6: Chapter Reporting and Interpreting Sales Revenue, Receivables & Cash I)ACCOUNTING FOR SALES REVENUE The Revenue Principle: requires that revenue be recorded when earned WHEN IS REVENUE EARNED? For Sellers of Goods: revenue is earned when the title and risks of ownership of a good are transferred to the buyer, the details of this transfer are explained in the shipping terms on the sales contract FOB Shipping Point: revenue is recognized at shipment Buyer usually pays for shipping FOB Destination: revenue is recognized at delivery Seller usually pays for shipping For Service Companies: revenue recognized when service is rendered REVENUE RECOGNITION METHODS: a companys method of revenue recognition is outlined in footnote Summary of Significant Acc. Policies THE AMOUNT OF REVENUE RECOGNIZED: the cash equivalent sales price Methods of Receiving Revenue: Allowing Customers to use Credit Cards Giving Business Customers Direct Credit option and Early Payment Discounts Allowing Customers to Return Goods
Each method of receiving revenue affects the way the company computes Net Sales Revenue
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b Credit Card Sales to Customers: companies extend credit to customers b/c: Increase Consumer Traffic Avoid Cost to Provide Customers w/ Credit (recordkeeping, bad debt) Gets Them Money Faster (Credit Card Receipts Direct Deposited) Lowers Losses From Bad Checks Lowers Losses from Fraudulent Credit Cards (verification etc) CREDIT CARD DISCOUNT: a fee charged by credit card companies for the services they perform which is recorded as an expense Example: credit card sales were $3,000, 3% CC discount Gross Sales Revenue Less: Credit Card Discount (3,000 x .03) Net Sales (Reported on Income Statement) $3,000 90 $2,910
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Sales Discounts for Early Payment: many companies sell merchandise to other companies on open account (no formal promissory note or credit card) CREDIT TERMS: usually printed on the sales invoice, often w/ abbreviations
N/30: the full price is due within 30 days of the invoice date
N= Sales Amount, Net of and Sales Returns 30= How May Days the Customer has to Pay Their Bill
SALES DISCOUNT: granted to the customer to encourage early payment 2/10: 2% will be deducted from invoice price if paid w/in 10 days
2= % Discount 10=Period Which the Customer Can Receive the Discount
BENEFITS OF EARLY PAYMENT TO SELLER: Prompt receipt of cash from customers reduces necessity to borrow $ Customers tend to pay discounted bills first, decreasing the possibility that they will run out of cash before the bill is paid EXAMPLE: Sales Revenue $1,000 Less: Sales Discounts (1,000x.02) 20 Net Sales (Reported on Income Statement) $980
If payment is made after the discount period, the full $1,000 would be reported on the income statement as Net Sales d Sales Returns & Allowances: customers have right to return damaged merchandise SALES RETURNS & ALLOWANCES: separate account to record returned goods Must be Deducted from Gross Sales Revenue to determine Net Sales EXAMPLE: Deckers sells Fontana 40 Shoes for $2,000, before paying, Fontana realizes that 10 pairs are the wrong color and returns them Sales Revenue $2,000 Less: Sales Returns & Allowances ([40/10] x $2,000) 500 Net Sales (Reported on Income Statement) $1,500
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The Cost of Goods Sold related to the 10 pairs must taken away when calculating gross profit Reporting Net Sales: on the companys financial statements, credit card discounts, sales discounts, and sales returns & allowances are accounted for separately to allow managers to monitor the costs of credit card use, sales discounts, and returns EXAMPLE: Sales Revenue $6,000 Less: Credit Card Discounts (a contra-revenue) 90 Sales Discounts (a contra-revenue) 20 Sales Returns & Allowances (a contra-revenue) 500 Net Sales (Reported on Income Statement) $5,390
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Net Sales
Gross Profit Cost of Goods Old
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Gross Profit Margin: a measure of the managements ability to sell goods and services for more than the costs to purchase or produce them GROSS PROFIT PERCENTAGE = GROSS PROFIT / NET SALES GROSS PROFIT = NET SALES COST OF GOODS SOLD High Gross Profit = High Net Income Product Differentiation Strategy: allow companies to charge premium prices for their goods, producing a higher gross profit percentage Low Cost Strategy: relies on efficient management of production to reduce costs and increase the gross profit percentage II)MEASURING & REPORTING RECEIVABLES Classifying Receivables: NOTE RECEIVABLE VS. ACCOUNT RECEIVABLE: Note Receivable: a written promise to pay a specified amount of money called a principal at a definite future date called maturity date with a specified amount of interest Account Receivable: created by a credit sale on an open account TRADE RECEIVABLE VS. NONTRADE RECEIVABLE: Trade Receivable: a normal sale of merchandise on account Nontrade Receivable: created from abnormal business transactions
Lending money to CEO to finance his mortgage
CURRENT VS. NONCURRENT RECEIVABLES: Current: due to be received within one year Noncurrent: due to be received after one year b Accounting for Bad Debt: when a company extends credit to its customers, not all customers pay their debts yet the matching principle requires that the bad debt expense must be recorded in the same period as the related sales are made ALLOWANCE METHOD: bases bad debt expense on an estimate of uncollectible accounts, which has 2 steps 1. Record Bad Debt Expense Estimate: in end-ofperiod adjusting entries
Bad Debt Expense: expense associated w/ estimated uncollectible accounts receivable requiring an adjusting journal entry at the end of the accounting period to record bad debt estimate Recorded in Income Statement category Selling Expenses Not recorded on balance sheet! Allowance for Doubtful Accounts: a contra-asset account established as the credit associated w/ the bad debt expense Will be subtracted from the balance of the asset accounts receivable to find the net book value Example Adjusting Journal Entry!
Bad Debt Expense (+E, -SE) Allowance for Doubtful Accounts (+XA, -A)
504
2. Write off Specific Accounts: determined to be uncollectible (due to customer bankruptcy etc.)
Example Adjusting Journal Entry! 876 876 Allowance for Doubtful Accounts (-XA,+A) Accounts Receivable (-A)
This entry does NOT affect any income statement items! Nor did it affect net book value of receivables
SUMMARY OF ACCOUNTING PROCESS!
Adjusti ng Journ al Accou nts Affecte d
Bade Debt Expens e Allowa nce for Doubtfu l Accoun ts (XA)
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N A
Accoun ts Receiva ble (A) Allowa nce for Doubtfu l Accoun ts
N A
Beg. Bal.: 22,804 Sales on Account 121,055 End Bal.: 20,326
TCHARTS FOR RECORDING BAD DEBT:
Collections on Account 122,657 Writs Offs 876
Accounts Receivable (Gross) (A)
Allowance for Doubtful Accounts (XA)
Write Offs 876 Beginning Balance 1,953 Bad Debt Expense 504 End Bal: 1,581
Accounts Receivable on the Balance Sheet will be net of allowance for doubtful accounts = the net book value
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Estimating Bad Debts: is how a company reaches the amount of bad debt to be recorded in the end-of-period adjusting entry, there are 2 methods TAKING A PERCENTAGE OF TOTAL CREDIT SALES: method that bases a companys bad debt estimate by applying a historical % to credit sales (determined by dividing total bad debt losses by total credit sales) Easier to determine, yet not as accurate as aging, therefore used on a weekly or monthly Example: basis
a company estimates a .5% loss due to bad debt
Credit Sales x Bad Debt Loss Rate (.5%) Bad Debt Expense
income statement
$150,000 x .005 $750
This Bad Debt Expense of $750 will be reported on the The Bad Debt Expense will also increase the Allowance for
Doubtful Accounts
T Chart to Record Bad Debt Expense:
Allowance for Doubtful Accounts (XA)
B B E
AGING ACCOUNTS RECEIVABLE: estimates uncollectible accounts based on the age of each account receivable (older, more overdue accounts are less likely to be collected) Harder to determine, yet more accurate than an arbitrary percentage and is therefore used on a monthly or quarterly basis inkling
Example: companies often split their accounts receivable into age categories + apply a % of estimated uncollectibles to each
AGING SCHEDULE
Sales Estimated % Estimated Amount Amount Uncollectible Uncollectible Accounts Not Yet Due 16,000 2% $320 Accounts up to 90 Days Past Due 6,000 8% 480 Accounts 90 Days Past Due 3,000 20% 600 Estimated Ending Balance in Allowance for Doubtful Accounts: $1,400 Less: Balance in Allowance for Doubtful Accounts before Adjustment (1,581-931) - 650 Bad Debt Expense for the Year 750 Aged Accounts Receivable
We subtract the Current balance for Allowance for Doubtful Accounts (Beginning Balance Write Offs, 1,581-931) from the above Estimated Balance in Allowance for Doubtful Accounts ($1,400) TChart for Adjusting Entry:
Allowance for Doubtful Accounts (XA)
B B E
BOTH METHODS of Estimating Bad Debt have the same balance sheet Presentation Accounts Receivable (Gross) 25,000 Less: Allowance for Doubtful Accounts 1,400 Accounts Receivable, Net of Allowance for Doubtful Accounts 23,600
d Receivables Turnover: measurement of the effectiveness of credit-granting and
collection activities
Receivables Turnover = Net Sales / Avg. Net Trade Accounts Receivable The faster the collection of receivable accounts, the higher the ratio Avergae Collection Period: indicates the average time it takes a customer to pay their accounts
Avg Coll. Period = 365 / Receivables Turnover Ratio =__ Days
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The Statement of Cash Flows!! Accounts receivable also significantly affect the operating section of cash flows WHEN ACCOUNTS RECEIVABLE DECREASES: (collection occurs), the Trade Accounts Receivable, Net of Provision for Doubtful Accounts must be decreased on The Cash Flows Statement WHEN ACCOUNTS RECEIVABLE INCREASES: (sales made on credit and cash has not been collected) the Trade Accounts Receivable, Net of Provision for Doubtful Accounts must be increased on the Cash Flows Statement III)REPORTING AND SAFEGUARDING CASH Cash & Cash Equivalents Defined: both are reported in one account, Cash and Equivalents for financial reporting purposes CASH: money or any instrument that banks will accept for deposit and immediate credit to a companys account (check, money order, bank draft)
CASH EQUIVALENTS: investments with original maturities of three months or less that are readily convertible to cash and whose value is unlikely to change (bank certificates of deposit and treasury bills that the US govnt issues to finance its activities) b Cash Management: responsibilities to keep cash safe ACCURATE ACCOUNTING: so reports of cash flows + balances may be prepared CONTROLS: TO ENSURE ENOUGH CASH IS AVAILABLE TO MEET.. Current Operating Needs Maturing Liabilities Unexpected Emergencies PREVENTION OF ACCUMULATION OF IDLE CASH: idle cash earns no revenue, and must
be invested in securities to earn a return until it is needed for operations
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Internal Control of Cash: INTERNAL CONTROLS: the process by which a company safeguards its assets and
provides reasonable assurance regarding the reliability of the companys financial reporting, efficiency of operations, and compliance with laws and regulations
Internal Control Procedures must extend to all assets: cash, receivables, investments, plant and equipment
Internal Controls increase reliability of financial statements and are therefore reviewed by outside independent auditors Cash! Is the asset most vulnerable to theft, and therefore has a significant # of controls
EFFECTIVE INTERNAL CONTROL OF CASH: Separation of Employee Duties Prescribed Policies + Procedures (daily bank deposits etc) d Reconciliation of the Cash Accounts and Bank Statements: BANK STATEMENTS CONTAIN: Record of each deposit by the bank during the period List of each check cleared by the bank during the period The balance in the companys account COMMON TERMS: NSF Check: not sufficient funds, the check then becomes a receivable
DEBIT receivables CREDIT cash DEBIT relevant expense account (Bank Service Expense) CREDIT cash DEBIT cash CREDIT Interest Income
SC: bank service charge INT: interest earned
BANK RECONCILIATION: the process of comparing (reconciling) the ending cash balance in a companys records and the ending cash balance reported by the bank on the monthly bank statement Should be completed at the end of each month The ending cash balance on the bank statement the ending cash balance by the related cash ledger amount on the companys books b/c
Outstanding Checks: checks written not cleared w/ the bank Deposits in Transit: when check deposits are made right before the statement period ends and have not been recorded by the bank Bank Service Charges: expense for bank services deducted on bank statement but not the companys books NSF Checks: a bounced check that must be deducted from the companys cash account and rerecorded as an account receivable Interest: interest paid by the bank to the company on its balance Errors: w/ such large volume of cash, both bank + companies make mistakes
ILLUSTRATING BANK RECONCILIATION On the completed bank reconciliation, the correct balance is the amount that should be shown in the Cash account after the reconciliation on the balance sheet! Any Changes to the Companys Books from the Reconciliation need journal entries! Preparing a Reconciliation:
Identify Outstanding Checks: compare checks listed on bank statement w/ the companys record to show those still outstanding: Check No.Amount 101 $ 1 4 5. 0 0 123 8 1 5 . 0 0 131 1 1 7 . 2 0 Total $1,077.20
This total ($1,077.20) will be deducted from the bank account on the reconciliation
These checks will actually be subtracted from the account when they clear with the bank Identify Deposits in Transit: compare deposit slips on hand with those listed on the bank statement, add any deposits not listed on the bank statement to the reconciliation Record Bank Charges and Credits: Interest Received from the Bank- enter on the bank reconciliation as an addition to the book balance (it has already been deducted from the bank balance) DEBIT cash CREDIT Interest Income NSF Checks- enter on the bank reconciliation as a deduction from the book balance (it has already been deducted from the bank statement balance) DEBIT Accounts Receivable CREDIT cash Bank Service Charges- enter on the bank reconciliation as a deduction from the book balance (it has been deducted from the bank balance) DEBIT Bank Service Expense CREDIT cash Determine the Impact of Errors: if the reconciliation still does not balance, check the journal entries made during the period, add items to book cash balance on the reconciliation (if the bank cleared a check for more than it was worth) and subtract the item if the bank under marked the item DEBIT cash CREDIT Accounts Payable