Financial Accounting Sales Revenue

7/30/2019 Financial Accounting Sales Revenue

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Chapter 6 Accounting for Sales

Revenue and Receivables

Recall the principles that apply:

Revenue recognition principle recognizerevenue in period earned

Matching principle recognize expense inthe period that corresponding revenue is

recognized

Cost principle value revenue at the cash-equivalent value of the assets received


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Why is accounting for revenue so important?

Suppose a company should report the following:

Revenue $70,000

COGS 50,000Gross profit 20,000

Other expenses 18,000Net income $ 2,000

What is the effect of a 1% error in revenue?


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Report with 1% overstatement of revenueRevenue $70,700COGS 50,000

Gross profit 20,000

Other expenses 18,000

Net income $ 2,700

A 1% overstatement of revenue

raises net income and ROE by 35%.


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Accounting for Sales Revenue

Record revenue as theamount of cash received.

Record revenue as the

amount of cashequivalent of the goodsreceived or given up,whichever is moreclearly determinable.

Sales for Cash

Sales for NoncashAssets


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Gift Cards

Suppose Walmart sells a gift card for

$25 on 6/17/20A. The gift card has no

expiration date. How should Walmartaccount for this card sale and

subsequent use (or nonuse)?


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Gift Cards6/17/20A: Cash (+A) 25

Unearned Rev (+L) 25

When used: Unearned rev (-L) 25

Revenue (+SE) 25

COGS (-SE) xx

Inventory (-A) xx

If unused: Unearned rev (-L) 25

Revenue (+SE) 25

When should this entry be made?


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Credit Card Sales

A customer uses a credit card to acquire merchandise

with a retail price of $1,000. The credit card

company charges a 3% fee. The journal entry wouldbe:

Cash or Receivable from VISA (+A) 970

Credit Card Discount (+XR, R,SE) 30

Sales Revenue (+R,+SE) 1,000


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Credit Card SalesSelling companys income statement

would report:

Revenue $1,000

Less: credit card discount (30)

Net revenue $ 970


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Sales Discounts

When customers purchase on account, theymay be offered a sales discount toencourage early payment.

If used, the sales discount account is acontra revenue account (so it has a debit

balance).


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Sales Discounts - Terminology

Terms of a credit sale: 2/10, n/30

Translation: A 2% discount off of the invoiceprice is allowed if payment is received within

10 days. Otherwise, the full invoice price is

due within 30 days.


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Sales Discounts

Two possible ways to account for sales discounts

1. Gross Method Sales are recorded at theirgross amounts. Sales discounts are recorded ifpayment is received within the discount period.

This is the method in the textbook and the method

used by most companies.

2. Net Method Sales are recorded at their net ofdiscount amount.


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Sales Discounts - Gross Method

On July 6, Kids Clothes sold $400 of

merchandise on credit with terms of 2/10, n/30.

Give the journal entry.

7/6 Accounts Receivable (+A) 400

Revenue (+SE) 400


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On July 14, Kids Clothes receives payment

in full from the customer for the July 6 sale.


7/14 Cash (+A) 392

Sales Discounts (SE) 8

Accounts Receivable (A) 400


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Reporting Credit Sales and Sales

Discounts Gross MethodRecall that the sales discount account is a

contra revenue account. In the preceding

example, we would report:

Sales Revenue 400

Less: Sales discounts (8)

Net sales 392


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Assume instead the customer remits the

payment in full on July 20, what entry would

Kids Clothes make?

7/20 Cash (+A) 400



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Sales Discounts Gross Method

Some accountants point out that the Gross

Methodis conceptually flawed why?

Overstates income from Sales and

Understates income from Financing.

They prefer theNet Methodof accounting for

sales discounts.


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Sales Discounts - Net method

On July 6, Kids Clothes sold $400 of

merchandise on credit with terms of

2/10, n/30.Give the journal entry.

7/6 Accounts receivable (+A) 392

Revenue (+SE) 392


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On July 14, Kids Clothes receives payment

in full from the customer for the July 6 sale.


7/14 Cash (+A) 392



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Kids Clothes make?

7/20 Cash (+A) 400


???? 8


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Kids Clothes make?

7/20 Cash (+A) 400


Interest Revenue (+SE) 8


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Comparison of Gross and Net

Methods Income StatementAssuming payment received within discount period

Net Gross

Sales revenue 392 400

Less: Sales discounts ( 8)Net sales revenue 392 392

Assuming payment received after discount period

Net GrossSales revenue 392 400

Less: Sales discounts ( 0)

Net sales revenue 392 400Interest revenue 8


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Comparison of Gross and Net

Methods Income StatementWhy use the Gross Methodif it

misclassifies interest income as

sales revenue?

Easy to use. Not materially

different fromNet Method.


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Accounting for Bad Debts

Bad debtsresult from credit customers whocan not or will not pay the business the amount

they owe, regardless of collection efforts. Is a low level of bad debts expense always

good?

What is wrong with simply writing off anuncollectible account when a company

determines that it is uncollectible (the

Direct write-off method )?


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Bad Debts

Other terms for bad debt expense:doubtful accounts expenseprovision for uncollectible accountsuncollectible accounts expense


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Accounting for bad debts

We account for bad debts by estimatingthepercentage of accounts receivable that will not

be collected (through an ADJUSTING entry at

the end of the accounting period).

In conformity with the matching principle, baddebt expense is recognized (i.e. recorded as an

expense) in the same period as the relatedrevenue

Referred to as theAllowance Method


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Recording Bad Debt Expense

EstimatesKids Clothes estimated bad debt expense for

20A to be $1,500.

Give the adjusting entry at12/31/20A

Bad debt expense (SE) 1,500

Allowance for

doubtful accounts (A) 1,500


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Recording Bad Debt Expense

Bad Debt Expenseis normallyclassified as a selling expense andis closed at year-end.

Can you think of another way we mightreasonably treat bad debts on the income

statement?


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Allowance for Doubtful Accounts

The Allowance for Doubtful Accounts is aContra Asset that is subtracted from

Accounts Receivable

We credit this account instead of A/Rbecause there is no way to know which

specific A/R will be uncollectible in the

future


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Accounts Receivable

Beginning balance 0

From credit sales 75,000 From cash collections 53,650

Ending balance 21,350

Assume $75,000 in credit sales, $53,650 in cash collections,and estimated bad debt expense of $1,500. AR andAllowance would be:

Allowance for Uncollectible Accounts

Beginning balance 0

From bad debt expense 1,500

Ending balance 1,500


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Allowance for Doubtful Accounts

Accounts receivable $21,350

Less: Allowance for doubtful accounts (1,500)

Net realizable value ofaccounts receivable $19,850

The net realizable value is the amount ofaccounts receivable that the business

expectsto collect.


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Writing Off Uncollectible

AccountsWhen it is clear that a specific customers account

receivable is uncollectible, the amount should be

removed from the Accounts Receivable account andcharged to the Allowance for Doubtful Accounts.

The journal entry reduces both the Accounts Receivableand the Allowance for Doubtful Accounts balances.

Net Accounts Receivable are not affected.A write-off does not affect the income statement.


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AccountsAssume that on January 5, Kids Clothes

determined that Jason Clark would not pay the

$500 he owes.Give the journal entry.

1/5 Allowance for Doubtful Accounts (+A) 500



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AccountsAssume that before this entry, the Accounts

Receivable balance was $21,350 and the

Allowance for Doubtful Accounts balancewas $1,500.

What effect did the write-off have on theseaccounts?


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AccountsBefore

Write-Off

After

Write-Off

Accounts receivable $21,350 20,850$Less: Allow. for doubtful accts. 1,500 1,000

Net realizable value $19,850 19,850$

Notice that the $500 write-off did not change the net

realizable value of accounts receivable nor did it affect any

income statement accounts.


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Collection of Accounts

PreviouslyWritten OffWhen a customer makes a payment after an

account has been written off, two journal

entries are required:

Reverse the write-off.Record the cash collection.


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1st Entry: Reinstatement of

Accounts Written OffAssume that on January 30, Jason Clark surprised

Kids Clothes by paying $500 he owed.

1/30 Accounts Receivable (+A) 500

Allowance for

Doubtful Accounts (A) 500


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2nd Entry: Collection of Account

Written Off

1/30 Cash (+A) 500



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Estimating Bad Debts

How do we estimate the amount of the bad debts at

the end of the accounting period?

Two primary methods

Percentage of credit sales (Income Statementapproach)

Aging of Accounts Receivable (Balance Sheetapproach)


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Method 1

Percentage of Credit Sales MethodThe estimate for bad debt expense is based on

the historical percentage of credit sales that

result in uncollectible accounts.The resulting calculation is an estimate ofbad

debt expense that should be recognized in

the Income Statement for the period.


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Percentage of Credit Sales

Credit Sales

% Estimated UncollectibleBad debt expense


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Percentage of Credit SalesIn previous years, Kids Clothes had 1% of credit

sales that ultimately became uncollectible.

In Year 20A, Kids Clothes had credit sales of

$60,000.

Using the prior years percentage of 1%, what is

the estimate of bad debts expense for 20A?

$60,000 .01 = $600

Give the required adjusting entry.


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Percentage of Credit Sales

12/31/Year 2Bad debt expense (-SE) 600

Allowance for doubtful accounts (-A) 600

Think about the appropriateness of this method when the

economic climate changes or the credit worthiness ofcustomers is relaxed.


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Aging of Accounts Receivable Method

Estimate of the ending balance forAllowance forDoubtful Accounts balance in the Balance Sheet.

Adjust the Allowance account to that balance:

Bad debt expense y x

Allowance for doubtful accounts y x

Unadjusted Balance = $x

Estimate ending balance = $y

Allowance forDoubtful Accounts

Plug amount needed to bring todesired ending balance $y$x

l f A i S h d l


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Example of Aging Schedule

Days Past Due

Customer

Not Yet

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

Total

A/R

Balance

Aaron, R. 235$ 235$

Baxter, T. 1,200$ 300 1,500Clark, 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

Based on past experience, the business estimates the percentage

of uncollectible accounts in each time category.

These percentages are then multiplied by the appropriate

column totals.

A i f A t R i bl


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Aging of Accounts Receivable

Days Past Due

Customer

Not Yet

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

Total

A/R

Balance

Aaron, R. 235$ 235$

Baxter, T. 1,200$ 300 1,500Clark, 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

Estimated

Uncoll. Amount 35$ 102$ 183$ 385$ 496$ 1,201$

The total estimated amount ($1,201) is the

balance that we want in the Allowance forDoubtful Accounts at the end of the period.

Record the Dec. 31 adjusting entry assuming that

the Allowance for Doubtful Accounts currentlyhas a $50 credit balance.


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Aging of Accounts Receivable

After posting, the Allowance accountwould look like this . . .

1,201 Desired Balance

- 50 Credit Balance

1,151$ Adjusting Entry

12/31 Bad debt expense 1,151Allow. For doubtful accts 1,151


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Aging of Accounts ReceivableAllowance for Doubtful Accounts

50 Balance

before adj.

1,151 current year adjust

1,201 Balance

after adj.

Notice that the balanceafter adjustment is equalto the estimate of $1,201

based on the aginganalysis performedearlier.


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Example 1K-Stores estimates bad debts as 2% of creditsales.

The following information is available from K-Stores Unadjusted Trial Balance:

Give K-Stores adjusting entry for Bad DebtExpense.

Credit Sales 120,000$

Accounts Receivable 23,000

Allow. for Doubtful Accts. 450 (credit)


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Adjusting entry:

12/31 Bad debt expense (SE) 2,400

Allow. For doubtful acct (A) 2,400

$120,000 2% = $2,400 bad debt expense


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Example 2K-Storesagedits accounts receivable and estimatedthat $2,400 would be uncollectible.

The following information is available from K-Stores Unadjusted Trial Balance:

Give K-Stores adjusting entry for Bad DebtExpense.

Credit Sales 120,000$

Accounts Receivable 23,000

Allow. for Doubtful Accts. 450 (credit)


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12/31 Bad debt expense (SE) 1,950Allow. For doubtful acct. (A) 1,950

Allow. For doubtful acct450

2,400 needed in account

1,950 adjusting entry


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Sales Returns (SR)

Allowance method should be used if amount ofreturns can be estimated. SR - Debited for estimates of damaged

merchandise to be exchanged by customers at somefuture date.

SR - Debited for estimates of merchandise to bereturned by customer for refunds.

SR is a contra revenue account.


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Sales Returns

Consider how a change in return policy islikely to affect revenues.

Allowance method is used to reflect the costof the return policy in the year of revenue

(parallel to reasoning for uncollectible

accounts).


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Sales Returns Example 1During Year 1, Burk Company had sales of $100,000 on

account. Merchandise sold (on account) for $5,000 wasreturned during the year. At 12/31/Year 1, Burk estimated thattotal returns related to Year 1 sales would amount to 7% ofsales on account.

Give the journal entries related to returns.

During Yr 1 Sales returns (SE) 5,000

Accounts receivable (A) 5,000

12/31/Yr1 Sales returns (SE) 2,000

Allow. For SR (A) 2,000


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Sales Returns Example 2

During Year 2, Burk Company had sales of $120,000

on account. Merchandise sold (on account) for

$6,000 was returned during the year. At 12/31/Year

2, Burk estimated that returns related to Year 2 saleswould amount to 7% of sales on account.



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Sales Returns Example 2During Year 2, Burk Company had sales of $120,000 on

account. Merchandise sold (on account) for $6,000 wasreturned during the year. At 12/31/Year 2, Burk estimated thatreturns related to Year 2 sales would amount to 7% of sales onaccount.


During Yr 2 Sales returns (SE) 6,000

Accounts receivable (A) 6,000

12/31/Yr2 Sales returns (SE) 2,400

Allow. For SR (A) 2,400


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Sales Returns

Note that the balance in the contra account "Allow. ForSR" is now $4,400.

Estimated total returns for years 1 and 2 are $7,000 +

$8,400 = $15,400.

Actual returns for years 1 and 2 were $5,000 + $6,000 =

$11,000.

Thus, the estimated future returns are $4,400.


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Sales ReturnsSuppose an item is returned that can be replaced in

inventory (that is, it is not damaged and can be

resold).


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Sales Returns Example

On July 8, a customer returns $25 of merchandisethat was originally purchased for cash. Themerchandise cost $20, is undamaged, and is

returned to inventory.7/8 Sales Returns (SE) 25

Cash (A) 25

Inventory (+A) 20Cost of Goods Sold (+SE) 20


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Reporting Net Sales

Companies account for sales discounts,

sales returns, and credit card discounts

separately to allow management tomonitor these transactions.


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Reporting Net Sales

Sales revenue

Less: Sales returns

Sales discounts

Credit card discounts

Net sales

Note: these contra accounts are usually not reported onthe income statement.


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Receivable Turnover

This ratio measures how quickly a company

collects its accounts receivable.

Net SalesAverage Net Trade Receivables

ReceivableTurnover

=

Average Collection Period = 365 / Receivable Turnover


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Receivable TurnoverNet Sales

Average Net Trade ReceivablesReceivable

Turnover=

Blockbuster receivable turnover = 45.9

Blockbuster average collection period = 8 days

Netflix reports no receivables


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Gross Profit Percentage

Gross Profit

Percentage

Gross Profit

Net Sales

=

All else equal, a higher gross profit resultsin higher net income.

Gross profit = Net Sales Cost of goods sold


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Gross Profit Percentage

Netflix Gross Profit

Percentage

= 33% in 2008 and 35%

in 2007

Gross ProfitPercentage

Gross ProfitNet Sales

=

Blockbuster Gross Profit

Percentage= 51% in 2008 and 52% in

2007

Documents

Financial Accounting Sales Revenue