Transcript Libby Chapter 6 - University of Minnesota

Reporting and
Interpreting
Sales Revenue,
Receivables,
and Cash
Chapter 6
Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
6-2
Learning Objectives
Apply the revenue principle to determine the
accepted time to record sales revenue for
typical retailers, wholesalers, manufacturers,
and service companies.
6-3
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.
6-4
Learning Objectives
Analyze the impact of credit card sales, sales
discounts, and sales returns on the amounts
reported as net sales.
6-5
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
6-6
Credit Card Sales
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.
6-7
Credit Card Sales
When credit card sales are made, the
company must pay the credit card
company a fee for the service it provides.
6-8
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.
6-9
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.
6-10
Sales Discounts
2/10, n/30
Discount
Percentage
# of Days in
Discount
Period
Otherwise,
the Full
Amount Is
Due
Maximum
Days in
Credit
Period
6-11
To Take or Not Take the Discount
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
Annual Interest Rate =
= 2.04%
365 Days × 2.04% = 37.23%
20 Days
6-12
Sales Returns and Allowances
Debited for damaged
merchandise.
Debited for returned
merchandise.
Contra revenue
account.
6-13
Learning Objectives
Analyze and interpret the gross
profit percentage.
6-14
Gross Profit Percentage
Gross Profit
Percentage
=
Gross Profit
Net Sales
In 2003, Deckers reported gross profit
of $51,345,000 on sales of
$121,055,000.
All other things equal, a higher
gross profit results in higher net
income.
6-15
Gross Profit Percentage
Gross Profit
Percentage
Gross Profit
Percentage
=
Gross Profit
Net Sales
=
$51,345,000
$121,055,000
=
42.4%
All other things equal, a higher gross
profit results in higher net income.
2003 Gross Profit Comparisons
Deckers
Skechers U.S.A.
Timberland
42.4%
38.0%
46.5%
6-16
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.
6-17
Measuring and Reporting Receivables –
Notes Receivable
$1,200
Term
Sixty days
Principal
the order
of
Goleta, CA
January 5, 2006
Payee
after date I promise to pay to
Deckers Outdoor Corporation
One thousand two hundred --------------------------------- Dollars
Payable at
Interest
First
GoletaRate
National Bank
Value received with interest at
No. 10242 Due
March 6, 2007
12%
Maker
per annum
Ivan Goodson
Goodson Sporting Goods
Due Date
6-18
Learning Objectives
Estimate, report, and evaluate the effects of
uncollectible accounts receivable (bad debts)
on financial statements.
6-19
Accounting for Bad Debts
Bad debts result from credit customers
who will not pay the business the amount
they owe, regardless of collection efforts.
6-20
Accounting for Bad Debts
Bad Debt
Expense
Matching
Principle
Record in same
accounting
period.
Sales
Revenue
6-21
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.
6-22
Recording Bad Debt Expense Estimates
Deckers estimated bad debt expense
for 2003 to be $504,000.
Prepare the adjusting entry.
GENERAL JOURNAL
Date
Dec. 31
Description
Debit
Credit
6-23
Recording Bad Debt Expense Estimates
Deckers estimated bad debt expense
for 2003 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
6-24
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.
6-25
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.
6-26
Writing Off Uncollectible Accounts
Deckers’ total write-offs for
2003 were $876,000.
Prepare a summary journal
entry for these write-offs.
GENERAL JOURNAL
Date
Description
Debit
Credit
6-27
Writing Off Uncollectible Accounts
Deckers’ total write-offs for
2003 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
6-28
Writing Off Uncollectible Accounts
Assume that before the write-off, Deckers’
Accounts Receivable balance was
$11,000,000 and the Allowance for
Doubtful Accounts
balance was $1,000,000.
Let’s see what effect the total write-offs of
$876,000 had on these accounts.
6-29
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.
6-30
Methods for Estimating Bad Debts
Percentage of credit sales
or
Aging of accounts receivable
????
6-31
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.
6-32
Percentage of Credit Sales
Net credit sales
 % Bad debt loss rate
Amount of journal entry
6-33
Percentage of Credit Sales
In 2006, Kid’s Clothes had credit sales of
$600,000. Past experience indicates that bad
debts are one percent of sales.
What is the estimate of bad debts expense for
2006?
$600,000 × .01 = $6,000
Now, prepare the adjusting entry.
6-34
Percentage of Credit Sales
GENERAL JOURNAL
Date
Description
Dec. 31 Bad Debt Expense
Allowance for Doubtful Accounts
Debit Credit
6,000
6,000
6-35
Now let’s discuss
another method that is
used to account for
uncollectible accounts.
6-36
Aging of Accounts Receivable
Focus is on determining the desired
balance in the Allowance for Doubtful
Accounts on the balance sheet.
6-37
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.
An aging of accounts receivable for Kid’s
Clothes in 2006 might look like this . . .
6-38
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.
6-39
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.
325
$10,660
6-40
Aging Schedule
Days Past Due
Total
The column
totals are then added to
Not Yet
A/R
arrive
the total
estimate
of 90 Balance
Customer
Due at 1-30
31-60
61-90 Over
Aaron, R.
$ 235
uncollectible
accounts of $1,201. $ 235
Baxter, T.
$ 1,200
300
1,500
Clark, J.
$
50 $ 200 $ 500
750
Zak, R.
Total
% Uncollectible
Estimated
Uncoll. Amount
$ 3,500
0.01
$ 2,550
0.04
325
$ 1,830
0.10
$
$
$
35
102
183
$ 1,540
0.25
$ 1,240
0.40
$
$
385
496
325
$10,660
$ 1,201
6-41
Aging of Accounts Receivable
Days Past
Due
Record the Dec. 31, 2006,
adjusting
entry
assuming that the Allowance for Doubtful Total
Not Yet
A/R
currently
a $50 61-90
creditOver
balance.
CustomerAccountsDue
1-30 has31-60
90 Balance
Aaron, R.
Baxter, T.
Clark, J.
Zak, R.
Total
% Uncollectible
Estimated
Uncoll. Amount
$ 1,200
$ 235
300
$
$
50
$ 3,500
0.01
$ 2,550
0.04
325
$ 1,830
0.10
$
$
$
35
102
183
$ 200
$ 500
$ 1,540
0.25
$ 1,240
0.40
$
$
385
496
235
1,500
750
325
$10,660
$ 1,201
6-42
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 . . .
6-43
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
12/31/2006
before adj.
2006 adjustment
Balance at
12/31/2006
after adj.
6-44
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
6-45
Learning Objectives
Analyze and interpret the accounts receivable
turnover ratio and the effects of accounts
receivable on cash flows.
6-46
Receivables Turnover
Receivables
Turnover =
Net Sales
Average Net Trade Receivables
Deckers reported 2003 net sales of $121,055,000.
December 31, 2002, receivables were $18,745,000
and
December 31, 2003, receivables were $20,851,000.
This ratio measures how many times
average receivables are recorded and
collected for the year.
6-47
Receivables Turnover
Receivables
Turnover =
Net Sales
Average Net Trade Receivables
Receivables
$121,055,000
= 6.1
=
Turnover
($18,745,000 + $20,851,000) ÷ 2
This ratio measures how many times average
receivables are recorded and collected for the year.
2003 Receivables Turnover Comparisons
Deckers
6.1
Skechers
8.5
Timberland
10.4
6-48
Focus on Cash Flows
Add Decrease
in Accounts
Receivable
Sales
Revenue
Subtract
Increase in
Accounts
Receivable
Cash Collected
from
Customers
6-49
Learning Objectives
Report, control, and safeguard cash.
6-50
Cash and Cash Equivalents
Checks
Money
Orders
Cash and
Cash
Equivalents
Certificates
of Deposit
Bank Drafts
T-Bills
6-51
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.
6-52
Internal Control of Cash
Custody
Separation
of Duties
Recording
Authorization
6-53
Internal Control of Cash
Bank
Reconciliations
Daily
Deposits
Cash
Controls
Payment
Approval
Purchase
Approval
Check
Signatures
Prenumbered
Checks
6-54
Bank Reconciliation
Explains the difference between cash
reported on bank statement and cash
balance on company’s books.
Provides information for
reconciling journal entries.
6-55
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
6-56
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
6-57
Bank Reconciliation
Prepare a 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,
while the cash ledger account on that date
shows a balance of $7,430.
Additional information necessary for the
reconciliation is shown on the next page.
6-58
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.
6-59
Bank Reconciliation
Ending bank balance, July 31
Additions:
Deposit in transit
Deductions:
Bank error
$
486
Outstanding checks
2,417
Correct cash balance
$ 9,610
500
2,903
$ 7,207
6-60
Bank Reconciliation
Ending bank balance, July 31
Additions:
Deposit in transit
Deductions:
Bank error
$
486
Outstanding checks
2,417
Correct cash balance
$ 9,610
Ending book balance, July 31
Additions:
Interest
Deductions:
Recording error
$
NSF check
Correct cash balance
$ 7,430
500
2,903
$ 7,207
30
28
225
253
$ 7,207
6-61
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
6-62
Chapter Supplement A
Recording Discounts and Returns
6-63
Credit Card Sales
On January 2, a Deckers factory store’s credit
card sales were $3,000. The credit card
company charges a 3% service fee.
Prepare the Deckers journal entry.
GENERAL JOURNAL
Date
Jan. 2
Description
Debit
Credit
6-64
Credit Card Sales
On January 2, a Deckers factory store’s credit
card sales were $3,000. The credit card
company charges a 3% service fee.
Prepare the Deckers journal entry.
Credit Card Discounts are reported
as a contra-revenue account.
GENERAL JOURNAL
Date
Description
Jan. 2 Accounts Receivable
Credit Card Discounts
Sales Revenue
$3,000 × 3% = $90 Credit Card Fee
Debit
Credit
2,910
90
3,000
6-65
Sales Discounts
On January 6, Deckers sold $1,000 of merchandise
on credit with terms of 2/10, n/30.
Prepare the Deckers journal entry.
GENERAL JOURNAL
Date
Jan.
6
Description
Debit
Credit
6-66
Sales Discounts
On January 6, Deckers sold $1,000 of merchandise
on credit with terms of 2/10, n/30.
Prepare the Deckers journal entry.
GENERAL JOURNAL
Date
Jan.
Description
6 Accounts Receivable
Sales Revenue
Debit
Credit
1,000
1,000
6-67
Sales Discounts
On January 14, Deckers receives the
appropriate payment from the customer for
the January 6 sale.
Prepare the Deckers journal entry.
GENERAL JOURNAL
Date
Jan. 14
Description
Debit
Credit
6-68
Sales Discounts
On January 14, Deckers receives the
appropriate payment from the customer for
the January 6 sale.
Prepare the Deckers 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
6-69
Sales Discounts
If the customer remits the appropriate amount
on January 20 instead of January 14, what
entry would Deckers make?
GENERAL JOURNAL
Date
Jan. 20
Description
Debit
Credit
6-70
Sales Discounts
If the customer remits the appropriate amount
on January 20 instead of January 14, what
entry would Deckers make?
Since the customer paid outside of the discount
period, a sales discount is not granted.
GENERAL JOURNAL
Date
Description
Jan. 20 Cash
Accounts Receivable
Debit
Credit
1,000
1,000
6-71
Sales Returns and Allowances
On July 8, before paying, a customer returns $500 of
sandals originally purchased on account from
Deckers. The sandals originally cost Deckers $300.
Prepare the Deckers journal entry.
GENERAL JOURNAL
Date
Description
Debit
Credit
6-72
Sales Returns and Allowances
On July 8, before paying, a customer returns $500 of
sandals originally purchased on account from
Deckers. The sandals originally cost Deckers $300.
Prepare the Deckers 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
6-73
Chapter Supplement B
Applying the Revenue Principle in
Special Circumstances
6-74
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.
6-75
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.
Let’s look at an example of the percentage-of-completion method.
6-76
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
How much revenue and expense
should be recognized on the
project in year one using the
percentage of completion method?
Year 2
Year 3
6-77
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
6-78
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
Construction revenue (25% of $50,000,000)
Construction expense
Construction income
Year 3
$
$
12,500,000
10,000,000
2,500,000
6-79
End of Chapter 6