000

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Contrarevenue

account


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Sales Discounts

When companies allow customers topurchase merchandise on an open account ,the customer promises to pay the company

for the purchase in the future.

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When customers purchase on open

account, they may be offered a salesdiscount to encourage early payment .


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Sales Discounts (Credit Terms)9

2/10, n/30Discount

Percentage# of Days in

DiscountPeriod

Otherwise,the Full

Amount IsDue

MaximumDays inCreditPeriod

Pay 98% if payment is made within 10 days,otherwise pay the full amount within 30 days

Read as: Two ten, net thirty


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To Take or Not Take the Discount?10

With discount terms of 2/10,n/30, a customersaves $2 on a $100 purchase by payingon the 10 th day instead of the 30 th day.

$2$98

= 2.04%Interest Rate for 20 Days =

Interest Rate for 20 Days = Amount Saved Amount Paid

So, should the customer take the discount?

Annual Interest Rate = 365 Days20 Days 2.04% = 37.23%


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Example: Sales Discount On 2/1/09, OfficeMax sold a copier to a customer at an

invoice price of $2,000, terms 3/10, n/60. Purchase cost ofthe copier was $1,500.

Accounts Receivable 2,000Sales Revenue 2,000

Cost of Goods Sold 1,500Inventory 1,500 The customer paid the full amount on 2/4/09.

Cash 1,940Sales Discount 60

Accounts Receivable 2,000 Implicit annual interest rate in the sales discount?

Interest rate for 50 days: 60/(2,000-60) = 3.09% Annual interest rate: 3.09%*365/50 = 22.56%

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Contrarevenueaccount


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Sales Returns and Allowances Sales returns and allowance account Contra revenue account

Debited for damaged merchandise Debited for returned merchandise

See Chapter 6 Supplement A Recording Credit Card Sales, Sales Discount and Returns

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Credit Card Sales13

On January 2, a Deckers factory stores credit card saleswere $3,000. The credit card company charges a 3%service fee. Prepare the Deckers journal entry

Date Description Debit Credit

Jan. 2 Accounts Receivable (+A) 2,910

Credit Card Discounts (+XR, - R, -SE) 90

Sales Revenue (+R, +SE) 3,000

$3,000 3% = $90 Credit Card Fee

GENERAL JOURNAL

Credit Card Discounts are reported

as a contra-revenue account.


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Sales Discounts14

On January 6, Deckers sold $1,000 of merchandise oncredit with terms of 2/10, n/30 . Prepare the Deckers journalentry.


Jan. 6 Accounts Receivable (+A) 1,000Sales Revenue (+R, +SE) 1,000

GENERAL JOURNAL


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Sales Discounts15

On January 14, Deckers receives the appropriate paymentfrom the customer for the January 6 sale. Prepare theDeckers journal entry


Jan. 14 Cash (+A) 980

Sales Discounts (+XR, -R, -SE) 20

Accounts Receivable (-A) 1,000

GENERAL JOURNAL

$1,000 2% = $20 sales discount

$1,000 - $20 = $980 cash receipt

Contra-revenue account


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Sales Discounts16

If the customer remits the appropriate amount on January20 instead of January 14, what entry would Deckers make?


Jan. 20 Cash (+A) 1,000


GENERAL JOURNAL

Since the customer paid outside of the discountperiod, a sales discount is not granted .


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Sales Returns and Allowances17

On July 8, before paying, a customer returns $500 ofsandals originally purchased on account from Deckers. Thesandals originally cost Deckers $300. Prepare the Deckers

journal entry.


July 8 Sales Returns and Allowances (+XR, -R, -SE) 500

Accounts Receivable (-A) 500

July 8 Merchandise Inventory (+A) 300

Cost of Goods Sold (-E, +SE) 300

GENERAL JOURNAL


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Reporting Net Sales

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(Gross) Sales revenue $6,000

Less: Credit card discounts 90Sales discounts 20Sales returns and allowances 500

Net Sales Revenue 5,390


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Concept Quiz

What are the three common contra-revenueaccounts?

What is the meaning of 2/10, n/30?

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Sales Revenue

Less: ( )( )( )

Net Sales

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More Challenging Example1. Target offers its customers who use its store credit card 5%

off all transactions.2. Wal-Mart allows customers to use other credit cards and

then pays 3% to the credit card company.3. Starbucks has a rewards card which gives customers a

cash back reward online of $1 for every $100 spent. Assuming the customer pays using the above form of

payment, what amount would each company record in netrevenue for a $100 transaction.

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Classification of Receivables21

Accounts

Receivable

Trade receivables are amountsowed to the business for credit

sales of goods, or services.

Nontrade receivables are amountsowed to the business for other

than business transactions.

NotesReceivable

A promise in writing (a formaldocument) to pay (1) principal and

(2) interest at future dates

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Receiving Payment for Goods and Services

On credit through Accounts Receivable

Bad debts are possible Credit cards

Least risky method for a firm

Must pay service charge to credit card company Cash

Control of cash is a major issue

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Considerations of Receipt ofRevenue Payment

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Accounts Receivable

Accounts receivable ( AR ) are the expected futurecash receipts of a company for sales made on account

Receivables are reported at their face value less an

allowance for accounts which are likely to beuncollectible.

The amount which is actually expected to be collected iscalled the net realizable value (NRV). GAAP requires that AR be reported at NRV.

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Bad Debts (Uncollectible Accounts)

When customers default , account becomesvalueless and must be removed .

Could be considered a reversal of revenue,however, it is considered a cost of business (an expense ) and gross revenue remains.

An uncollectible account is written-off (asset

removed ) and an expense is recognized .

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Bad debts (uncollectible accounts) resultfrom credit customers who will not pay thebusiness the amount they owe, regardless

of collection efforts.

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Accounting for Bad Debts25

MatchingPrinciple

Bad DebtExpense

SalesRevenue

Record in sameaccounting

period.

Most businesses record an estimate ofthe bad debt expense by an adjusting

entry at the end of the accounting period .

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Accounting Process for Bad Debt

Step 1: Record estimated bad debts expense At end of period in which sales are made(Matching principle)

Expense goes up , Allowance for doubtful accounts

(contra asset) goes up Step 2: Identify and write off actual bad debts

Throughout the period as bad debts becomeknown

Accounts Receivable go down , Allowance fordoubtful accounts goes down .

No effect on Net Income and Assets in the

second step !!!

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Step 1: Recording of Estimated Bad Debtsexpense

Journal EntryBad Debt Expense (+E, -SE) xxx Allowance for Doubtful Accounts (+XA,-A) xxx

Allowance Account: a contra-asset on the balance sheet Bad Debt Expense: is normally classified as a selling

expense and is closed at year-end .

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Balance Sheet Disclosure Accounts Receivable (Gross) 500,000

Less: Allowance for doubtful accounts (25,000)

Accounts Receivable (Net) 475,000

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Step 2: Actual Write-off of an UncollectableAccount

Journal Entry Allowance for Doubtful Accounts(-XA,+A) xxx Accounts Receivable(-A) xxx

Uncollectable accounts are written off against theallowance account

No effect on Net Income and Assets !!!

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Example: Deckers29


Dec. 31 Bad Debt Expense (+E, -SE) 27,567

Allowance for Doubtful Accounts (+XA, -A) 27,567

GENERAL JOURNAL

Deckers estimated bad debt expense for 2008 to be

$27,567. Prepare the adjusting entry (at the end ofDecember 2008)

Deckers total write -offs for 2008 were $25,216. Prepare a

summary journal entry for these write-offs.Date Description Debit Credit

Allowance for Doubtful Accounts (-XA, +A) 25,216


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Example: Deckers30

Assume that before the write- off, Deckers Accounts

Receivable balance was $300,000 and the Allowance forDoubtful Accounts balance was $30,000.Lets see what effect the total write -offs of $25,216 had onthese accounts.

Before Write-Off

After Write-Off

Accounts Receivable 144,051$ 118,835$Less: Allow. for doubtful accts. 35,922 10,706 Accounts receivable (Net) 108,129$ 108,129$

Notice that the total write-offs of $25,216 did not change the AccountsReceivables (net) nor did it affect any income statement accounts .

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Quick Review Net Sales Revenue

Record by creating a contra-revenue account

Recording Bad Debt Expense

Bad Debt Expense (+E, -SE) xxx Allowance for Doubtful Accounts (+XA,-A) xxx

Record Write-Offs Allowance for Doubtful Accounts(-XA,+A) xxx

Accounts Receivable -A xxx

(Gross) Sales revenueLess: Credit card discounts

Sales discounts

Sales returns and allowancesNet Sales Revenue

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More Challenging ExampleWhat is the January 31 st Net Accounts Receivable and Net

Sales Revenue Balance for Proctor and Gamble? (assume 0beginning balances)

January 3 rd P&G sold $500,000 in cleaning supplies to Target with terms1/10, n/30 (the cleaning supplies cost P&G $300,000). On January 5 th Target paid $396,000 of the balance. On January 30 th

Target paid the remainder of the balance ($100,000). On January 17 th Target notified P&G that it received the wrong size of

$8,000 worth of cleaning supplies and that it has sent them back(inventory cost $5,000). Assume this $8,000 merchandise had not yetbeen paid for.

On January 28 th, P&G shipped $100,000 in personal care products to Boand Mos family shop.

On January 31 st , P&G estimates based on past experience that $2,000 of

the Bo and Mo sale will be uncollectable .

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Solution

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Methods for Estimating Bad Debts

Percentage of credit sales or

Aging of accounts receivable

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Percentage of Credit Sales A company estimates the percentage of credit sales that will

prove uncollectable . Bad debt percentage is based on actual uncollectable accounts from

prior years credit sales

The focus is on determining the amount to record as BadDebt Expense on the i n c o m e s t a t em en t The bad debt expense for the period = the percentage * Credit Sales for the period This amount is used in an adjusting journal entry

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Example: Percentage of Credit Sales


Dec. 31 Bad Debt Expense (+E) 6,000

Allowance for Doubtful Accounts (+ XA, -A) 6,000

GENERAL JOURNAL

In 2009, Kids Clothes had credit sales of $600,000. Past

experience indicates that bad debts are one percent ofcredit sales . What is the estimate of bad debts expense for2006?

$ 600,000 * 0.01 = $ 6,000

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Aging of Accounts Receivable

A company estimates the percentage ofaccounts receivable that will proveuncollectable . Adjust net account receivable up or down to this

number The difference goes to bad debt expense

The focus is on determining the desiredbalance in the Allowance for Doubtful

Accounts on the b al an c e s h eet

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Aging of Accounts ReceivableAccounts Receivable

% Estimated UncollectibleDesired Balance in Allowance Account

- Allowance Account Cr ed i t Balance

Amount of Journal Entry

Accounts Receivable % Estimated Uncollectible

Desired Balance in Allowance Account- Allowance Account C r e d i t Balance

Amount of Journal Entry for Bad Debt Expense

Focus is on determining the ( ending )

desired balance in the Allowance forDoubtful Accounts on the balance sheet.

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Example: Aging Schedule

Each customers account is aged bybreaking down the balance byshowing the age (in number of days)

of each part of the balance. An aging of accounts receivable for

Kids Clothes in 2009 might look likethis . . .

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Days Past Due

Customer Not Yet

Due 1-30 31-60 61-90 Over 90

TotalA/R

BalanceAaron, R. 235$ 235$

Baxter, T. 1,200$ 300 1,500 Clark, J. 50$ 200$ 500$ 750

Zak, R. 325 325 Total 3,500$ 2,550$ 1,830$ 1,540$ 1,240$ 10,660$

Based on past experience, the businessestimates the percentage of uncollectible

accounts in each time category.

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Days Past Due

Customer Not Yet

Due 1-30 31-60 61-90 Over 90

TotalA/R


Baxter, T. 1,200$ 300 1,500 Clark, J. 50$ 200$ 500$ 750

Zak, R. 325 325 Total 3,500$ 2,550$ 1,830$ 1,540$ 1,240$ 10,660$% Uncollectible 0.01 0.04 0.10 0.25 0.40

These percentages are then multipliedby the appropriate column totals.

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Days Past Due

Customer Not Yet

Due 1-30 31-60 61-90 Over 90

TotalA/R


Baxter, T. 1,200$ 300 1,500 Clark, J. 50$ 200$ 500$ 750

Zak, R. 325 325 Total 3,500$ 2,550$ 1,830$ 1,540$ 1,240$ 10,660$% Uncollectible 0.01 0.04 0.10 0.25 0.40 EstimatedUncoll. Amount 35$ 102$ 183$ 385$ 496$ 1,201$

The column totals are then added toarrive at the total estimate of

uncollectible accounts of $1,201.


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After posting, the Allowance

account wouldlook like this . . .

Date DescriptionPost.Ref. Debit Credit

Dec. 31 Bad Debt Expense 1,151

Allowance for Doubtful Accounts 1,151

GENERAL JOURNAL

1,201 Desired Balance- 50 Credit Balance

1,151$ Adjusting Entry

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Allowance for Doubtful Accounts50 Balance at

12/31/2009before adj.

1,151 2009 adjustment1,201 Balance at

12/31/2009after adj.

Notice that the balanceafter adjustment is equal

to the estimate of $1,201based on the aginganalysis performed

earlier.

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Difference between the Two Methods

Percentage of CreditSales Aging of Account

Focus Estimate thebad debt expense(Income Statement )

Estimate the endingbalance of allowancefor doubtful accounts

(Balance Sheet )

Calculationof bad debt

expenseDirect Indirect

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Concept Quiz What is the difference between Accounts Receivable and

Notes Receivable?

What are Bad Debts?

By ( ) principle, a company must recognize baddebt expenses in the same period when it recognizes salesrevenue.

What are the two steps to account for bad debts?

What are the two methods for estimating bad debt expenses?How do they differ?

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Two Ratios

Gross Profit PercentageGross Profit=

Net Sales

All other things remaining equal,a higher gross profit percentage

higher net income Used to assess profitability

Receivable TurnoverNet Sales

=

Average AccountsReceivable

A measure of how many times averagereceivables are recorded and collectedfor the year

The higher ratio the faster thecollection of receivables

Used to assess liquidity of receivables(a companys management ofreceivables)

whereAverage Accounts Receivable

= Beginning Balance + Ending Balance

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Example: Deckers Data from the 2006 financial statement (dollars in

thousands) Gross Sales: $ 314,423 Credit Card Discounts: $10,000 Cost of Sales: $163,224 Net Accounts Receivable:

Beginning balance $39,683Ending balance $49,571

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Example: Deckers

Gross Profit = Net Sales Cost of Sales

Gross Profit Margin = Gross Profit / Net Sales

Average Accounts Receivable

Receivable Turnover= Net Sales / Average Accounts Receivable

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Reporting and Safeguarding Cash Cash Equivalents: Short-term investments with original

maturities of three months or less that are readily convertibleto cash. Examples? Certificates of Deposit (


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Safeguarding Cash Internal Controls: processes by which a company safeguards

its assets and provides reasonable assurance regarding thereliability of the companys financial reporting, theeffectiveness and efficiency of its operations, and compliancewith applicable laws and regulation

Effective Internal Control: Separation of duties

Separate physical handing of cash and accounting for cash Separate receiving and dispersing cash

Prescribed policies and procedures Require daily deposits Certain individuals are required to approve expenditures (sign checks) Includes monthly bank reconciliation


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Balance per Bank

+ Deposits in Transit

- Outstanding Checks

Bank Errors

= Correct Balance

Balance per Book

+ Deposits by Bank

(credit memos)

- Service Charge

- NSF Checks

Book Errors

= Correct Balance

Bank ReconciliationExplains the difference between cash reported on bankstatement and cash balance on companys books and

provides information for reconciling journal entries.

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Bank Reconciliation ExamplePrepare a July 31 bank reconciliation statementand the resulting journal entries for the SimmonsCompany. The July 31 bank statement indicateda cash balance of $9,610, while the cash ledgeraccount on that date shows a balance of $7,430.

Additional information necessary for thereconciliation is shown on the next page.

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Bank Reconciliation Example Outstanding checks totaled $2,417. A $500 check mailed to the bank for deposit had not

reached the bank at the statement date. The bank returned a customers NSF check for $225

received as payment of an account receivable. The bank statement showed $30 interest earned on the

bank balance for the month of July. Check 781 for supplies cleared the bank for $268 but was

erroneously recorded in our books as $240. A $486 deposit by Acme Company was erroneously

credited to our account by the bank.

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Bank ReconciliationEnding bank balance, July 31 9,610$Additions: Deposit in transit 500 Deductions: Bank error 486$

Outstanding checks 2,417 2,903 Correct cash balance 7,207$

Ending book balance, July 31 7,430$Additions:

Interest 30 Deductions: Recording error 28$

NSF check 225 253 Correct cash balance 7,207$

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Take-aways of Chapter 6 Revenue and Net Sales

How to record credit card sales, sales discount, and salesreturns?

How to compute the implicit annual interest rate of salesdiscount?

Bad Debts and Uncollectible Accounts How to account for bad debt? (Recording allowance and

writing off bed debt?)

How to estimate bad debt expense? (Percentage of Creditsales vs. aging of accounts)

Gross profit margin and receivable turnover Cash control & bank reconciliations

Documents

Chapter 6 (Student) Accounting UMN