Week 7 _8, Chap6 Accounting 1A, Financial Accounting Reporting and Interpreting Sales Revenue, Receivables, and Cash
Instructor: Michael Booth
Learning Objectives Apply the revenue principle to determine the accepted time to record sales revenue for typical retailers, wholesalers, manufacturers, and service companies.
Accounting for Sales Revenue The revenue principle requires that revenues be recorded when earned:
Goods or services have been delivered. Amount of customer payments known. Collection is reasonably assured.
Learning Objectives Analyze the impact of credit card sales, sales discounts, and sales returns on the amounts reported as net sales.
Reporting Net Sales Companies record credit card discounts, sales discounts, and sales returns and allowances separately to allow management to monitor these transactions. Sales revenue Less: Credit card discounts Sales discounts Sales returns and allowances Net sales
Credit Card Sales to Consumers
Companies accept credit cards for several reasons: 1. To increase sales. 2. To avoid providing credit directly to customers. 3. To avoid losses due to bad checks. 4. To avoid losses due to fraudulent credit card sales. 5. To receive payment quicker.
When credit card sales are made, the company must pay the credit card company a fee for the service it provides.
Credit Card Sales When credit card sales are made, the company must pay the credit card company a fee for the service it provides.
Sales on Account When companies allow customers to purchase merchandise on an open account, the customer promises to pay the company in the future for the purchase.
Sales Discounts
2/10, n/30 Read as: “Two ten, net thirty” When customers purchase on open account, they may be offered a sales discount to encourage early payment.
Sales Discounts
2/10, n/30 Discount Percentage
# of Days in Discount Period
Otherwise, the Full Amount Is Due
Maximum Days in Credit Period
To Take or Not Take the Discount, That is the Question With discount terms of 2/10,n/30, a customer saves $2 on a $100 purchase by paying on the 10th day instead of the 30th day. Interest Rate for 20 Days =
Amount Saved Amount Paid
Interest Rate for 20 Days =
$2 $98
= 2.04%
365 Days × 2.04% = 37.23% 20 Days
Sales Returns and Allowances Debited for damaged merchandise. Debited for returned merchandise. Contra revenue account.
Sales Returns & Allowance After we post the entry to the T-accounts, the account balances look like this: Sales Returns & Allowance
Revenue
$ Amount of return
$ Sales Accounts Receivable $ Amount of return
Reporting Net Sales Companies record credit card discounts, sales discounts, and sales returns and allowances separately to allow management to monitor these transactions.
Sales revenue Less: Credit card discounts Sales discounts Sales returns and allowances Net sales
Learning Objectives Analyze and interpret the gross profit percentage.
Gross Profit Percentage Gross Profit Percentage
=
Gross Profit Net Sales
In 2010, Gaiam Q2 reported gross profit of $36,150,000 on sales of $57,220,000. A higher gross profit results in higher net income. Gross Profit indicates amount per $ remaining from each sale for operational expense and peripheral expense.
Gross Profit Percentage Gross Profit Percentage Gross Profit Percentage
=
Gross Profit Net Sales
=
$36,500 $57,220,000
=
64%
All other things equal, a higher gross profit results in higher net income.
Gaiam 64.0%
2010 Gross Profit Comparisons Industry S & P 500 5.4% 35.5%
Learning Objectives Estimate, report, and evaluate : •Effects of uncollectible accounts receivable (bad debts) on financial statements.
Measuring and Reporting Receivables
Accounts Receivable Trade receivables are amounts owed to the business for credit sales of goods, or services.
Nontrade receivables are amounts owed to the business for other than business transactions.
Measuring and Reporting Receivables Accounts receivable are created when companies have sales to customers on open accounts.
Notes receivable are written promises from another party to pay with specified terms.
Trade receivables are amounts owed to the business for credit sales of goods, or services.
Nontrade receivables are amounts owed to the business for other than business transactions.
Balance Sheet Classifications Current (short term) Noncurrent (long term)
Measuring and Reporting Receivables – Notes Receivable $1,200
Term
Sixty days Principal the order of
Goleta, CA
January 5, 2010 Payee
after date I promise to pay to Pacific BioDiesel
One thousand two hundred --------------------------------- Dollars Payable at
Interest Rate Goleta Bank of America, Maker CA 12% Value received with interest at per annum No. 10242 Due
March 6, 2011 Due Date
Jorda Evans
Ben Lomond Feed
Accounting for Bad Debts Bad debts result from credit customers who will not pay the business the amount they owe, regardless of collection efforts.
Accounting for Bad Debts
Bad Debt Expense Matching Principle
Record in same accounting period.
Sales Revenue
Accounting for Bad Debts Most businesses record an estimate of the bad debt expense by an adjusting entry at the end of the accounting period.
Recording Bad Debt Expense Estimates SunSolar estimated bad debt expense for 2010 to be $504,000. Prepare the adjusting entry.
GENERAL JOURNAL Date Dec. 31
Description
Debit
Credit
Recording Bad Debt Expense Estimates SunSolar estimated bad debt expense for 2010 to be $504,000. Prepare the adjusting entry. Bad Debt Expense is normally classified as a GENERAL JOURNAL and is closed at year-end. Date selling expense Description Debit Dec. 31 Bad Debt Expense Allowance for Doubtful Accounts
Contra asset account
Credit
504,000 504,000
Allowance for Doubtful Accounts Balance Sheet Disclosure Accounts receivable Less: Allowance for doubtful accounts Net realizable value of accounts receivable
Amount the business expects to collect.
Writing Off Uncollectible Accounts When it is clear that a specific customer’s account receivable will be uncollectible, the amount should be removed from the Accounts Receivable account and charged to the Allowance for Doubtful Accounts.
Writing Off Uncollectible Accounts Sun Solars’ total write-offs for 2011 were $876,000. Prepare a summary journal entry for these write-offs. GENERAL JOURNAL Date
Description
Debit
Credit
Writing Off Uncollectible Accounts Sun Solars’ total write-offs for 2011 were $876,000. Prepare a summary journal entry for these write-offs. GENERAL JOURNAL Date
Description Allowance for Doubtful Accounts Accounts Receivable
Debit
Credit
876,000 876,000
Writing Off Uncollectible Accounts Before the write-off: Sun Solars’ Accounts Receivable balance was $11,000,000 Allowance for Doubtful Accounts balance was $1,000,000 (after the allowance increase of $504,000)
What is the effect of total write-offs of $876,000 had on these accounts.
Writing Off Uncollectible Accounts Before WriteOff Accounts receivable $ 11,000,000 Less: Allow. for doubtful accts. 1,000,000 Net realizable value $ 10,000,000
After WriteOff $ 10,124,000 124,000 $ 10,000,000
Notice that the total write-offs of $876,000 did not change the net realizable value nor did it affect any income statement accounts.
Writing Off Uncollectible Accounts Before the write-off: Sun Solars’ Accounts Receivable balance was $10,660 Allowance for Doubtful Accounts balance was $1,200 What is the effect of total write-offs of $1,150 had on these accounts.
Writing Off Uncollectible Accounts
Accounts receivable $ Less: Allow. for doubtful accts. Net realizable value $
Before Write-Off 10,660 1,200 9,460
After WriteOff $ 9,510 50 $ 9,460
Notice that the total write-offs of $1,150 did not change the net realizable value nor did it affect any income statement accounts.
Methods for Estimating Bad Debts
Percentage of credit sales Aging of accounts receivable
Percentage of Credit Sales Bad debt percentage is based on actual uncollectible accounts from prior years’ credit sales.
Focus is on determining the amount to record on the income statement as Bad Debt Expense.
Percentage of Credit Sales Net credit sales % Bad debt loss rate Amount of journal entry
Percentage of Credit Sales In 2010, XYZ Companyhad credit sales of $127,660. Past experience indicates that bad debts are one percent (1%) of sales.
What is the estimate of bad debts expense for 2010? $127,660 × .01 = $1,280 Now, prepare the adjusting entry.
Percentage of Credit Sales GENERAL JOURNAL Date
Description
Dec. 31 Bad Debt Expense Allowance for Doubtful Accounts
Debit Credit 1,280 1,280
Now let’s discuss another method that is used to account for uncollectible accounts.
Aging of Accounts Receivable Focus is on determining the desired balance in the Allowance for Doubtful Accounts on the balance sheet.
Aging Schedule Each customer’s account is aged by breaking down the balance by showing the age (in number of days) of each part of the balance.
Aging Schedule Days Past Due
Customer Aaron, R. Baxter, T. Clark, J. Zak, R. Total
Not Yet Due $ 1,200
1-30 $ 235 300
50
Total A/R 61-90 Over 90 Balance $ 235 1,500 $ 200 $ 500 750
325 $ 1,830
325 $10,660
31-60
$ $ 3,500
$ 2,550
$ 1,540
$ 1,240
Based on past experience, the business estimates the percentage of uncollectible accounts in each time category.
Aging Schedule Days Past Due Not Yet Due
Customer Aaron, R. Baxter, T. Clark, J.
$ 1,200
1-30 $ 235 300
31-60
$
Zak, R. Total % Uncollectible
$ 3,500 0.01
$ 2,550 0.04
50
325 $ 1,830 0.10
Total A/R 61-90 Over 90 Balance $ 235 1,500 $ 200 $ 500 750 $ 1,540 0.25
$ 1,240 0.40
These percentages are then multiplied by the appropriate column totals. Note: based on historical past experience
325 $10,660
Aging Schedule Days Past Due
Customer Aaron, R. Baxter, T. Clark, J. Zak, R. Total % Uncollectible Estimated Uncoll. Amount
Not Yet Due $ 1,200
1-30 $ 235 300
31-60
$
50
$ 3,500 0.01
$ 2,550 0.04
325 $ 1,830 0.10
$
$
$
35
102
183
Total A/R 61-90 Over 90 Balance $ 235 1,500 $ 200 $ 500 750 $ 1,540 0.25
$ 1,240 0.40
$
$
385
496
The column totals are then added to arrive at the total estimate of uncollectible accounts of $1,201.
325 $10,660
$ 1,201
Aging of Accounts Receivable Days Past Due
Customer Aaron, R. Baxter, T. Clark, J. Zak, R. Total % Uncollectible Estimated Uncoll. Amount
Not Yet Due $ 1,200
1-30 $ 235 300
31-60
$
50
$ 3,500 0.01
$ 2,550 0.04
325 $ 1,830 0.10
$
$
$
35
102
183
Total A/R 61-90 Over 90 Balance $ 235 1,500 $ 200 $ 500 750 $ 1,540 0.25
$ 1,240 0.40
$
$
385
496
325 $10,660
$ 1,201
Record the Dec. 31, 2010, adjusting entry assuming that the Allowance for Doubtful Accounts currently has a $50 credit balance.
Aging of Accounts Receivable GENERAL JOURNAL Date
Description
Dec. 31 Bad Debt Expense Allowance for Doubtful Accounts
Post. Ref.
Debit
Credit
1,151 1,151
1,201 Desired Balance After posting, the Allowance 50 Credit Balance account would $ 1,151 Adjusting Entry look like this . . .
Aging of Accounts Receivable Allowance for Doubtful Accounts 50
Notice that the balance after adjustment is equal to the estimate of $1,201 based on the aging analysis performed earlier.
1,151 1,201
Balance at 12/31/2010 before adj. 2010 adjustment Balance at 12/31/2010 after adj.
Aging of Accounts Receivable Accounts Receivable % Estimated Uncollectible Desired Balance in Allowance Account - Allowance Account Credit Balance Amount of Journal Entry Accounts Receivable % Estimated Uncollectible Desired Balance in Allowance Account + Allowance Account Debit Balance Amount of Journal Entry
Learning Objectives Analyze and interpret the accounts receivable turnover ratio and the effects of accounts receivable on cash flows.
Receivables Turnover Receivables Turnover =
Net Sales Average Net Trade Receivables
Gaiam reported 2010 net sales of $262,943. December 31, 2009, receivables were $25,324 and December 31, 2010, receivables were $30,157. This ratio measures how many times average receivables are recorded and collected for the year.
Receivables Turnover Receivables Turnover =
Net Sales Average Net Trade Receivables
Receivables $262,943 = Turnover ($25,324 + $30,157) ÷ 2
= 9.48
This ratio measures how many times average receivables are recorded and collected for the year.
2008 Receivables Turnover Comparisons Gaiam 9.48
Revelon 7.57
Mary-Kay 6.51
Avg Days Receivable Outstanding Gaiam: Avg Days Sales = # days in year Outstanding A/R Turn = 365 /9.48 Avg Days Sales Outstanding = 38.5 days Revelon:
365/7.57 =
Mary-Kay: 365/6.51 =
48.2 days 56.1 days
Focus on Cash Flows Add Decrease in Accounts Receivable Sales Revenue Subtract Increase in Accounts Receivable
Cash Collected from Customers
Learning Objectives
Report, control, and safeguard cash.
Cash and Cash Equivalents Checks
Money Orders
Cash and Cash Equivalents Certificates of Deposit
Bank Drafts T-Bills
Internal Control of Cash Internal control refers to policies and procedures that are designed to: Properly account for assets.
Safeguard assets.
Ensure the accuracy of financial records.
Cash is the asset most susceptible to theft and fraud.
Internal Control of Cash Custody
Separation of Duties
Recording
Authorization
Internal Control of Cash Bank Reconciliations
Daily Deposits
Cash Controls
Payment Approval
Purchase Approval
Check Signatures
Prenumbered Checks
Bank Reconciliation Explains the difference between cash reported on bank statement and cash balance on company’s books.
Provides information for reconciling journal entries.
Bank Reconciliation Balance per Bank
Balance per Book
+ Deposits in Transit
+ Deposits by Bank (credit memos)
- Outstanding Checks
- Service Charge - NSF Checks
± Bank Errors
± Book Errors
= Correct Balance
= Correct Balance
Bank Reconciliation
All reconciling +items Deposits in Transit on the book side - Outstanding requireChecks an adjusting ±entry Bank Errors to the cash account. Balance per Bank
= Adjusted Balance
Balance per Book
+ Deposits by Bank (credit memos) - Service Charge - NSF Checks ± Book Errors = Correct Balance
Bank Reconciliation Example: July 31 bank reconciliation statement and the resulting journal entries for the Simmons Company. The July 31 bank statement indicated a cash balance of $9,610 Cash ledger account on that date shows a balance of $7,430.
Bank Reconciliation
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 customer’s 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.
Bank Reconciliation A
$486 deposit by Acme Ending bank balance, July 31Company was $ 9,610 erroneously credited to our account by the Additions: Outstanding checks totaled $2,417. bank. Deposit in transit 500 Deductions: Bank error $ 486 A $500 check mailed to the bank for deposit Outstanding checks 2,417 2,903 had not reached the bank at the statement Correct cash balance $ 7,207 date.
Bank Reconciliation Ending bank balance, July 31 $ 9,610 Additions: Deposit in transit 500 The bank statement showed $30 interest Deductions: earnedBank on the for the errorbank balance $ 486 month of July. Outstanding checks 2,417 2,903 Check 781 for supplies cleared the bank Correct cash balance $ 7,207
for $268 but was erroneously recorded in ourEnding books as balance, $240.a July ($268-$240=$28) The bankbook returned customer’s NSF $ 7,430 31 check for $225 received as payment of an Additions: account receivable. Interest 30 Deductions: Recording error NSF check Correct cash balance
$
28 225
253 $ 7,207
Bank Reconciliation GENERAL JOURNAL Date
Description
Jul 31 Cash
Post. Ref.
Debit 30
Interest Revenue 31 Supplies Inventory Accounts Receivable Cash
Credit 30
28 225 253
Recording Discounts and Returns
Credit Card Sales On January 2, a Gaiam Retail Store credit card sales were $3,000. The credit card company charges a 3% service fee. Prepare the Gaiam’s journal entry.
Credit Card Sales On January 2, a Gaiam’s Retail store credit card sales were $3,000. The credit card company charges a 3% service fee. Prepare the Gaiam’s journal entry. Credit Card Discounts are reported as a contra-revenue account.
Sales Discounts On January 6, Gaiam sold $1,000 of merchandise on credit with terms of 2/10, n/30. Prepare the Gaiam’s journal entry.
GENERAL JOURNAL Date Jan.
6
Description
Debit
Credit
Sales Discounts On January 6, Gaiam’s sold $1,000 of merchandise on credit with terms of 2/10, n/30. Prepare the Gaiam’s journal entry.
GENERAL JOURNAL Date Jan.
Description
6 Accounts Receivable Sales Revenue
Debit
Credit
1,000 1,000
Sales Discounts On January 14, Gaiam receives the appropriate payment from the customer for the January 6 sale. Prepare the Gaiam’s journal entry.
GENERAL JOURNAL Date Jan. 14
Description
Debit
Credit
Sales Discounts On January 14, Gaiam receives the appropriate payment from the customer for the January 6 sale. Prepare the Gaiam’s journal entry. $1,000 × 2% = $20 sales discount $1,000 - $20 = $980 cash receipt GENERAL JOURNAL Date
Description
Jan. 14 Cash Sales Discounts Accounts Receivable
Contra-revenue account
Debit
Credit
980 20 1,000
Sales Discounts If the customer remits the appropriate amount on January 20 instead of January 14, what entry would Gaiam make?
Sales Discounts If the customer remits the appropriate amount on January 20 instead of January 14, what entry would Gaiam make? GENERAL Since the customer paidJOURNAL outside of the discount Date Description period, a sales discount is not Debit granted. Credit Jan. 20 Cash Accounts Receivable
1,000 1,000
Sales Returns and Allowances
On July 8, before paying, a customer returns $500 of sandals originally purchased on account from Gaiam. The sandals originally cost Gaiam $300. Prepare the Gaiam journal entry.
Sales Returns and Allowances On July 8, before paying, a customer returns $500 of sandals originally purchased on account from Gaiam. The sandals originally cost Gaiam $300. Prepare the Gaiam’s journal entry. GENERAL JOURNAL Date July
Description
8 Sales Returns and Allowances
Debit 500
Accounts Receivable
July
8 Merchandise Inventory Cost of Goods Sold
Credit 500
300 300
Applying the Revenue Principle in Special Circumstances
Delayed Revenue Recognition: Installment Method Generally, revenue is recognized when: An exchange has taken place. The earnings process is nearly complete. Collection is probable. Uncertain collectibles result in delaying revenue recognition until cash is collected. Installment method: revenue is recognized as cash is collected, often over several accounting periods.
Revenue Recognition Before the Earnings Process is Complete: Long-Term Construction Contracts Completed Contract Method
Percentage-ofCompletion Method
Revenue and expenses are recognized in the year the contract is completed. Construction-in progress years show no revenue or expenses.
Revenue and expenses recognized each year as work is accomplished. Revenues each year are based on the ratio of costs incurred to total costs.
Revenue Recognition Before the Earnings Process is Complete: Long-Term Construction Contracts •An example of the percentage-of-completion method.
Acme Construction is constructing a building for Jones Foods over a three-year period for a total price of $50,000,000. Acme reported the following progress in year one: Estimated total cost Cost incurred in year one
Year 1 40,000,000 10,000,000
How much revenue and expense should be recognized on the project in year one using the percentage of completion method?
Year 2
Year 3
Revenue Recognition Before the Earnings Process is Complete: Long-Term Construction Contracts Acme Construction is constructing a building for Jones Foods over a three-year period for a total price of $50,000,000. Acme reported the following progress in year one:
Estimated total cost Cost incurred in year one
Year 1 40,000,000 10,000,000
Year 2
Year 3
Percent complete =
Total costs incurred to date Estimate of total project cost
Percent complete =
$10,000,000 = 25% $40,000,000
Revenue Recognition Before the Earnings Process is Complete: Long-Term Construction Contracts Acme Construction is constructing a building for Jones Foods over a three-year period for a total price of $50,000,000. Acme reported the following progress in year one: Estimated total cost Cost incurred in year one
Year 1 40,000,000 10,000,000
Year 2
Year 3
$10,000,000 Percent complete = = 25% $40,000,000 Construction revenue (25% of $50,000,000) Construction expense Construction income
$ $
12,500,000 10,000,000 2,500,000
In class Exercise
•AP 6-4, Page 324 •Complete Requirement 1-2 •When you have completed each task, pause and we will review the solution
Assignments: See web: http//cabrillo.edu/~mbooth This will be updated weekly as required •Update your weekly journal for the Final Journal •Work weekly on your final project, do the analysis with information learned during the week
Note: Use McGrawHill CONNECT manager to submit assignments