Slide 1

Revenue and Monetary
Assets
JOIN KHALID AZIZ
COACHING CLASSES
ICMAP STAGE 1,2,3,4,5
ICAP MODULE A,B,C,D
PIPFA
BBA & MBA
B.COM & M.COM
ACCOUNTING OF O/A LEVEL
MA-ECONOMICS
0322-3385752
KARACHI, PAKISTAN

Operating Cycle


Cash-to-cash.
• Receive cash from customer
• Purchase materials/services & pay cash
• Convert materials/services to salable
product
• Store product
• Sell product
• Receive cash from customer
2

Revenue Recognition:
When? (Timing) & How much? (Amt.)




At one point in revenue cycle
(objectivity).
Criteria:
• When? Earned (Conservatism)



Normally, goods shipped.
Service performed.

• How much? Realized or realizable
(Realization).





Already collected or collectible.
Amount can be measured reliably.

Next step: matching costs.

3

Basic Revenue Recognition Criteria


Recognize revenue in earliest period
in which:
• Entity has substantially performed what
is required in order to earn income and
• Amount of income can be reliably
measured.

4

Delivery Method




Recognize revenue when goods or
services are delivered.
For goods: when title transfers.
• FOB shipping point (when goods are
given to carrier).



Example 1:
• Order is received for Rs900. Sales
entry?
• Goods are produced. Sales entry?
• Goods are shipped. Sales entry?

5

Consignment Method


Consignor ships goods to
consignee.





Inventory on consignment
Merchandise inventory
1,000

1,000

Consignor retains title until goods
are sold to customer. At sale:





Accounts receivable
Sales revenue
COGS
Inventory on consignment

1,400
1,400
1,000
6

Franchise Revenue


Recognize:
• When earned.
• Not when agreement signed or fee
received.

7

Franchise Revenue First
Example


Tariq & Tariq’s charges a franchise
fee primarily for identifying the site,
designing the store, training
management and staff, and
otherwise helping to get the
franchise started in business.
Assume the initial fee is Rs100,000.
When should this Rs100,000 be
recorded as revenue?

8

Franchise Revenue Second
Example
• Golden, Inc. receives Rs6,000 from a
franchisee for the right to use its
trademark and have access to its
“know-how” for a period of 5 years.
This know-how includes training
sessions, and some one available to
answer questions. When should the
Rs6,000 be recognized as revenue?
9

Percentage-of-Completion Method








Design/development and
construction/production projects that
extends over several years.
Customer pays either fixed price or cost
reimbursement contract.
Reasonable assurance of profit margin and
ultimate realization.
Revenue recognized based on total
percentage of project work performed
during period.
10

Completed Contract Method


Percentage of completion method
required unless:
• Amount of income to be earned on
contract cannot reasonably be
determined.



Alternative is completed contract
method.
• Costs incurred are an asset (Contract
Work in Progress) until revenue is
recognized.

11

Production Method



Applies to agricultural and mining.
Criteria:
• Clear market determined price.
• Performance substantially complete.




Minimal remaining costs.

Permitted but not required by GAAP.

12

Installment Method






Customer pays a certain amount per
period.
Installment payment is recognized as
revenue and a proportional part of
cost of sales is recorded.
Under cost recovery method, cost is
recorded equal to installment
payment until total cost of sales is
covered.
13

Real Estate Sales





Developer often finances over many years.
Uncertainty of income due to uncertainty
of receipt of future payments.
Conditions required for revenue
recognition:
• Period allowing cancellation and refund to
buyer has expired.
• Cum payments equal to 10% of purchase
price.
• Seller has completed or is clearly capable of
completing required improvement.

14

Amount of Revenue
Recognized




Net realizable value (amount
reasonably estimated to be
collected).
2 approaches:
• Direct write-off method.
• Allowance method.



% of sales.
% of (analysis of) AR.
15

Direct Write-Off Method




Write-off when specific account that
is uncollectible is identified.
Why is this not acceptable under
GAAP?

16

Allowance Method


Estimate amount of current period
credit sales that will not be collected.
• Historical % tempered by judgment.
• Historical % of aged receivables
(+judgment).




Adjusting entry at end of period.
When an uncollectible account is
identified, it is written off.
17

Example


Amount of revenue recognized:
• Sales for the year were Rs2,000 for
cash and Rs6,000 on credit.
• Historically we don’t collect about 5%
of our credit sales due to customer
bankruptcies or unable to locate
customer.
• A customer, The XYZ Company went
bankrupt. They owed us Rs175.







Entry for revenue?
Entry for bad debts - direct write-off
(not-GAAP)?
Entries for bad debts (allowance
method)?

18

Example






Balances in Accounts
• Accounts receivable dr 3,000.
 Consisting of 2,000 current and 1,000
overdue.
• Allowance for doubtful accounts cr 50.
Estimated amount of accounts that are
uncollectible:
• 2% for current and 10% for non-current
accounts.
What entry do we make at the end of the year
to accrue for bad debts?
19

Allowance Method (continued)




Allowance… is a contra-asset
account.
Collection of a bad debt that was
written-off:


Cash
 Allowance for Doubtful Accounts

20

Sales Discounts


Sales terms are “2/10 net 30”
• Customer gets 2% cash discount if paid
within 10 days.
• Otherwise, total amount is due within
30 days.




What does “1/15 net 45” mean?
What is the effective annual rate of
savings by taking advantage of
terms of “2/10 net 30”?
21

Alternative Methods of
Accounting for Sales Discounts


Record initial sale at gross.
 At collection of net amount record
discount as a reduction from gross
sales.



Record initial sale at gross.
 At collection of net amount record
discount as an expense of the period.



Record initial sale at net.
 Record amounts not taken as discounts
as additional revenue.

22

Example


We sold Rs10,000 of mdse. Sales
terms are 2/10, n/30.
Customers paid us for Rs8,000 of
the merchandise billed within 10
days. The remaining Rs2,000
was paid within 30 days.
• Record at gross.
• Record at net.
23

Credit Card Sales


If cash received by merchant
immediately (Bank plan, MC, Visa):




Cash
Sales discount
Sales revenue

970
30
1000

24

Credit Card Sales (continued)


If cash received by merchant in 30
days (American Express, Discover):




Accounts receivable
Sales discount
Sales revenue

970
30
1000

25

Sales Returns & Allowances


Similar to bad debt expense,
 Estimate percentage of revenues that
will eventually result in returns or
allowances.
 Adjusting entry at end of period.
 Actual return or allowance.

26

Example
 On average 2% of our Rs10,000 of sales
is returned. Adjusting entry at end of
period?
 Entry for return of Rs80 of goods?
 Same for direct write-off method?

27

Sales Returns & Allowances
(Continued)




Provision for Returns and Allowances
is a liability account.
Alternative:
 Not accrue for returns and allowances
but write them off as they occur.
 Is this GAAP?

28

Adjustment vs. Expense





Realization concept suggests
adjustment to revenue.
In practice both methods are found.
Consistency:
 Same handling from year to year.




Allows same company results to be
compared from year to year.
Comparisons between companies may be
distorted.
29

Warranty Costs








Amounts are estimated (usually as a
percentage of sales).
Part of Cost of goods sold.
Record accrual (adjusting entry)
Record the actual expenditures.
Allowance… is a liability account.
Est. warranty exp. Is part of costs of
sales.
30

Warranty Expenses Example




We estimate that warranty expenses
will be 4% of our Rs10,000 of sales.
Entry?
We spent Rs120 on parts and Rs250
on labor for repairs under warranty.
Entry?

31

Interest Revenue




Amount earned by lender during the
period.
2 approaches
• Interest paid at maturity.


Interest is explicit.

• Discounted loan.




Interest is implicit.

Accounted for separately from sale.
32

Example: Interest Revenue


On January 1, 19x1 sold a customer
Rs1,000 of mdse. We received a
promissory note for Rs1,000 plus 8%
interest to be paid in one year.
• Entry for sale?
• Entry for accrual of interest on December 31,
19x1?
• Entry for receipt of payment on note on
January 1, 19x2?



On January 1, 19x1, we sold mdse. and
received a promissory note for Rs5,000
with no interest. The note is due in one
year. The market rate of interest on such
a note is 9%.
• Entry at sale:
• Year end adjusting entry (12/31/19x1)
• Entry when customer pays note (1/1/19x2)

33

Monetary& Non-monetary
Assets







Monetary assets are money or claims to
receive fixed sums of money.
Non-monetary assets are items used in
future production and sales of goods
and services.
Balance sheet distinction
 Current and non-current assets.
 Not monetary and non-monetary.





Non-monetary assets (except
inventory) on BS at unexpired cost.
(Cost less depreciation)
Monetary assets: Cash reported at face.
AR at NRV. Other at fair value.

34

Cash



Funds available for disbursement.
May include liquid short term
investments.
• Highly liquid debt instruments with
original maturities of 90 days or less.

35

Receivables


Trade receivables
• Accounts receivables from usual sales of
products or services for non-financial
institutions.



Other receivables are shown
separately.
 E.g., Due from employees, advances or
loans.
36

Marketable Securities





Must be marketable.
E.g., commercial paper, treasury
bills, publicly traded stocks and
bonds issued by companies.
Also called “Temporary Investments.”

37

Accounting for Marketable
Securities


Three categories
 Held-to-maturity: debt securities,


Valued at cost.

 Trading securities: debt or equity held
for current resale, valued at market.


Realized (i.e., if sold during period) and
unrealized (not yet sold but market price
has changed) gain or loss included in
current year’s income.
38

Accounting for Marketable
Securities (Continued)


Available-for-sale securities:
 Debt or equity securities that do not fit
either of the other 2 categories.
 Reported at market value.
 Realized gains and losses go through
income.
 Unrealized gains and losses directly
credited (or debited) to a stockholders’
equity account.

39

Analysis of Monetary Assets





Current ratio = CA/CL
Acid-test ratio = quick ratio = monetary
CA/CL= (CA - inventories - prepaid
items) /CL.
Days cash = cash/(cash expenses 
365)
 Cash expenses  total expenses depreciation.





Days receivable = average collection
period = Receivables/(Sales  365)
Ratios differ by industry.

40

41


Slide 2

Revenue and Monetary
Assets
JOIN KHALID AZIZ
COACHING CLASSES
ICMAP STAGE 1,2,3,4,5
ICAP MODULE A,B,C,D
PIPFA
BBA & MBA
B.COM & M.COM
ACCOUNTING OF O/A LEVEL
MA-ECONOMICS
0322-3385752
KARACHI, PAKISTAN

Operating Cycle


Cash-to-cash.
• Receive cash from customer
• Purchase materials/services & pay cash
• Convert materials/services to salable
product
• Store product
• Sell product
• Receive cash from customer
2

Revenue Recognition:
When? (Timing) & How much? (Amt.)




At one point in revenue cycle
(objectivity).
Criteria:
• When? Earned (Conservatism)



Normally, goods shipped.
Service performed.

• How much? Realized or realizable
(Realization).





Already collected or collectible.
Amount can be measured reliably.

Next step: matching costs.

3

Basic Revenue Recognition Criteria


Recognize revenue in earliest period
in which:
• Entity has substantially performed what
is required in order to earn income and
• Amount of income can be reliably
measured.

4

Delivery Method




Recognize revenue when goods or
services are delivered.
For goods: when title transfers.
• FOB shipping point (when goods are
given to carrier).



Example 1:
• Order is received for Rs900. Sales
entry?
• Goods are produced. Sales entry?
• Goods are shipped. Sales entry?

5

Consignment Method


Consignor ships goods to
consignee.





Inventory on consignment
Merchandise inventory
1,000

1,000

Consignor retains title until goods
are sold to customer. At sale:





Accounts receivable
Sales revenue
COGS
Inventory on consignment

1,400
1,400
1,000
6

Franchise Revenue


Recognize:
• When earned.
• Not when agreement signed or fee
received.

7

Franchise Revenue First
Example


Tariq & Tariq’s charges a franchise
fee primarily for identifying the site,
designing the store, training
management and staff, and
otherwise helping to get the
franchise started in business.
Assume the initial fee is Rs100,000.
When should this Rs100,000 be
recorded as revenue?

8

Franchise Revenue Second
Example
• Golden, Inc. receives Rs6,000 from a
franchisee for the right to use its
trademark and have access to its
“know-how” for a period of 5 years.
This know-how includes training
sessions, and some one available to
answer questions. When should the
Rs6,000 be recognized as revenue?
9

Percentage-of-Completion Method








Design/development and
construction/production projects that
extends over several years.
Customer pays either fixed price or cost
reimbursement contract.
Reasonable assurance of profit margin and
ultimate realization.
Revenue recognized based on total
percentage of project work performed
during period.
10

Completed Contract Method


Percentage of completion method
required unless:
• Amount of income to be earned on
contract cannot reasonably be
determined.



Alternative is completed contract
method.
• Costs incurred are an asset (Contract
Work in Progress) until revenue is
recognized.

11

Production Method



Applies to agricultural and mining.
Criteria:
• Clear market determined price.
• Performance substantially complete.




Minimal remaining costs.

Permitted but not required by GAAP.

12

Installment Method






Customer pays a certain amount per
period.
Installment payment is recognized as
revenue and a proportional part of
cost of sales is recorded.
Under cost recovery method, cost is
recorded equal to installment
payment until total cost of sales is
covered.
13

Real Estate Sales





Developer often finances over many years.
Uncertainty of income due to uncertainty
of receipt of future payments.
Conditions required for revenue
recognition:
• Period allowing cancellation and refund to
buyer has expired.
• Cum payments equal to 10% of purchase
price.
• Seller has completed or is clearly capable of
completing required improvement.

14

Amount of Revenue
Recognized




Net realizable value (amount
reasonably estimated to be
collected).
2 approaches:
• Direct write-off method.
• Allowance method.



% of sales.
% of (analysis of) AR.
15

Direct Write-Off Method




Write-off when specific account that
is uncollectible is identified.
Why is this not acceptable under
GAAP?

16

Allowance Method


Estimate amount of current period
credit sales that will not be collected.
• Historical % tempered by judgment.
• Historical % of aged receivables
(+judgment).




Adjusting entry at end of period.
When an uncollectible account is
identified, it is written off.
17

Example


Amount of revenue recognized:
• Sales for the year were Rs2,000 for
cash and Rs6,000 on credit.
• Historically we don’t collect about 5%
of our credit sales due to customer
bankruptcies or unable to locate
customer.
• A customer, The XYZ Company went
bankrupt. They owed us Rs175.







Entry for revenue?
Entry for bad debts - direct write-off
(not-GAAP)?
Entries for bad debts (allowance
method)?

18

Example






Balances in Accounts
• Accounts receivable dr 3,000.
 Consisting of 2,000 current and 1,000
overdue.
• Allowance for doubtful accounts cr 50.
Estimated amount of accounts that are
uncollectible:
• 2% for current and 10% for non-current
accounts.
What entry do we make at the end of the year
to accrue for bad debts?
19

Allowance Method (continued)




Allowance… is a contra-asset
account.
Collection of a bad debt that was
written-off:


Cash
 Allowance for Doubtful Accounts

20

Sales Discounts


Sales terms are “2/10 net 30”
• Customer gets 2% cash discount if paid
within 10 days.
• Otherwise, total amount is due within
30 days.




What does “1/15 net 45” mean?
What is the effective annual rate of
savings by taking advantage of
terms of “2/10 net 30”?
21

Alternative Methods of
Accounting for Sales Discounts


Record initial sale at gross.
 At collection of net amount record
discount as a reduction from gross
sales.



Record initial sale at gross.
 At collection of net amount record
discount as an expense of the period.



Record initial sale at net.
 Record amounts not taken as discounts
as additional revenue.

22

Example


We sold Rs10,000 of mdse. Sales
terms are 2/10, n/30.
Customers paid us for Rs8,000 of
the merchandise billed within 10
days. The remaining Rs2,000
was paid within 30 days.
• Record at gross.
• Record at net.
23

Credit Card Sales


If cash received by merchant
immediately (Bank plan, MC, Visa):




Cash
Sales discount
Sales revenue

970
30
1000

24

Credit Card Sales (continued)


If cash received by merchant in 30
days (American Express, Discover):




Accounts receivable
Sales discount
Sales revenue

970
30
1000

25

Sales Returns & Allowances


Similar to bad debt expense,
 Estimate percentage of revenues that
will eventually result in returns or
allowances.
 Adjusting entry at end of period.
 Actual return or allowance.

26

Example
 On average 2% of our Rs10,000 of sales
is returned. Adjusting entry at end of
period?
 Entry for return of Rs80 of goods?
 Same for direct write-off method?

27

Sales Returns & Allowances
(Continued)




Provision for Returns and Allowances
is a liability account.
Alternative:
 Not accrue for returns and allowances
but write them off as they occur.
 Is this GAAP?

28

Adjustment vs. Expense





Realization concept suggests
adjustment to revenue.
In practice both methods are found.
Consistency:
 Same handling from year to year.




Allows same company results to be
compared from year to year.
Comparisons between companies may be
distorted.
29

Warranty Costs








Amounts are estimated (usually as a
percentage of sales).
Part of Cost of goods sold.
Record accrual (adjusting entry)
Record the actual expenditures.
Allowance… is a liability account.
Est. warranty exp. Is part of costs of
sales.
30

Warranty Expenses Example




We estimate that warranty expenses
will be 4% of our Rs10,000 of sales.
Entry?
We spent Rs120 on parts and Rs250
on labor for repairs under warranty.
Entry?

31

Interest Revenue




Amount earned by lender during the
period.
2 approaches
• Interest paid at maturity.


Interest is explicit.

• Discounted loan.




Interest is implicit.

Accounted for separately from sale.
32

Example: Interest Revenue


On January 1, 19x1 sold a customer
Rs1,000 of mdse. We received a
promissory note for Rs1,000 plus 8%
interest to be paid in one year.
• Entry for sale?
• Entry for accrual of interest on December 31,
19x1?
• Entry for receipt of payment on note on
January 1, 19x2?



On January 1, 19x1, we sold mdse. and
received a promissory note for Rs5,000
with no interest. The note is due in one
year. The market rate of interest on such
a note is 9%.
• Entry at sale:
• Year end adjusting entry (12/31/19x1)
• Entry when customer pays note (1/1/19x2)

33

Monetary& Non-monetary
Assets







Monetary assets are money or claims to
receive fixed sums of money.
Non-monetary assets are items used in
future production and sales of goods
and services.
Balance sheet distinction
 Current and non-current assets.
 Not monetary and non-monetary.





Non-monetary assets (except
inventory) on BS at unexpired cost.
(Cost less depreciation)
Monetary assets: Cash reported at face.
AR at NRV. Other at fair value.

34

Cash



Funds available for disbursement.
May include liquid short term
investments.
• Highly liquid debt instruments with
original maturities of 90 days or less.

35

Receivables


Trade receivables
• Accounts receivables from usual sales of
products or services for non-financial
institutions.



Other receivables are shown
separately.
 E.g., Due from employees, advances or
loans.
36

Marketable Securities





Must be marketable.
E.g., commercial paper, treasury
bills, publicly traded stocks and
bonds issued by companies.
Also called “Temporary Investments.”

37

Accounting for Marketable
Securities


Three categories
 Held-to-maturity: debt securities,


Valued at cost.

 Trading securities: debt or equity held
for current resale, valued at market.


Realized (i.e., if sold during period) and
unrealized (not yet sold but market price
has changed) gain or loss included in
current year’s income.
38

Accounting for Marketable
Securities (Continued)


Available-for-sale securities:
 Debt or equity securities that do not fit
either of the other 2 categories.
 Reported at market value.
 Realized gains and losses go through
income.
 Unrealized gains and losses directly
credited (or debited) to a stockholders’
equity account.

39

Analysis of Monetary Assets





Current ratio = CA/CL
Acid-test ratio = quick ratio = monetary
CA/CL= (CA - inventories - prepaid
items) /CL.
Days cash = cash/(cash expenses 
365)
 Cash expenses  total expenses depreciation.





Days receivable = average collection
period = Receivables/(Sales  365)
Ratios differ by industry.

40

41


Slide 3

Revenue and Monetary
Assets
JOIN KHALID AZIZ
COACHING CLASSES
ICMAP STAGE 1,2,3,4,5
ICAP MODULE A,B,C,D
PIPFA
BBA & MBA
B.COM & M.COM
ACCOUNTING OF O/A LEVEL
MA-ECONOMICS
0322-3385752
KARACHI, PAKISTAN

Operating Cycle


Cash-to-cash.
• Receive cash from customer
• Purchase materials/services & pay cash
• Convert materials/services to salable
product
• Store product
• Sell product
• Receive cash from customer
2

Revenue Recognition:
When? (Timing) & How much? (Amt.)




At one point in revenue cycle
(objectivity).
Criteria:
• When? Earned (Conservatism)



Normally, goods shipped.
Service performed.

• How much? Realized or realizable
(Realization).





Already collected or collectible.
Amount can be measured reliably.

Next step: matching costs.

3

Basic Revenue Recognition Criteria


Recognize revenue in earliest period
in which:
• Entity has substantially performed what
is required in order to earn income and
• Amount of income can be reliably
measured.

4

Delivery Method




Recognize revenue when goods or
services are delivered.
For goods: when title transfers.
• FOB shipping point (when goods are
given to carrier).



Example 1:
• Order is received for Rs900. Sales
entry?
• Goods are produced. Sales entry?
• Goods are shipped. Sales entry?

5

Consignment Method


Consignor ships goods to
consignee.





Inventory on consignment
Merchandise inventory
1,000

1,000

Consignor retains title until goods
are sold to customer. At sale:





Accounts receivable
Sales revenue
COGS
Inventory on consignment

1,400
1,400
1,000
6

Franchise Revenue


Recognize:
• When earned.
• Not when agreement signed or fee
received.

7

Franchise Revenue First
Example


Tariq & Tariq’s charges a franchise
fee primarily for identifying the site,
designing the store, training
management and staff, and
otherwise helping to get the
franchise started in business.
Assume the initial fee is Rs100,000.
When should this Rs100,000 be
recorded as revenue?

8

Franchise Revenue Second
Example
• Golden, Inc. receives Rs6,000 from a
franchisee for the right to use its
trademark and have access to its
“know-how” for a period of 5 years.
This know-how includes training
sessions, and some one available to
answer questions. When should the
Rs6,000 be recognized as revenue?
9

Percentage-of-Completion Method








Design/development and
construction/production projects that
extends over several years.
Customer pays either fixed price or cost
reimbursement contract.
Reasonable assurance of profit margin and
ultimate realization.
Revenue recognized based on total
percentage of project work performed
during period.
10

Completed Contract Method


Percentage of completion method
required unless:
• Amount of income to be earned on
contract cannot reasonably be
determined.



Alternative is completed contract
method.
• Costs incurred are an asset (Contract
Work in Progress) until revenue is
recognized.

11

Production Method



Applies to agricultural and mining.
Criteria:
• Clear market determined price.
• Performance substantially complete.




Minimal remaining costs.

Permitted but not required by GAAP.

12

Installment Method






Customer pays a certain amount per
period.
Installment payment is recognized as
revenue and a proportional part of
cost of sales is recorded.
Under cost recovery method, cost is
recorded equal to installment
payment until total cost of sales is
covered.
13

Real Estate Sales





Developer often finances over many years.
Uncertainty of income due to uncertainty
of receipt of future payments.
Conditions required for revenue
recognition:
• Period allowing cancellation and refund to
buyer has expired.
• Cum payments equal to 10% of purchase
price.
• Seller has completed or is clearly capable of
completing required improvement.

14

Amount of Revenue
Recognized




Net realizable value (amount
reasonably estimated to be
collected).
2 approaches:
• Direct write-off method.
• Allowance method.



% of sales.
% of (analysis of) AR.
15

Direct Write-Off Method




Write-off when specific account that
is uncollectible is identified.
Why is this not acceptable under
GAAP?

16

Allowance Method


Estimate amount of current period
credit sales that will not be collected.
• Historical % tempered by judgment.
• Historical % of aged receivables
(+judgment).




Adjusting entry at end of period.
When an uncollectible account is
identified, it is written off.
17

Example


Amount of revenue recognized:
• Sales for the year were Rs2,000 for
cash and Rs6,000 on credit.
• Historically we don’t collect about 5%
of our credit sales due to customer
bankruptcies or unable to locate
customer.
• A customer, The XYZ Company went
bankrupt. They owed us Rs175.







Entry for revenue?
Entry for bad debts - direct write-off
(not-GAAP)?
Entries for bad debts (allowance
method)?

18

Example






Balances in Accounts
• Accounts receivable dr 3,000.
 Consisting of 2,000 current and 1,000
overdue.
• Allowance for doubtful accounts cr 50.
Estimated amount of accounts that are
uncollectible:
• 2% for current and 10% for non-current
accounts.
What entry do we make at the end of the year
to accrue for bad debts?
19

Allowance Method (continued)




Allowance… is a contra-asset
account.
Collection of a bad debt that was
written-off:


Cash
 Allowance for Doubtful Accounts

20

Sales Discounts


Sales terms are “2/10 net 30”
• Customer gets 2% cash discount if paid
within 10 days.
• Otherwise, total amount is due within
30 days.




What does “1/15 net 45” mean?
What is the effective annual rate of
savings by taking advantage of
terms of “2/10 net 30”?
21

Alternative Methods of
Accounting for Sales Discounts


Record initial sale at gross.
 At collection of net amount record
discount as a reduction from gross
sales.



Record initial sale at gross.
 At collection of net amount record
discount as an expense of the period.



Record initial sale at net.
 Record amounts not taken as discounts
as additional revenue.

22

Example


We sold Rs10,000 of mdse. Sales
terms are 2/10, n/30.
Customers paid us for Rs8,000 of
the merchandise billed within 10
days. The remaining Rs2,000
was paid within 30 days.
• Record at gross.
• Record at net.
23

Credit Card Sales


If cash received by merchant
immediately (Bank plan, MC, Visa):




Cash
Sales discount
Sales revenue

970
30
1000

24

Credit Card Sales (continued)


If cash received by merchant in 30
days (American Express, Discover):




Accounts receivable
Sales discount
Sales revenue

970
30
1000

25

Sales Returns & Allowances


Similar to bad debt expense,
 Estimate percentage of revenues that
will eventually result in returns or
allowances.
 Adjusting entry at end of period.
 Actual return or allowance.

26

Example
 On average 2% of our Rs10,000 of sales
is returned. Adjusting entry at end of
period?
 Entry for return of Rs80 of goods?
 Same for direct write-off method?

27

Sales Returns & Allowances
(Continued)




Provision for Returns and Allowances
is a liability account.
Alternative:
 Not accrue for returns and allowances
but write them off as they occur.
 Is this GAAP?

28

Adjustment vs. Expense





Realization concept suggests
adjustment to revenue.
In practice both methods are found.
Consistency:
 Same handling from year to year.




Allows same company results to be
compared from year to year.
Comparisons between companies may be
distorted.
29

Warranty Costs








Amounts are estimated (usually as a
percentage of sales).
Part of Cost of goods sold.
Record accrual (adjusting entry)
Record the actual expenditures.
Allowance… is a liability account.
Est. warranty exp. Is part of costs of
sales.
30

Warranty Expenses Example




We estimate that warranty expenses
will be 4% of our Rs10,000 of sales.
Entry?
We spent Rs120 on parts and Rs250
on labor for repairs under warranty.
Entry?

31

Interest Revenue




Amount earned by lender during the
period.
2 approaches
• Interest paid at maturity.


Interest is explicit.

• Discounted loan.




Interest is implicit.

Accounted for separately from sale.
32

Example: Interest Revenue


On January 1, 19x1 sold a customer
Rs1,000 of mdse. We received a
promissory note for Rs1,000 plus 8%
interest to be paid in one year.
• Entry for sale?
• Entry for accrual of interest on December 31,
19x1?
• Entry for receipt of payment on note on
January 1, 19x2?



On January 1, 19x1, we sold mdse. and
received a promissory note for Rs5,000
with no interest. The note is due in one
year. The market rate of interest on such
a note is 9%.
• Entry at sale:
• Year end adjusting entry (12/31/19x1)
• Entry when customer pays note (1/1/19x2)

33

Monetary& Non-monetary
Assets







Monetary assets are money or claims to
receive fixed sums of money.
Non-monetary assets are items used in
future production and sales of goods
and services.
Balance sheet distinction
 Current and non-current assets.
 Not monetary and non-monetary.





Non-monetary assets (except
inventory) on BS at unexpired cost.
(Cost less depreciation)
Monetary assets: Cash reported at face.
AR at NRV. Other at fair value.

34

Cash



Funds available for disbursement.
May include liquid short term
investments.
• Highly liquid debt instruments with
original maturities of 90 days or less.

35

Receivables


Trade receivables
• Accounts receivables from usual sales of
products or services for non-financial
institutions.



Other receivables are shown
separately.
 E.g., Due from employees, advances or
loans.
36

Marketable Securities





Must be marketable.
E.g., commercial paper, treasury
bills, publicly traded stocks and
bonds issued by companies.
Also called “Temporary Investments.”

37

Accounting for Marketable
Securities


Three categories
 Held-to-maturity: debt securities,


Valued at cost.

 Trading securities: debt or equity held
for current resale, valued at market.


Realized (i.e., if sold during period) and
unrealized (not yet sold but market price
has changed) gain or loss included in
current year’s income.
38

Accounting for Marketable
Securities (Continued)


Available-for-sale securities:
 Debt or equity securities that do not fit
either of the other 2 categories.
 Reported at market value.
 Realized gains and losses go through
income.
 Unrealized gains and losses directly
credited (or debited) to a stockholders’
equity account.

39

Analysis of Monetary Assets





Current ratio = CA/CL
Acid-test ratio = quick ratio = monetary
CA/CL= (CA - inventories - prepaid
items) /CL.
Days cash = cash/(cash expenses 
365)
 Cash expenses  total expenses depreciation.





Days receivable = average collection
period = Receivables/(Sales  365)
Ratios differ by industry.

40

41


Slide 4

Revenue and Monetary
Assets
JOIN KHALID AZIZ
COACHING CLASSES
ICMAP STAGE 1,2,3,4,5
ICAP MODULE A,B,C,D
PIPFA
BBA & MBA
B.COM & M.COM
ACCOUNTING OF O/A LEVEL
MA-ECONOMICS
0322-3385752
KARACHI, PAKISTAN

Operating Cycle


Cash-to-cash.
• Receive cash from customer
• Purchase materials/services & pay cash
• Convert materials/services to salable
product
• Store product
• Sell product
• Receive cash from customer
2

Revenue Recognition:
When? (Timing) & How much? (Amt.)




At one point in revenue cycle
(objectivity).
Criteria:
• When? Earned (Conservatism)



Normally, goods shipped.
Service performed.

• How much? Realized or realizable
(Realization).





Already collected or collectible.
Amount can be measured reliably.

Next step: matching costs.

3

Basic Revenue Recognition Criteria


Recognize revenue in earliest period
in which:
• Entity has substantially performed what
is required in order to earn income and
• Amount of income can be reliably
measured.

4

Delivery Method




Recognize revenue when goods or
services are delivered.
For goods: when title transfers.
• FOB shipping point (when goods are
given to carrier).



Example 1:
• Order is received for Rs900. Sales
entry?
• Goods are produced. Sales entry?
• Goods are shipped. Sales entry?

5

Consignment Method


Consignor ships goods to
consignee.





Inventory on consignment
Merchandise inventory
1,000

1,000

Consignor retains title until goods
are sold to customer. At sale:





Accounts receivable
Sales revenue
COGS
Inventory on consignment

1,400
1,400
1,000
6

Franchise Revenue


Recognize:
• When earned.
• Not when agreement signed or fee
received.

7

Franchise Revenue First
Example


Tariq & Tariq’s charges a franchise
fee primarily for identifying the site,
designing the store, training
management and staff, and
otherwise helping to get the
franchise started in business.
Assume the initial fee is Rs100,000.
When should this Rs100,000 be
recorded as revenue?

8

Franchise Revenue Second
Example
• Golden, Inc. receives Rs6,000 from a
franchisee for the right to use its
trademark and have access to its
“know-how” for a period of 5 years.
This know-how includes training
sessions, and some one available to
answer questions. When should the
Rs6,000 be recognized as revenue?
9

Percentage-of-Completion Method








Design/development and
construction/production projects that
extends over several years.
Customer pays either fixed price or cost
reimbursement contract.
Reasonable assurance of profit margin and
ultimate realization.
Revenue recognized based on total
percentage of project work performed
during period.
10

Completed Contract Method


Percentage of completion method
required unless:
• Amount of income to be earned on
contract cannot reasonably be
determined.



Alternative is completed contract
method.
• Costs incurred are an asset (Contract
Work in Progress) until revenue is
recognized.

11

Production Method



Applies to agricultural and mining.
Criteria:
• Clear market determined price.
• Performance substantially complete.




Minimal remaining costs.

Permitted but not required by GAAP.

12

Installment Method






Customer pays a certain amount per
period.
Installment payment is recognized as
revenue and a proportional part of
cost of sales is recorded.
Under cost recovery method, cost is
recorded equal to installment
payment until total cost of sales is
covered.
13

Real Estate Sales





Developer often finances over many years.
Uncertainty of income due to uncertainty
of receipt of future payments.
Conditions required for revenue
recognition:
• Period allowing cancellation and refund to
buyer has expired.
• Cum payments equal to 10% of purchase
price.
• Seller has completed or is clearly capable of
completing required improvement.

14

Amount of Revenue
Recognized




Net realizable value (amount
reasonably estimated to be
collected).
2 approaches:
• Direct write-off method.
• Allowance method.



% of sales.
% of (analysis of) AR.
15

Direct Write-Off Method




Write-off when specific account that
is uncollectible is identified.
Why is this not acceptable under
GAAP?

16

Allowance Method


Estimate amount of current period
credit sales that will not be collected.
• Historical % tempered by judgment.
• Historical % of aged receivables
(+judgment).




Adjusting entry at end of period.
When an uncollectible account is
identified, it is written off.
17

Example


Amount of revenue recognized:
• Sales for the year were Rs2,000 for
cash and Rs6,000 on credit.
• Historically we don’t collect about 5%
of our credit sales due to customer
bankruptcies or unable to locate
customer.
• A customer, The XYZ Company went
bankrupt. They owed us Rs175.







Entry for revenue?
Entry for bad debts - direct write-off
(not-GAAP)?
Entries for bad debts (allowance
method)?

18

Example






Balances in Accounts
• Accounts receivable dr 3,000.
 Consisting of 2,000 current and 1,000
overdue.
• Allowance for doubtful accounts cr 50.
Estimated amount of accounts that are
uncollectible:
• 2% for current and 10% for non-current
accounts.
What entry do we make at the end of the year
to accrue for bad debts?
19

Allowance Method (continued)




Allowance… is a contra-asset
account.
Collection of a bad debt that was
written-off:


Cash
 Allowance for Doubtful Accounts

20

Sales Discounts


Sales terms are “2/10 net 30”
• Customer gets 2% cash discount if paid
within 10 days.
• Otherwise, total amount is due within
30 days.




What does “1/15 net 45” mean?
What is the effective annual rate of
savings by taking advantage of
terms of “2/10 net 30”?
21

Alternative Methods of
Accounting for Sales Discounts


Record initial sale at gross.
 At collection of net amount record
discount as a reduction from gross
sales.



Record initial sale at gross.
 At collection of net amount record
discount as an expense of the period.



Record initial sale at net.
 Record amounts not taken as discounts
as additional revenue.

22

Example


We sold Rs10,000 of mdse. Sales
terms are 2/10, n/30.
Customers paid us for Rs8,000 of
the merchandise billed within 10
days. The remaining Rs2,000
was paid within 30 days.
• Record at gross.
• Record at net.
23

Credit Card Sales


If cash received by merchant
immediately (Bank plan, MC, Visa):




Cash
Sales discount
Sales revenue

970
30
1000

24

Credit Card Sales (continued)


If cash received by merchant in 30
days (American Express, Discover):




Accounts receivable
Sales discount
Sales revenue

970
30
1000

25

Sales Returns & Allowances


Similar to bad debt expense,
 Estimate percentage of revenues that
will eventually result in returns or
allowances.
 Adjusting entry at end of period.
 Actual return or allowance.

26

Example
 On average 2% of our Rs10,000 of sales
is returned. Adjusting entry at end of
period?
 Entry for return of Rs80 of goods?
 Same for direct write-off method?

27

Sales Returns & Allowances
(Continued)




Provision for Returns and Allowances
is a liability account.
Alternative:
 Not accrue for returns and allowances
but write them off as they occur.
 Is this GAAP?

28

Adjustment vs. Expense





Realization concept suggests
adjustment to revenue.
In practice both methods are found.
Consistency:
 Same handling from year to year.




Allows same company results to be
compared from year to year.
Comparisons between companies may be
distorted.
29

Warranty Costs








Amounts are estimated (usually as a
percentage of sales).
Part of Cost of goods sold.
Record accrual (adjusting entry)
Record the actual expenditures.
Allowance… is a liability account.
Est. warranty exp. Is part of costs of
sales.
30

Warranty Expenses Example




We estimate that warranty expenses
will be 4% of our Rs10,000 of sales.
Entry?
We spent Rs120 on parts and Rs250
on labor for repairs under warranty.
Entry?

31

Interest Revenue




Amount earned by lender during the
period.
2 approaches
• Interest paid at maturity.


Interest is explicit.

• Discounted loan.




Interest is implicit.

Accounted for separately from sale.
32

Example: Interest Revenue


On January 1, 19x1 sold a customer
Rs1,000 of mdse. We received a
promissory note for Rs1,000 plus 8%
interest to be paid in one year.
• Entry for sale?
• Entry for accrual of interest on December 31,
19x1?
• Entry for receipt of payment on note on
January 1, 19x2?



On January 1, 19x1, we sold mdse. and
received a promissory note for Rs5,000
with no interest. The note is due in one
year. The market rate of interest on such
a note is 9%.
• Entry at sale:
• Year end adjusting entry (12/31/19x1)
• Entry when customer pays note (1/1/19x2)

33

Monetary& Non-monetary
Assets







Monetary assets are money or claims to
receive fixed sums of money.
Non-monetary assets are items used in
future production and sales of goods
and services.
Balance sheet distinction
 Current and non-current assets.
 Not monetary and non-monetary.





Non-monetary assets (except
inventory) on BS at unexpired cost.
(Cost less depreciation)
Monetary assets: Cash reported at face.
AR at NRV. Other at fair value.

34

Cash



Funds available for disbursement.
May include liquid short term
investments.
• Highly liquid debt instruments with
original maturities of 90 days or less.

35

Receivables


Trade receivables
• Accounts receivables from usual sales of
products or services for non-financial
institutions.



Other receivables are shown
separately.
 E.g., Due from employees, advances or
loans.
36

Marketable Securities





Must be marketable.
E.g., commercial paper, treasury
bills, publicly traded stocks and
bonds issued by companies.
Also called “Temporary Investments.”

37

Accounting for Marketable
Securities


Three categories
 Held-to-maturity: debt securities,


Valued at cost.

 Trading securities: debt or equity held
for current resale, valued at market.


Realized (i.e., if sold during period) and
unrealized (not yet sold but market price
has changed) gain or loss included in
current year’s income.
38

Accounting for Marketable
Securities (Continued)


Available-for-sale securities:
 Debt or equity securities that do not fit
either of the other 2 categories.
 Reported at market value.
 Realized gains and losses go through
income.
 Unrealized gains and losses directly
credited (or debited) to a stockholders’
equity account.

39

Analysis of Monetary Assets





Current ratio = CA/CL
Acid-test ratio = quick ratio = monetary
CA/CL= (CA - inventories - prepaid
items) /CL.
Days cash = cash/(cash expenses 
365)
 Cash expenses  total expenses depreciation.





Days receivable = average collection
period = Receivables/(Sales  365)
Ratios differ by industry.

40

41


Slide 5

Revenue and Monetary
Assets
JOIN KHALID AZIZ
COACHING CLASSES
ICMAP STAGE 1,2,3,4,5
ICAP MODULE A,B,C,D
PIPFA
BBA & MBA
B.COM & M.COM
ACCOUNTING OF O/A LEVEL
MA-ECONOMICS
0322-3385752
KARACHI, PAKISTAN

Operating Cycle


Cash-to-cash.
• Receive cash from customer
• Purchase materials/services & pay cash
• Convert materials/services to salable
product
• Store product
• Sell product
• Receive cash from customer
2

Revenue Recognition:
When? (Timing) & How much? (Amt.)




At one point in revenue cycle
(objectivity).
Criteria:
• When? Earned (Conservatism)



Normally, goods shipped.
Service performed.

• How much? Realized or realizable
(Realization).





Already collected or collectible.
Amount can be measured reliably.

Next step: matching costs.

3

Basic Revenue Recognition Criteria


Recognize revenue in earliest period
in which:
• Entity has substantially performed what
is required in order to earn income and
• Amount of income can be reliably
measured.

4

Delivery Method




Recognize revenue when goods or
services are delivered.
For goods: when title transfers.
• FOB shipping point (when goods are
given to carrier).



Example 1:
• Order is received for Rs900. Sales
entry?
• Goods are produced. Sales entry?
• Goods are shipped. Sales entry?

5

Consignment Method


Consignor ships goods to
consignee.





Inventory on consignment
Merchandise inventory
1,000

1,000

Consignor retains title until goods
are sold to customer. At sale:





Accounts receivable
Sales revenue
COGS
Inventory on consignment

1,400
1,400
1,000
6

Franchise Revenue


Recognize:
• When earned.
• Not when agreement signed or fee
received.

7

Franchise Revenue First
Example


Tariq & Tariq’s charges a franchise
fee primarily for identifying the site,
designing the store, training
management and staff, and
otherwise helping to get the
franchise started in business.
Assume the initial fee is Rs100,000.
When should this Rs100,000 be
recorded as revenue?

8

Franchise Revenue Second
Example
• Golden, Inc. receives Rs6,000 from a
franchisee for the right to use its
trademark and have access to its
“know-how” for a period of 5 years.
This know-how includes training
sessions, and some one available to
answer questions. When should the
Rs6,000 be recognized as revenue?
9

Percentage-of-Completion Method








Design/development and
construction/production projects that
extends over several years.
Customer pays either fixed price or cost
reimbursement contract.
Reasonable assurance of profit margin and
ultimate realization.
Revenue recognized based on total
percentage of project work performed
during period.
10

Completed Contract Method


Percentage of completion method
required unless:
• Amount of income to be earned on
contract cannot reasonably be
determined.



Alternative is completed contract
method.
• Costs incurred are an asset (Contract
Work in Progress) until revenue is
recognized.

11

Production Method



Applies to agricultural and mining.
Criteria:
• Clear market determined price.
• Performance substantially complete.




Minimal remaining costs.

Permitted but not required by GAAP.

12

Installment Method






Customer pays a certain amount per
period.
Installment payment is recognized as
revenue and a proportional part of
cost of sales is recorded.
Under cost recovery method, cost is
recorded equal to installment
payment until total cost of sales is
covered.
13

Real Estate Sales





Developer often finances over many years.
Uncertainty of income due to uncertainty
of receipt of future payments.
Conditions required for revenue
recognition:
• Period allowing cancellation and refund to
buyer has expired.
• Cum payments equal to 10% of purchase
price.
• Seller has completed or is clearly capable of
completing required improvement.

14

Amount of Revenue
Recognized




Net realizable value (amount
reasonably estimated to be
collected).
2 approaches:
• Direct write-off method.
• Allowance method.



% of sales.
% of (analysis of) AR.
15

Direct Write-Off Method




Write-off when specific account that
is uncollectible is identified.
Why is this not acceptable under
GAAP?

16

Allowance Method


Estimate amount of current period
credit sales that will not be collected.
• Historical % tempered by judgment.
• Historical % of aged receivables
(+judgment).




Adjusting entry at end of period.
When an uncollectible account is
identified, it is written off.
17

Example


Amount of revenue recognized:
• Sales for the year were Rs2,000 for
cash and Rs6,000 on credit.
• Historically we don’t collect about 5%
of our credit sales due to customer
bankruptcies or unable to locate
customer.
• A customer, The XYZ Company went
bankrupt. They owed us Rs175.







Entry for revenue?
Entry for bad debts - direct write-off
(not-GAAP)?
Entries for bad debts (allowance
method)?

18

Example






Balances in Accounts
• Accounts receivable dr 3,000.
 Consisting of 2,000 current and 1,000
overdue.
• Allowance for doubtful accounts cr 50.
Estimated amount of accounts that are
uncollectible:
• 2% for current and 10% for non-current
accounts.
What entry do we make at the end of the year
to accrue for bad debts?
19

Allowance Method (continued)




Allowance… is a contra-asset
account.
Collection of a bad debt that was
written-off:


Cash
 Allowance for Doubtful Accounts

20

Sales Discounts


Sales terms are “2/10 net 30”
• Customer gets 2% cash discount if paid
within 10 days.
• Otherwise, total amount is due within
30 days.




What does “1/15 net 45” mean?
What is the effective annual rate of
savings by taking advantage of
terms of “2/10 net 30”?
21

Alternative Methods of
Accounting for Sales Discounts


Record initial sale at gross.
 At collection of net amount record
discount as a reduction from gross
sales.



Record initial sale at gross.
 At collection of net amount record
discount as an expense of the period.



Record initial sale at net.
 Record amounts not taken as discounts
as additional revenue.

22

Example


We sold Rs10,000 of mdse. Sales
terms are 2/10, n/30.
Customers paid us for Rs8,000 of
the merchandise billed within 10
days. The remaining Rs2,000
was paid within 30 days.
• Record at gross.
• Record at net.
23

Credit Card Sales


If cash received by merchant
immediately (Bank plan, MC, Visa):




Cash
Sales discount
Sales revenue

970
30
1000

24

Credit Card Sales (continued)


If cash received by merchant in 30
days (American Express, Discover):




Accounts receivable
Sales discount
Sales revenue

970
30
1000

25

Sales Returns & Allowances


Similar to bad debt expense,
 Estimate percentage of revenues that
will eventually result in returns or
allowances.
 Adjusting entry at end of period.
 Actual return or allowance.

26

Example
 On average 2% of our Rs10,000 of sales
is returned. Adjusting entry at end of
period?
 Entry for return of Rs80 of goods?
 Same for direct write-off method?

27

Sales Returns & Allowances
(Continued)




Provision for Returns and Allowances
is a liability account.
Alternative:
 Not accrue for returns and allowances
but write them off as they occur.
 Is this GAAP?

28

Adjustment vs. Expense





Realization concept suggests
adjustment to revenue.
In practice both methods are found.
Consistency:
 Same handling from year to year.




Allows same company results to be
compared from year to year.
Comparisons between companies may be
distorted.
29

Warranty Costs








Amounts are estimated (usually as a
percentage of sales).
Part of Cost of goods sold.
Record accrual (adjusting entry)
Record the actual expenditures.
Allowance… is a liability account.
Est. warranty exp. Is part of costs of
sales.
30

Warranty Expenses Example




We estimate that warranty expenses
will be 4% of our Rs10,000 of sales.
Entry?
We spent Rs120 on parts and Rs250
on labor for repairs under warranty.
Entry?

31

Interest Revenue




Amount earned by lender during the
period.
2 approaches
• Interest paid at maturity.


Interest is explicit.

• Discounted loan.




Interest is implicit.

Accounted for separately from sale.
32

Example: Interest Revenue


On January 1, 19x1 sold a customer
Rs1,000 of mdse. We received a
promissory note for Rs1,000 plus 8%
interest to be paid in one year.
• Entry for sale?
• Entry for accrual of interest on December 31,
19x1?
• Entry for receipt of payment on note on
January 1, 19x2?



On January 1, 19x1, we sold mdse. and
received a promissory note for Rs5,000
with no interest. The note is due in one
year. The market rate of interest on such
a note is 9%.
• Entry at sale:
• Year end adjusting entry (12/31/19x1)
• Entry when customer pays note (1/1/19x2)

33

Monetary& Non-monetary
Assets







Monetary assets are money or claims to
receive fixed sums of money.
Non-monetary assets are items used in
future production and sales of goods
and services.
Balance sheet distinction
 Current and non-current assets.
 Not monetary and non-monetary.





Non-monetary assets (except
inventory) on BS at unexpired cost.
(Cost less depreciation)
Monetary assets: Cash reported at face.
AR at NRV. Other at fair value.

34

Cash



Funds available for disbursement.
May include liquid short term
investments.
• Highly liquid debt instruments with
original maturities of 90 days or less.

35

Receivables


Trade receivables
• Accounts receivables from usual sales of
products or services for non-financial
institutions.



Other receivables are shown
separately.
 E.g., Due from employees, advances or
loans.
36

Marketable Securities





Must be marketable.
E.g., commercial paper, treasury
bills, publicly traded stocks and
bonds issued by companies.
Also called “Temporary Investments.”

37

Accounting for Marketable
Securities


Three categories
 Held-to-maturity: debt securities,


Valued at cost.

 Trading securities: debt or equity held
for current resale, valued at market.


Realized (i.e., if sold during period) and
unrealized (not yet sold but market price
has changed) gain or loss included in
current year’s income.
38

Accounting for Marketable
Securities (Continued)


Available-for-sale securities:
 Debt or equity securities that do not fit
either of the other 2 categories.
 Reported at market value.
 Realized gains and losses go through
income.
 Unrealized gains and losses directly
credited (or debited) to a stockholders’
equity account.

39

Analysis of Monetary Assets





Current ratio = CA/CL
Acid-test ratio = quick ratio = monetary
CA/CL= (CA - inventories - prepaid
items) /CL.
Days cash = cash/(cash expenses 
365)
 Cash expenses  total expenses depreciation.





Days receivable = average collection
period = Receivables/(Sales  365)
Ratios differ by industry.

40

41


Slide 6

Revenue and Monetary
Assets
JOIN KHALID AZIZ
COACHING CLASSES
ICMAP STAGE 1,2,3,4,5
ICAP MODULE A,B,C,D
PIPFA
BBA & MBA
B.COM & M.COM
ACCOUNTING OF O/A LEVEL
MA-ECONOMICS
0322-3385752
KARACHI, PAKISTAN

Operating Cycle


Cash-to-cash.
• Receive cash from customer
• Purchase materials/services & pay cash
• Convert materials/services to salable
product
• Store product
• Sell product
• Receive cash from customer
2

Revenue Recognition:
When? (Timing) & How much? (Amt.)




At one point in revenue cycle
(objectivity).
Criteria:
• When? Earned (Conservatism)



Normally, goods shipped.
Service performed.

• How much? Realized or realizable
(Realization).





Already collected or collectible.
Amount can be measured reliably.

Next step: matching costs.

3

Basic Revenue Recognition Criteria


Recognize revenue in earliest period
in which:
• Entity has substantially performed what
is required in order to earn income and
• Amount of income can be reliably
measured.

4

Delivery Method




Recognize revenue when goods or
services are delivered.
For goods: when title transfers.
• FOB shipping point (when goods are
given to carrier).



Example 1:
• Order is received for Rs900. Sales
entry?
• Goods are produced. Sales entry?
• Goods are shipped. Sales entry?

5

Consignment Method


Consignor ships goods to
consignee.





Inventory on consignment
Merchandise inventory
1,000

1,000

Consignor retains title until goods
are sold to customer. At sale:





Accounts receivable
Sales revenue
COGS
Inventory on consignment

1,400
1,400
1,000
6

Franchise Revenue


Recognize:
• When earned.
• Not when agreement signed or fee
received.

7

Franchise Revenue First
Example


Tariq & Tariq’s charges a franchise
fee primarily for identifying the site,
designing the store, training
management and staff, and
otherwise helping to get the
franchise started in business.
Assume the initial fee is Rs100,000.
When should this Rs100,000 be
recorded as revenue?

8

Franchise Revenue Second
Example
• Golden, Inc. receives Rs6,000 from a
franchisee for the right to use its
trademark and have access to its
“know-how” for a period of 5 years.
This know-how includes training
sessions, and some one available to
answer questions. When should the
Rs6,000 be recognized as revenue?
9

Percentage-of-Completion Method








Design/development and
construction/production projects that
extends over several years.
Customer pays either fixed price or cost
reimbursement contract.
Reasonable assurance of profit margin and
ultimate realization.
Revenue recognized based on total
percentage of project work performed
during period.
10

Completed Contract Method


Percentage of completion method
required unless:
• Amount of income to be earned on
contract cannot reasonably be
determined.



Alternative is completed contract
method.
• Costs incurred are an asset (Contract
Work in Progress) until revenue is
recognized.

11

Production Method



Applies to agricultural and mining.
Criteria:
• Clear market determined price.
• Performance substantially complete.




Minimal remaining costs.

Permitted but not required by GAAP.

12

Installment Method






Customer pays a certain amount per
period.
Installment payment is recognized as
revenue and a proportional part of
cost of sales is recorded.
Under cost recovery method, cost is
recorded equal to installment
payment until total cost of sales is
covered.
13

Real Estate Sales





Developer often finances over many years.
Uncertainty of income due to uncertainty
of receipt of future payments.
Conditions required for revenue
recognition:
• Period allowing cancellation and refund to
buyer has expired.
• Cum payments equal to 10% of purchase
price.
• Seller has completed or is clearly capable of
completing required improvement.

14

Amount of Revenue
Recognized




Net realizable value (amount
reasonably estimated to be
collected).
2 approaches:
• Direct write-off method.
• Allowance method.



% of sales.
% of (analysis of) AR.
15

Direct Write-Off Method




Write-off when specific account that
is uncollectible is identified.
Why is this not acceptable under
GAAP?

16

Allowance Method


Estimate amount of current period
credit sales that will not be collected.
• Historical % tempered by judgment.
• Historical % of aged receivables
(+judgment).




Adjusting entry at end of period.
When an uncollectible account is
identified, it is written off.
17

Example


Amount of revenue recognized:
• Sales for the year were Rs2,000 for
cash and Rs6,000 on credit.
• Historically we don’t collect about 5%
of our credit sales due to customer
bankruptcies or unable to locate
customer.
• A customer, The XYZ Company went
bankrupt. They owed us Rs175.







Entry for revenue?
Entry for bad debts - direct write-off
(not-GAAP)?
Entries for bad debts (allowance
method)?

18

Example






Balances in Accounts
• Accounts receivable dr 3,000.
 Consisting of 2,000 current and 1,000
overdue.
• Allowance for doubtful accounts cr 50.
Estimated amount of accounts that are
uncollectible:
• 2% for current and 10% for non-current
accounts.
What entry do we make at the end of the year
to accrue for bad debts?
19

Allowance Method (continued)




Allowance… is a contra-asset
account.
Collection of a bad debt that was
written-off:


Cash
 Allowance for Doubtful Accounts

20

Sales Discounts


Sales terms are “2/10 net 30”
• Customer gets 2% cash discount if paid
within 10 days.
• Otherwise, total amount is due within
30 days.




What does “1/15 net 45” mean?
What is the effective annual rate of
savings by taking advantage of
terms of “2/10 net 30”?
21

Alternative Methods of
Accounting for Sales Discounts


Record initial sale at gross.
 At collection of net amount record
discount as a reduction from gross
sales.



Record initial sale at gross.
 At collection of net amount record
discount as an expense of the period.



Record initial sale at net.
 Record amounts not taken as discounts
as additional revenue.

22

Example


We sold Rs10,000 of mdse. Sales
terms are 2/10, n/30.
Customers paid us for Rs8,000 of
the merchandise billed within 10
days. The remaining Rs2,000
was paid within 30 days.
• Record at gross.
• Record at net.
23

Credit Card Sales


If cash received by merchant
immediately (Bank plan, MC, Visa):




Cash
Sales discount
Sales revenue

970
30
1000

24

Credit Card Sales (continued)


If cash received by merchant in 30
days (American Express, Discover):




Accounts receivable
Sales discount
Sales revenue

970
30
1000

25

Sales Returns & Allowances


Similar to bad debt expense,
 Estimate percentage of revenues that
will eventually result in returns or
allowances.
 Adjusting entry at end of period.
 Actual return or allowance.

26

Example
 On average 2% of our Rs10,000 of sales
is returned. Adjusting entry at end of
period?
 Entry for return of Rs80 of goods?
 Same for direct write-off method?

27

Sales Returns & Allowances
(Continued)




Provision for Returns and Allowances
is a liability account.
Alternative:
 Not accrue for returns and allowances
but write them off as they occur.
 Is this GAAP?

28

Adjustment vs. Expense





Realization concept suggests
adjustment to revenue.
In practice both methods are found.
Consistency:
 Same handling from year to year.




Allows same company results to be
compared from year to year.
Comparisons between companies may be
distorted.
29

Warranty Costs








Amounts are estimated (usually as a
percentage of sales).
Part of Cost of goods sold.
Record accrual (adjusting entry)
Record the actual expenditures.
Allowance… is a liability account.
Est. warranty exp. Is part of costs of
sales.
30

Warranty Expenses Example




We estimate that warranty expenses
will be 4% of our Rs10,000 of sales.
Entry?
We spent Rs120 on parts and Rs250
on labor for repairs under warranty.
Entry?

31

Interest Revenue




Amount earned by lender during the
period.
2 approaches
• Interest paid at maturity.


Interest is explicit.

• Discounted loan.




Interest is implicit.

Accounted for separately from sale.
32

Example: Interest Revenue


On January 1, 19x1 sold a customer
Rs1,000 of mdse. We received a
promissory note for Rs1,000 plus 8%
interest to be paid in one year.
• Entry for sale?
• Entry for accrual of interest on December 31,
19x1?
• Entry for receipt of payment on note on
January 1, 19x2?



On January 1, 19x1, we sold mdse. and
received a promissory note for Rs5,000
with no interest. The note is due in one
year. The market rate of interest on such
a note is 9%.
• Entry at sale:
• Year end adjusting entry (12/31/19x1)
• Entry when customer pays note (1/1/19x2)

33

Monetary& Non-monetary
Assets







Monetary assets are money or claims to
receive fixed sums of money.
Non-monetary assets are items used in
future production and sales of goods
and services.
Balance sheet distinction
 Current and non-current assets.
 Not monetary and non-monetary.





Non-monetary assets (except
inventory) on BS at unexpired cost.
(Cost less depreciation)
Monetary assets: Cash reported at face.
AR at NRV. Other at fair value.

34

Cash



Funds available for disbursement.
May include liquid short term
investments.
• Highly liquid debt instruments with
original maturities of 90 days or less.

35

Receivables


Trade receivables
• Accounts receivables from usual sales of
products or services for non-financial
institutions.



Other receivables are shown
separately.
 E.g., Due from employees, advances or
loans.
36

Marketable Securities





Must be marketable.
E.g., commercial paper, treasury
bills, publicly traded stocks and
bonds issued by companies.
Also called “Temporary Investments.”

37

Accounting for Marketable
Securities


Three categories
 Held-to-maturity: debt securities,


Valued at cost.

 Trading securities: debt or equity held
for current resale, valued at market.


Realized (i.e., if sold during period) and
unrealized (not yet sold but market price
has changed) gain or loss included in
current year’s income.
38

Accounting for Marketable
Securities (Continued)


Available-for-sale securities:
 Debt or equity securities that do not fit
either of the other 2 categories.
 Reported at market value.
 Realized gains and losses go through
income.
 Unrealized gains and losses directly
credited (or debited) to a stockholders’
equity account.

39

Analysis of Monetary Assets





Current ratio = CA/CL
Acid-test ratio = quick ratio = monetary
CA/CL= (CA - inventories - prepaid
items) /CL.
Days cash = cash/(cash expenses 
365)
 Cash expenses  total expenses depreciation.





Days receivable = average collection
period = Receivables/(Sales  365)
Ratios differ by industry.

40

41


Slide 7

Revenue and Monetary
Assets
JOIN KHALID AZIZ
COACHING CLASSES
ICMAP STAGE 1,2,3,4,5
ICAP MODULE A,B,C,D
PIPFA
BBA & MBA
B.COM & M.COM
ACCOUNTING OF O/A LEVEL
MA-ECONOMICS
0322-3385752
KARACHI, PAKISTAN

Operating Cycle


Cash-to-cash.
• Receive cash from customer
• Purchase materials/services & pay cash
• Convert materials/services to salable
product
• Store product
• Sell product
• Receive cash from customer
2

Revenue Recognition:
When? (Timing) & How much? (Amt.)




At one point in revenue cycle
(objectivity).
Criteria:
• When? Earned (Conservatism)



Normally, goods shipped.
Service performed.

• How much? Realized or realizable
(Realization).





Already collected or collectible.
Amount can be measured reliably.

Next step: matching costs.

3

Basic Revenue Recognition Criteria


Recognize revenue in earliest period
in which:
• Entity has substantially performed what
is required in order to earn income and
• Amount of income can be reliably
measured.

4

Delivery Method




Recognize revenue when goods or
services are delivered.
For goods: when title transfers.
• FOB shipping point (when goods are
given to carrier).



Example 1:
• Order is received for Rs900. Sales
entry?
• Goods are produced. Sales entry?
• Goods are shipped. Sales entry?

5

Consignment Method


Consignor ships goods to
consignee.





Inventory on consignment
Merchandise inventory
1,000

1,000

Consignor retains title until goods
are sold to customer. At sale:





Accounts receivable
Sales revenue
COGS
Inventory on consignment

1,400
1,400
1,000
6

Franchise Revenue


Recognize:
• When earned.
• Not when agreement signed or fee
received.

7

Franchise Revenue First
Example


Tariq & Tariq’s charges a franchise
fee primarily for identifying the site,
designing the store, training
management and staff, and
otherwise helping to get the
franchise started in business.
Assume the initial fee is Rs100,000.
When should this Rs100,000 be
recorded as revenue?

8

Franchise Revenue Second
Example
• Golden, Inc. receives Rs6,000 from a
franchisee for the right to use its
trademark and have access to its
“know-how” for a period of 5 years.
This know-how includes training
sessions, and some one available to
answer questions. When should the
Rs6,000 be recognized as revenue?
9

Percentage-of-Completion Method








Design/development and
construction/production projects that
extends over several years.
Customer pays either fixed price or cost
reimbursement contract.
Reasonable assurance of profit margin and
ultimate realization.
Revenue recognized based on total
percentage of project work performed
during period.
10

Completed Contract Method


Percentage of completion method
required unless:
• Amount of income to be earned on
contract cannot reasonably be
determined.



Alternative is completed contract
method.
• Costs incurred are an asset (Contract
Work in Progress) until revenue is
recognized.

11

Production Method



Applies to agricultural and mining.
Criteria:
• Clear market determined price.
• Performance substantially complete.




Minimal remaining costs.

Permitted but not required by GAAP.

12

Installment Method






Customer pays a certain amount per
period.
Installment payment is recognized as
revenue and a proportional part of
cost of sales is recorded.
Under cost recovery method, cost is
recorded equal to installment
payment until total cost of sales is
covered.
13

Real Estate Sales





Developer often finances over many years.
Uncertainty of income due to uncertainty
of receipt of future payments.
Conditions required for revenue
recognition:
• Period allowing cancellation and refund to
buyer has expired.
• Cum payments equal to 10% of purchase
price.
• Seller has completed or is clearly capable of
completing required improvement.

14

Amount of Revenue
Recognized




Net realizable value (amount
reasonably estimated to be
collected).
2 approaches:
• Direct write-off method.
• Allowance method.



% of sales.
% of (analysis of) AR.
15

Direct Write-Off Method




Write-off when specific account that
is uncollectible is identified.
Why is this not acceptable under
GAAP?

16

Allowance Method


Estimate amount of current period
credit sales that will not be collected.
• Historical % tempered by judgment.
• Historical % of aged receivables
(+judgment).




Adjusting entry at end of period.
When an uncollectible account is
identified, it is written off.
17

Example


Amount of revenue recognized:
• Sales for the year were Rs2,000 for
cash and Rs6,000 on credit.
• Historically we don’t collect about 5%
of our credit sales due to customer
bankruptcies or unable to locate
customer.
• A customer, The XYZ Company went
bankrupt. They owed us Rs175.







Entry for revenue?
Entry for bad debts - direct write-off
(not-GAAP)?
Entries for bad debts (allowance
method)?

18

Example






Balances in Accounts
• Accounts receivable dr 3,000.
 Consisting of 2,000 current and 1,000
overdue.
• Allowance for doubtful accounts cr 50.
Estimated amount of accounts that are
uncollectible:
• 2% for current and 10% for non-current
accounts.
What entry do we make at the end of the year
to accrue for bad debts?
19

Allowance Method (continued)




Allowance… is a contra-asset
account.
Collection of a bad debt that was
written-off:


Cash
 Allowance for Doubtful Accounts

20

Sales Discounts


Sales terms are “2/10 net 30”
• Customer gets 2% cash discount if paid
within 10 days.
• Otherwise, total amount is due within
30 days.




What does “1/15 net 45” mean?
What is the effective annual rate of
savings by taking advantage of
terms of “2/10 net 30”?
21

Alternative Methods of
Accounting for Sales Discounts


Record initial sale at gross.
 At collection of net amount record
discount as a reduction from gross
sales.



Record initial sale at gross.
 At collection of net amount record
discount as an expense of the period.



Record initial sale at net.
 Record amounts not taken as discounts
as additional revenue.

22

Example


We sold Rs10,000 of mdse. Sales
terms are 2/10, n/30.
Customers paid us for Rs8,000 of
the merchandise billed within 10
days. The remaining Rs2,000
was paid within 30 days.
• Record at gross.
• Record at net.
23

Credit Card Sales


If cash received by merchant
immediately (Bank plan, MC, Visa):




Cash
Sales discount
Sales revenue

970
30
1000

24

Credit Card Sales (continued)


If cash received by merchant in 30
days (American Express, Discover):




Accounts receivable
Sales discount
Sales revenue

970
30
1000

25

Sales Returns & Allowances


Similar to bad debt expense,
 Estimate percentage of revenues that
will eventually result in returns or
allowances.
 Adjusting entry at end of period.
 Actual return or allowance.

26

Example
 On average 2% of our Rs10,000 of sales
is returned. Adjusting entry at end of
period?
 Entry for return of Rs80 of goods?
 Same for direct write-off method?

27

Sales Returns & Allowances
(Continued)




Provision for Returns and Allowances
is a liability account.
Alternative:
 Not accrue for returns and allowances
but write them off as they occur.
 Is this GAAP?

28

Adjustment vs. Expense





Realization concept suggests
adjustment to revenue.
In practice both methods are found.
Consistency:
 Same handling from year to year.




Allows same company results to be
compared from year to year.
Comparisons between companies may be
distorted.
29

Warranty Costs








Amounts are estimated (usually as a
percentage of sales).
Part of Cost of goods sold.
Record accrual (adjusting entry)
Record the actual expenditures.
Allowance… is a liability account.
Est. warranty exp. Is part of costs of
sales.
30

Warranty Expenses Example




We estimate that warranty expenses
will be 4% of our Rs10,000 of sales.
Entry?
We spent Rs120 on parts and Rs250
on labor for repairs under warranty.
Entry?

31

Interest Revenue




Amount earned by lender during the
period.
2 approaches
• Interest paid at maturity.


Interest is explicit.

• Discounted loan.




Interest is implicit.

Accounted for separately from sale.
32

Example: Interest Revenue


On January 1, 19x1 sold a customer
Rs1,000 of mdse. We received a
promissory note for Rs1,000 plus 8%
interest to be paid in one year.
• Entry for sale?
• Entry for accrual of interest on December 31,
19x1?
• Entry for receipt of payment on note on
January 1, 19x2?



On January 1, 19x1, we sold mdse. and
received a promissory note for Rs5,000
with no interest. The note is due in one
year. The market rate of interest on such
a note is 9%.
• Entry at sale:
• Year end adjusting entry (12/31/19x1)
• Entry when customer pays note (1/1/19x2)

33

Monetary& Non-monetary
Assets







Monetary assets are money or claims to
receive fixed sums of money.
Non-monetary assets are items used in
future production and sales of goods
and services.
Balance sheet distinction
 Current and non-current assets.
 Not monetary and non-monetary.





Non-monetary assets (except
inventory) on BS at unexpired cost.
(Cost less depreciation)
Monetary assets: Cash reported at face.
AR at NRV. Other at fair value.

34

Cash



Funds available for disbursement.
May include liquid short term
investments.
• Highly liquid debt instruments with
original maturities of 90 days or less.

35

Receivables


Trade receivables
• Accounts receivables from usual sales of
products or services for non-financial
institutions.



Other receivables are shown
separately.
 E.g., Due from employees, advances or
loans.
36

Marketable Securities





Must be marketable.
E.g., commercial paper, treasury
bills, publicly traded stocks and
bonds issued by companies.
Also called “Temporary Investments.”

37

Accounting for Marketable
Securities


Three categories
 Held-to-maturity: debt securities,


Valued at cost.

 Trading securities: debt or equity held
for current resale, valued at market.


Realized (i.e., if sold during period) and
unrealized (not yet sold but market price
has changed) gain or loss included in
current year’s income.
38

Accounting for Marketable
Securities (Continued)


Available-for-sale securities:
 Debt or equity securities that do not fit
either of the other 2 categories.
 Reported at market value.
 Realized gains and losses go through
income.
 Unrealized gains and losses directly
credited (or debited) to a stockholders’
equity account.

39

Analysis of Monetary Assets





Current ratio = CA/CL
Acid-test ratio = quick ratio = monetary
CA/CL= (CA - inventories - prepaid
items) /CL.
Days cash = cash/(cash expenses 
365)
 Cash expenses  total expenses depreciation.





Days receivable = average collection
period = Receivables/(Sales  365)
Ratios differ by industry.

40

41


Slide 8

Revenue and Monetary
Assets
JOIN KHALID AZIZ
COACHING CLASSES
ICMAP STAGE 1,2,3,4,5
ICAP MODULE A,B,C,D
PIPFA
BBA & MBA
B.COM & M.COM
ACCOUNTING OF O/A LEVEL
MA-ECONOMICS
0322-3385752
KARACHI, PAKISTAN

Operating Cycle


Cash-to-cash.
• Receive cash from customer
• Purchase materials/services & pay cash
• Convert materials/services to salable
product
• Store product
• Sell product
• Receive cash from customer
2

Revenue Recognition:
When? (Timing) & How much? (Amt.)




At one point in revenue cycle
(objectivity).
Criteria:
• When? Earned (Conservatism)



Normally, goods shipped.
Service performed.

• How much? Realized or realizable
(Realization).





Already collected or collectible.
Amount can be measured reliably.

Next step: matching costs.

3

Basic Revenue Recognition Criteria


Recognize revenue in earliest period
in which:
• Entity has substantially performed what
is required in order to earn income and
• Amount of income can be reliably
measured.

4

Delivery Method




Recognize revenue when goods or
services are delivered.
For goods: when title transfers.
• FOB shipping point (when goods are
given to carrier).



Example 1:
• Order is received for Rs900. Sales
entry?
• Goods are produced. Sales entry?
• Goods are shipped. Sales entry?

5

Consignment Method


Consignor ships goods to
consignee.





Inventory on consignment
Merchandise inventory
1,000

1,000

Consignor retains title until goods
are sold to customer. At sale:





Accounts receivable
Sales revenue
COGS
Inventory on consignment

1,400
1,400
1,000
6

Franchise Revenue


Recognize:
• When earned.
• Not when agreement signed or fee
received.

7

Franchise Revenue First
Example


Tariq & Tariq’s charges a franchise
fee primarily for identifying the site,
designing the store, training
management and staff, and
otherwise helping to get the
franchise started in business.
Assume the initial fee is Rs100,000.
When should this Rs100,000 be
recorded as revenue?

8

Franchise Revenue Second
Example
• Golden, Inc. receives Rs6,000 from a
franchisee for the right to use its
trademark and have access to its
“know-how” for a period of 5 years.
This know-how includes training
sessions, and some one available to
answer questions. When should the
Rs6,000 be recognized as revenue?
9

Percentage-of-Completion Method








Design/development and
construction/production projects that
extends over several years.
Customer pays either fixed price or cost
reimbursement contract.
Reasonable assurance of profit margin and
ultimate realization.
Revenue recognized based on total
percentage of project work performed
during period.
10

Completed Contract Method


Percentage of completion method
required unless:
• Amount of income to be earned on
contract cannot reasonably be
determined.



Alternative is completed contract
method.
• Costs incurred are an asset (Contract
Work in Progress) until revenue is
recognized.

11

Production Method



Applies to agricultural and mining.
Criteria:
• Clear market determined price.
• Performance substantially complete.




Minimal remaining costs.

Permitted but not required by GAAP.

12

Installment Method






Customer pays a certain amount per
period.
Installment payment is recognized as
revenue and a proportional part of
cost of sales is recorded.
Under cost recovery method, cost is
recorded equal to installment
payment until total cost of sales is
covered.
13

Real Estate Sales





Developer often finances over many years.
Uncertainty of income due to uncertainty
of receipt of future payments.
Conditions required for revenue
recognition:
• Period allowing cancellation and refund to
buyer has expired.
• Cum payments equal to 10% of purchase
price.
• Seller has completed or is clearly capable of
completing required improvement.

14

Amount of Revenue
Recognized




Net realizable value (amount
reasonably estimated to be
collected).
2 approaches:
• Direct write-off method.
• Allowance method.



% of sales.
% of (analysis of) AR.
15

Direct Write-Off Method




Write-off when specific account that
is uncollectible is identified.
Why is this not acceptable under
GAAP?

16

Allowance Method


Estimate amount of current period
credit sales that will not be collected.
• Historical % tempered by judgment.
• Historical % of aged receivables
(+judgment).




Adjusting entry at end of period.
When an uncollectible account is
identified, it is written off.
17

Example


Amount of revenue recognized:
• Sales for the year were Rs2,000 for
cash and Rs6,000 on credit.
• Historically we don’t collect about 5%
of our credit sales due to customer
bankruptcies or unable to locate
customer.
• A customer, The XYZ Company went
bankrupt. They owed us Rs175.







Entry for revenue?
Entry for bad debts - direct write-off
(not-GAAP)?
Entries for bad debts (allowance
method)?

18

Example






Balances in Accounts
• Accounts receivable dr 3,000.
 Consisting of 2,000 current and 1,000
overdue.
• Allowance for doubtful accounts cr 50.
Estimated amount of accounts that are
uncollectible:
• 2% for current and 10% for non-current
accounts.
What entry do we make at the end of the year
to accrue for bad debts?
19

Allowance Method (continued)




Allowance… is a contra-asset
account.
Collection of a bad debt that was
written-off:


Cash
 Allowance for Doubtful Accounts

20

Sales Discounts


Sales terms are “2/10 net 30”
• Customer gets 2% cash discount if paid
within 10 days.
• Otherwise, total amount is due within
30 days.




What does “1/15 net 45” mean?
What is the effective annual rate of
savings by taking advantage of
terms of “2/10 net 30”?
21

Alternative Methods of
Accounting for Sales Discounts


Record initial sale at gross.
 At collection of net amount record
discount as a reduction from gross
sales.



Record initial sale at gross.
 At collection of net amount record
discount as an expense of the period.



Record initial sale at net.
 Record amounts not taken as discounts
as additional revenue.

22

Example


We sold Rs10,000 of mdse. Sales
terms are 2/10, n/30.
Customers paid us for Rs8,000 of
the merchandise billed within 10
days. The remaining Rs2,000
was paid within 30 days.
• Record at gross.
• Record at net.
23

Credit Card Sales


If cash received by merchant
immediately (Bank plan, MC, Visa):




Cash
Sales discount
Sales revenue

970
30
1000

24

Credit Card Sales (continued)


If cash received by merchant in 30
days (American Express, Discover):




Accounts receivable
Sales discount
Sales revenue

970
30
1000

25

Sales Returns & Allowances


Similar to bad debt expense,
 Estimate percentage of revenues that
will eventually result in returns or
allowances.
 Adjusting entry at end of period.
 Actual return or allowance.

26

Example
 On average 2% of our Rs10,000 of sales
is returned. Adjusting entry at end of
period?
 Entry for return of Rs80 of goods?
 Same for direct write-off method?

27

Sales Returns & Allowances
(Continued)




Provision for Returns and Allowances
is a liability account.
Alternative:
 Not accrue for returns and allowances
but write them off as they occur.
 Is this GAAP?

28

Adjustment vs. Expense





Realization concept suggests
adjustment to revenue.
In practice both methods are found.
Consistency:
 Same handling from year to year.




Allows same company results to be
compared from year to year.
Comparisons between companies may be
distorted.
29

Warranty Costs








Amounts are estimated (usually as a
percentage of sales).
Part of Cost of goods sold.
Record accrual (adjusting entry)
Record the actual expenditures.
Allowance… is a liability account.
Est. warranty exp. Is part of costs of
sales.
30

Warranty Expenses Example




We estimate that warranty expenses
will be 4% of our Rs10,000 of sales.
Entry?
We spent Rs120 on parts and Rs250
on labor for repairs under warranty.
Entry?

31

Interest Revenue




Amount earned by lender during the
period.
2 approaches
• Interest paid at maturity.


Interest is explicit.

• Discounted loan.




Interest is implicit.

Accounted for separately from sale.
32

Example: Interest Revenue


On January 1, 19x1 sold a customer
Rs1,000 of mdse. We received a
promissory note for Rs1,000 plus 8%
interest to be paid in one year.
• Entry for sale?
• Entry for accrual of interest on December 31,
19x1?
• Entry for receipt of payment on note on
January 1, 19x2?



On January 1, 19x1, we sold mdse. and
received a promissory note for Rs5,000
with no interest. The note is due in one
year. The market rate of interest on such
a note is 9%.
• Entry at sale:
• Year end adjusting entry (12/31/19x1)
• Entry when customer pays note (1/1/19x2)

33

Monetary& Non-monetary
Assets







Monetary assets are money or claims to
receive fixed sums of money.
Non-monetary assets are items used in
future production and sales of goods
and services.
Balance sheet distinction
 Current and non-current assets.
 Not monetary and non-monetary.





Non-monetary assets (except
inventory) on BS at unexpired cost.
(Cost less depreciation)
Monetary assets: Cash reported at face.
AR at NRV. Other at fair value.

34

Cash



Funds available for disbursement.
May include liquid short term
investments.
• Highly liquid debt instruments with
original maturities of 90 days or less.

35

Receivables


Trade receivables
• Accounts receivables from usual sales of
products or services for non-financial
institutions.



Other receivables are shown
separately.
 E.g., Due from employees, advances or
loans.
36

Marketable Securities





Must be marketable.
E.g., commercial paper, treasury
bills, publicly traded stocks and
bonds issued by companies.
Also called “Temporary Investments.”

37

Accounting for Marketable
Securities


Three categories
 Held-to-maturity: debt securities,


Valued at cost.

 Trading securities: debt or equity held
for current resale, valued at market.


Realized (i.e., if sold during period) and
unrealized (not yet sold but market price
has changed) gain or loss included in
current year’s income.
38

Accounting for Marketable
Securities (Continued)


Available-for-sale securities:
 Debt or equity securities that do not fit
either of the other 2 categories.
 Reported at market value.
 Realized gains and losses go through
income.
 Unrealized gains and losses directly
credited (or debited) to a stockholders’
equity account.

39

Analysis of Monetary Assets





Current ratio = CA/CL
Acid-test ratio = quick ratio = monetary
CA/CL= (CA - inventories - prepaid
items) /CL.
Days cash = cash/(cash expenses 
365)
 Cash expenses  total expenses depreciation.





Days receivable = average collection
period = Receivables/(Sales  365)
Ratios differ by industry.

40

41


Slide 9

Revenue and Monetary
Assets
JOIN KHALID AZIZ
COACHING CLASSES
ICMAP STAGE 1,2,3,4,5
ICAP MODULE A,B,C,D
PIPFA
BBA & MBA
B.COM & M.COM
ACCOUNTING OF O/A LEVEL
MA-ECONOMICS
0322-3385752
KARACHI, PAKISTAN

Operating Cycle


Cash-to-cash.
• Receive cash from customer
• Purchase materials/services & pay cash
• Convert materials/services to salable
product
• Store product
• Sell product
• Receive cash from customer
2

Revenue Recognition:
When? (Timing) & How much? (Amt.)




At one point in revenue cycle
(objectivity).
Criteria:
• When? Earned (Conservatism)



Normally, goods shipped.
Service performed.

• How much? Realized or realizable
(Realization).





Already collected or collectible.
Amount can be measured reliably.

Next step: matching costs.

3

Basic Revenue Recognition Criteria


Recognize revenue in earliest period
in which:
• Entity has substantially performed what
is required in order to earn income and
• Amount of income can be reliably
measured.

4

Delivery Method




Recognize revenue when goods or
services are delivered.
For goods: when title transfers.
• FOB shipping point (when goods are
given to carrier).



Example 1:
• Order is received for Rs900. Sales
entry?
• Goods are produced. Sales entry?
• Goods are shipped. Sales entry?

5

Consignment Method


Consignor ships goods to
consignee.





Inventory on consignment
Merchandise inventory
1,000

1,000

Consignor retains title until goods
are sold to customer. At sale:





Accounts receivable
Sales revenue
COGS
Inventory on consignment

1,400
1,400
1,000
6

Franchise Revenue


Recognize:
• When earned.
• Not when agreement signed or fee
received.

7

Franchise Revenue First
Example


Tariq & Tariq’s charges a franchise
fee primarily for identifying the site,
designing the store, training
management and staff, and
otherwise helping to get the
franchise started in business.
Assume the initial fee is Rs100,000.
When should this Rs100,000 be
recorded as revenue?

8

Franchise Revenue Second
Example
• Golden, Inc. receives Rs6,000 from a
franchisee for the right to use its
trademark and have access to its
“know-how” for a period of 5 years.
This know-how includes training
sessions, and some one available to
answer questions. When should the
Rs6,000 be recognized as revenue?
9

Percentage-of-Completion Method








Design/development and
construction/production projects that
extends over several years.
Customer pays either fixed price or cost
reimbursement contract.
Reasonable assurance of profit margin and
ultimate realization.
Revenue recognized based on total
percentage of project work performed
during period.
10

Completed Contract Method


Percentage of completion method
required unless:
• Amount of income to be earned on
contract cannot reasonably be
determined.



Alternative is completed contract
method.
• Costs incurred are an asset (Contract
Work in Progress) until revenue is
recognized.

11

Production Method



Applies to agricultural and mining.
Criteria:
• Clear market determined price.
• Performance substantially complete.




Minimal remaining costs.

Permitted but not required by GAAP.

12

Installment Method






Customer pays a certain amount per
period.
Installment payment is recognized as
revenue and a proportional part of
cost of sales is recorded.
Under cost recovery method, cost is
recorded equal to installment
payment until total cost of sales is
covered.
13

Real Estate Sales





Developer often finances over many years.
Uncertainty of income due to uncertainty
of receipt of future payments.
Conditions required for revenue
recognition:
• Period allowing cancellation and refund to
buyer has expired.
• Cum payments equal to 10% of purchase
price.
• Seller has completed or is clearly capable of
completing required improvement.

14

Amount of Revenue
Recognized




Net realizable value (amount
reasonably estimated to be
collected).
2 approaches:
• Direct write-off method.
• Allowance method.



% of sales.
% of (analysis of) AR.
15

Direct Write-Off Method




Write-off when specific account that
is uncollectible is identified.
Why is this not acceptable under
GAAP?

16

Allowance Method


Estimate amount of current period
credit sales that will not be collected.
• Historical % tempered by judgment.
• Historical % of aged receivables
(+judgment).




Adjusting entry at end of period.
When an uncollectible account is
identified, it is written off.
17

Example


Amount of revenue recognized:
• Sales for the year were Rs2,000 for
cash and Rs6,000 on credit.
• Historically we don’t collect about 5%
of our credit sales due to customer
bankruptcies or unable to locate
customer.
• A customer, The XYZ Company went
bankrupt. They owed us Rs175.







Entry for revenue?
Entry for bad debts - direct write-off
(not-GAAP)?
Entries for bad debts (allowance
method)?

18

Example






Balances in Accounts
• Accounts receivable dr 3,000.
 Consisting of 2,000 current and 1,000
overdue.
• Allowance for doubtful accounts cr 50.
Estimated amount of accounts that are
uncollectible:
• 2% for current and 10% for non-current
accounts.
What entry do we make at the end of the year
to accrue for bad debts?
19

Allowance Method (continued)




Allowance… is a contra-asset
account.
Collection of a bad debt that was
written-off:


Cash
 Allowance for Doubtful Accounts

20

Sales Discounts


Sales terms are “2/10 net 30”
• Customer gets 2% cash discount if paid
within 10 days.
• Otherwise, total amount is due within
30 days.




What does “1/15 net 45” mean?
What is the effective annual rate of
savings by taking advantage of
terms of “2/10 net 30”?
21

Alternative Methods of
Accounting for Sales Discounts


Record initial sale at gross.
 At collection of net amount record
discount as a reduction from gross
sales.



Record initial sale at gross.
 At collection of net amount record
discount as an expense of the period.



Record initial sale at net.
 Record amounts not taken as discounts
as additional revenue.

22

Example


We sold Rs10,000 of mdse. Sales
terms are 2/10, n/30.
Customers paid us for Rs8,000 of
the merchandise billed within 10
days. The remaining Rs2,000
was paid within 30 days.
• Record at gross.
• Record at net.
23

Credit Card Sales


If cash received by merchant
immediately (Bank plan, MC, Visa):




Cash
Sales discount
Sales revenue

970
30
1000

24

Credit Card Sales (continued)


If cash received by merchant in 30
days (American Express, Discover):




Accounts receivable
Sales discount
Sales revenue

970
30
1000

25

Sales Returns & Allowances


Similar to bad debt expense,
 Estimate percentage of revenues that
will eventually result in returns or
allowances.
 Adjusting entry at end of period.
 Actual return or allowance.

26

Example
 On average 2% of our Rs10,000 of sales
is returned. Adjusting entry at end of
period?
 Entry for return of Rs80 of goods?
 Same for direct write-off method?

27

Sales Returns & Allowances
(Continued)




Provision for Returns and Allowances
is a liability account.
Alternative:
 Not accrue for returns and allowances
but write them off as they occur.
 Is this GAAP?

28

Adjustment vs. Expense





Realization concept suggests
adjustment to revenue.
In practice both methods are found.
Consistency:
 Same handling from year to year.




Allows same company results to be
compared from year to year.
Comparisons between companies may be
distorted.
29

Warranty Costs








Amounts are estimated (usually as a
percentage of sales).
Part of Cost of goods sold.
Record accrual (adjusting entry)
Record the actual expenditures.
Allowance… is a liability account.
Est. warranty exp. Is part of costs of
sales.
30

Warranty Expenses Example




We estimate that warranty expenses
will be 4% of our Rs10,000 of sales.
Entry?
We spent Rs120 on parts and Rs250
on labor for repairs under warranty.
Entry?

31

Interest Revenue




Amount earned by lender during the
period.
2 approaches
• Interest paid at maturity.


Interest is explicit.

• Discounted loan.




Interest is implicit.

Accounted for separately from sale.
32

Example: Interest Revenue


On January 1, 19x1 sold a customer
Rs1,000 of mdse. We received a
promissory note for Rs1,000 plus 8%
interest to be paid in one year.
• Entry for sale?
• Entry for accrual of interest on December 31,
19x1?
• Entry for receipt of payment on note on
January 1, 19x2?



On January 1, 19x1, we sold mdse. and
received a promissory note for Rs5,000
with no interest. The note is due in one
year. The market rate of interest on such
a note is 9%.
• Entry at sale:
• Year end adjusting entry (12/31/19x1)
• Entry when customer pays note (1/1/19x2)

33

Monetary& Non-monetary
Assets







Monetary assets are money or claims to
receive fixed sums of money.
Non-monetary assets are items used in
future production and sales of goods
and services.
Balance sheet distinction
 Current and non-current assets.
 Not monetary and non-monetary.





Non-monetary assets (except
inventory) on BS at unexpired cost.
(Cost less depreciation)
Monetary assets: Cash reported at face.
AR at NRV. Other at fair value.

34

Cash



Funds available for disbursement.
May include liquid short term
investments.
• Highly liquid debt instruments with
original maturities of 90 days or less.

35

Receivables


Trade receivables
• Accounts receivables from usual sales of
products or services for non-financial
institutions.



Other receivables are shown
separately.
 E.g., Due from employees, advances or
loans.
36

Marketable Securities





Must be marketable.
E.g., commercial paper, treasury
bills, publicly traded stocks and
bonds issued by companies.
Also called “Temporary Investments.”

37

Accounting for Marketable
Securities


Three categories
 Held-to-maturity: debt securities,


Valued at cost.

 Trading securities: debt or equity held
for current resale, valued at market.


Realized (i.e., if sold during period) and
unrealized (not yet sold but market price
has changed) gain or loss included in
current year’s income.
38

Accounting for Marketable
Securities (Continued)


Available-for-sale securities:
 Debt or equity securities that do not fit
either of the other 2 categories.
 Reported at market value.
 Realized gains and losses go through
income.
 Unrealized gains and losses directly
credited (or debited) to a stockholders’
equity account.

39

Analysis of Monetary Assets





Current ratio = CA/CL
Acid-test ratio = quick ratio = monetary
CA/CL= (CA - inventories - prepaid
items) /CL.
Days cash = cash/(cash expenses 
365)
 Cash expenses  total expenses depreciation.





Days receivable = average collection
period = Receivables/(Sales  365)
Ratios differ by industry.

40

41


Slide 10

Revenue and Monetary
Assets
JOIN KHALID AZIZ
COACHING CLASSES
ICMAP STAGE 1,2,3,4,5
ICAP MODULE A,B,C,D
PIPFA
BBA & MBA
B.COM & M.COM
ACCOUNTING OF O/A LEVEL
MA-ECONOMICS
0322-3385752
KARACHI, PAKISTAN

Operating Cycle


Cash-to-cash.
• Receive cash from customer
• Purchase materials/services & pay cash
• Convert materials/services to salable
product
• Store product
• Sell product
• Receive cash from customer
2

Revenue Recognition:
When? (Timing) & How much? (Amt.)




At one point in revenue cycle
(objectivity).
Criteria:
• When? Earned (Conservatism)



Normally, goods shipped.
Service performed.

• How much? Realized or realizable
(Realization).





Already collected or collectible.
Amount can be measured reliably.

Next step: matching costs.

3

Basic Revenue Recognition Criteria


Recognize revenue in earliest period
in which:
• Entity has substantially performed what
is required in order to earn income and
• Amount of income can be reliably
measured.

4

Delivery Method




Recognize revenue when goods or
services are delivered.
For goods: when title transfers.
• FOB shipping point (when goods are
given to carrier).



Example 1:
• Order is received for Rs900. Sales
entry?
• Goods are produced. Sales entry?
• Goods are shipped. Sales entry?

5

Consignment Method


Consignor ships goods to
consignee.





Inventory on consignment
Merchandise inventory
1,000

1,000

Consignor retains title until goods
are sold to customer. At sale:





Accounts receivable
Sales revenue
COGS
Inventory on consignment

1,400
1,400
1,000
6

Franchise Revenue


Recognize:
• When earned.
• Not when agreement signed or fee
received.

7

Franchise Revenue First
Example


Tariq & Tariq’s charges a franchise
fee primarily for identifying the site,
designing the store, training
management and staff, and
otherwise helping to get the
franchise started in business.
Assume the initial fee is Rs100,000.
When should this Rs100,000 be
recorded as revenue?

8

Franchise Revenue Second
Example
• Golden, Inc. receives Rs6,000 from a
franchisee for the right to use its
trademark and have access to its
“know-how” for a period of 5 years.
This know-how includes training
sessions, and some one available to
answer questions. When should the
Rs6,000 be recognized as revenue?
9

Percentage-of-Completion Method








Design/development and
construction/production projects that
extends over several years.
Customer pays either fixed price or cost
reimbursement contract.
Reasonable assurance of profit margin and
ultimate realization.
Revenue recognized based on total
percentage of project work performed
during period.
10

Completed Contract Method


Percentage of completion method
required unless:
• Amount of income to be earned on
contract cannot reasonably be
determined.



Alternative is completed contract
method.
• Costs incurred are an asset (Contract
Work in Progress) until revenue is
recognized.

11

Production Method



Applies to agricultural and mining.
Criteria:
• Clear market determined price.
• Performance substantially complete.




Minimal remaining costs.

Permitted but not required by GAAP.

12

Installment Method






Customer pays a certain amount per
period.
Installment payment is recognized as
revenue and a proportional part of
cost of sales is recorded.
Under cost recovery method, cost is
recorded equal to installment
payment until total cost of sales is
covered.
13

Real Estate Sales





Developer often finances over many years.
Uncertainty of income due to uncertainty
of receipt of future payments.
Conditions required for revenue
recognition:
• Period allowing cancellation and refund to
buyer has expired.
• Cum payments equal to 10% of purchase
price.
• Seller has completed or is clearly capable of
completing required improvement.

14

Amount of Revenue
Recognized




Net realizable value (amount
reasonably estimated to be
collected).
2 approaches:
• Direct write-off method.
• Allowance method.



% of sales.
% of (analysis of) AR.
15

Direct Write-Off Method




Write-off when specific account that
is uncollectible is identified.
Why is this not acceptable under
GAAP?

16

Allowance Method


Estimate amount of current period
credit sales that will not be collected.
• Historical % tempered by judgment.
• Historical % of aged receivables
(+judgment).




Adjusting entry at end of period.
When an uncollectible account is
identified, it is written off.
17

Example


Amount of revenue recognized:
• Sales for the year were Rs2,000 for
cash and Rs6,000 on credit.
• Historically we don’t collect about 5%
of our credit sales due to customer
bankruptcies or unable to locate
customer.
• A customer, The XYZ Company went
bankrupt. They owed us Rs175.







Entry for revenue?
Entry for bad debts - direct write-off
(not-GAAP)?
Entries for bad debts (allowance
method)?

18

Example






Balances in Accounts
• Accounts receivable dr 3,000.
 Consisting of 2,000 current and 1,000
overdue.
• Allowance for doubtful accounts cr 50.
Estimated amount of accounts that are
uncollectible:
• 2% for current and 10% for non-current
accounts.
What entry do we make at the end of the year
to accrue for bad debts?
19

Allowance Method (continued)




Allowance… is a contra-asset
account.
Collection of a bad debt that was
written-off:


Cash
 Allowance for Doubtful Accounts

20

Sales Discounts


Sales terms are “2/10 net 30”
• Customer gets 2% cash discount if paid
within 10 days.
• Otherwise, total amount is due within
30 days.




What does “1/15 net 45” mean?
What is the effective annual rate of
savings by taking advantage of
terms of “2/10 net 30”?
21

Alternative Methods of
Accounting for Sales Discounts


Record initial sale at gross.
 At collection of net amount record
discount as a reduction from gross
sales.



Record initial sale at gross.
 At collection of net amount record
discount as an expense of the period.



Record initial sale at net.
 Record amounts not taken as discounts
as additional revenue.

22

Example


We sold Rs10,000 of mdse. Sales
terms are 2/10, n/30.
Customers paid us for Rs8,000 of
the merchandise billed within 10
days. The remaining Rs2,000
was paid within 30 days.
• Record at gross.
• Record at net.
23

Credit Card Sales


If cash received by merchant
immediately (Bank plan, MC, Visa):




Cash
Sales discount
Sales revenue

970
30
1000

24

Credit Card Sales (continued)


If cash received by merchant in 30
days (American Express, Discover):




Accounts receivable
Sales discount
Sales revenue

970
30
1000

25

Sales Returns & Allowances


Similar to bad debt expense,
 Estimate percentage of revenues that
will eventually result in returns or
allowances.
 Adjusting entry at end of period.
 Actual return or allowance.

26

Example
 On average 2% of our Rs10,000 of sales
is returned. Adjusting entry at end of
period?
 Entry for return of Rs80 of goods?
 Same for direct write-off method?

27

Sales Returns & Allowances
(Continued)




Provision for Returns and Allowances
is a liability account.
Alternative:
 Not accrue for returns and allowances
but write them off as they occur.
 Is this GAAP?

28

Adjustment vs. Expense





Realization concept suggests
adjustment to revenue.
In practice both methods are found.
Consistency:
 Same handling from year to year.




Allows same company results to be
compared from year to year.
Comparisons between companies may be
distorted.
29

Warranty Costs








Amounts are estimated (usually as a
percentage of sales).
Part of Cost of goods sold.
Record accrual (adjusting entry)
Record the actual expenditures.
Allowance… is a liability account.
Est. warranty exp. Is part of costs of
sales.
30

Warranty Expenses Example




We estimate that warranty expenses
will be 4% of our Rs10,000 of sales.
Entry?
We spent Rs120 on parts and Rs250
on labor for repairs under warranty.
Entry?

31

Interest Revenue




Amount earned by lender during the
period.
2 approaches
• Interest paid at maturity.


Interest is explicit.

• Discounted loan.




Interest is implicit.

Accounted for separately from sale.
32

Example: Interest Revenue


On January 1, 19x1 sold a customer
Rs1,000 of mdse. We received a
promissory note for Rs1,000 plus 8%
interest to be paid in one year.
• Entry for sale?
• Entry for accrual of interest on December 31,
19x1?
• Entry for receipt of payment on note on
January 1, 19x2?



On January 1, 19x1, we sold mdse. and
received a promissory note for Rs5,000
with no interest. The note is due in one
year. The market rate of interest on such
a note is 9%.
• Entry at sale:
• Year end adjusting entry (12/31/19x1)
• Entry when customer pays note (1/1/19x2)

33

Monetary& Non-monetary
Assets







Monetary assets are money or claims to
receive fixed sums of money.
Non-monetary assets are items used in
future production and sales of goods
and services.
Balance sheet distinction
 Current and non-current assets.
 Not monetary and non-monetary.





Non-monetary assets (except
inventory) on BS at unexpired cost.
(Cost less depreciation)
Monetary assets: Cash reported at face.
AR at NRV. Other at fair value.

34

Cash



Funds available for disbursement.
May include liquid short term
investments.
• Highly liquid debt instruments with
original maturities of 90 days or less.

35

Receivables


Trade receivables
• Accounts receivables from usual sales of
products or services for non-financial
institutions.



Other receivables are shown
separately.
 E.g., Due from employees, advances or
loans.
36

Marketable Securities





Must be marketable.
E.g., commercial paper, treasury
bills, publicly traded stocks and
bonds issued by companies.
Also called “Temporary Investments.”

37

Accounting for Marketable
Securities


Three categories
 Held-to-maturity: debt securities,


Valued at cost.

 Trading securities: debt or equity held
for current resale, valued at market.


Realized (i.e., if sold during period) and
unrealized (not yet sold but market price
has changed) gain or loss included in
current year’s income.
38

Accounting for Marketable
Securities (Continued)


Available-for-sale securities:
 Debt or equity securities that do not fit
either of the other 2 categories.
 Reported at market value.
 Realized gains and losses go through
income.
 Unrealized gains and losses directly
credited (or debited) to a stockholders’
equity account.

39

Analysis of Monetary Assets





Current ratio = CA/CL
Acid-test ratio = quick ratio = monetary
CA/CL= (CA - inventories - prepaid
items) /CL.
Days cash = cash/(cash expenses 
365)
 Cash expenses  total expenses depreciation.





Days receivable = average collection
period = Receivables/(Sales  365)
Ratios differ by industry.

40

41


Slide 11

Revenue and Monetary
Assets
JOIN KHALID AZIZ
COACHING CLASSES
ICMAP STAGE 1,2,3,4,5
ICAP MODULE A,B,C,D
PIPFA
BBA & MBA
B.COM & M.COM
ACCOUNTING OF O/A LEVEL
MA-ECONOMICS
0322-3385752
KARACHI, PAKISTAN

Operating Cycle


Cash-to-cash.
• Receive cash from customer
• Purchase materials/services & pay cash
• Convert materials/services to salable
product
• Store product
• Sell product
• Receive cash from customer
2

Revenue Recognition:
When? (Timing) & How much? (Amt.)




At one point in revenue cycle
(objectivity).
Criteria:
• When? Earned (Conservatism)



Normally, goods shipped.
Service performed.

• How much? Realized or realizable
(Realization).





Already collected or collectible.
Amount can be measured reliably.

Next step: matching costs.

3

Basic Revenue Recognition Criteria


Recognize revenue in earliest period
in which:
• Entity has substantially performed what
is required in order to earn income and
• Amount of income can be reliably
measured.

4

Delivery Method




Recognize revenue when goods or
services are delivered.
For goods: when title transfers.
• FOB shipping point (when goods are
given to carrier).



Example 1:
• Order is received for Rs900. Sales
entry?
• Goods are produced. Sales entry?
• Goods are shipped. Sales entry?

5

Consignment Method


Consignor ships goods to
consignee.





Inventory on consignment
Merchandise inventory
1,000

1,000

Consignor retains title until goods
are sold to customer. At sale:





Accounts receivable
Sales revenue
COGS
Inventory on consignment

1,400
1,400
1,000
6

Franchise Revenue


Recognize:
• When earned.
• Not when agreement signed or fee
received.

7

Franchise Revenue First
Example


Tariq & Tariq’s charges a franchise
fee primarily for identifying the site,
designing the store, training
management and staff, and
otherwise helping to get the
franchise started in business.
Assume the initial fee is Rs100,000.
When should this Rs100,000 be
recorded as revenue?

8

Franchise Revenue Second
Example
• Golden, Inc. receives Rs6,000 from a
franchisee for the right to use its
trademark and have access to its
“know-how” for a period of 5 years.
This know-how includes training
sessions, and some one available to
answer questions. When should the
Rs6,000 be recognized as revenue?
9

Percentage-of-Completion Method








Design/development and
construction/production projects that
extends over several years.
Customer pays either fixed price or cost
reimbursement contract.
Reasonable assurance of profit margin and
ultimate realization.
Revenue recognized based on total
percentage of project work performed
during period.
10

Completed Contract Method


Percentage of completion method
required unless:
• Amount of income to be earned on
contract cannot reasonably be
determined.



Alternative is completed contract
method.
• Costs incurred are an asset (Contract
Work in Progress) until revenue is
recognized.

11

Production Method



Applies to agricultural and mining.
Criteria:
• Clear market determined price.
• Performance substantially complete.




Minimal remaining costs.

Permitted but not required by GAAP.

12

Installment Method






Customer pays a certain amount per
period.
Installment payment is recognized as
revenue and a proportional part of
cost of sales is recorded.
Under cost recovery method, cost is
recorded equal to installment
payment until total cost of sales is
covered.
13

Real Estate Sales





Developer often finances over many years.
Uncertainty of income due to uncertainty
of receipt of future payments.
Conditions required for revenue
recognition:
• Period allowing cancellation and refund to
buyer has expired.
• Cum payments equal to 10% of purchase
price.
• Seller has completed or is clearly capable of
completing required improvement.

14

Amount of Revenue
Recognized




Net realizable value (amount
reasonably estimated to be
collected).
2 approaches:
• Direct write-off method.
• Allowance method.



% of sales.
% of (analysis of) AR.
15

Direct Write-Off Method




Write-off when specific account that
is uncollectible is identified.
Why is this not acceptable under
GAAP?

16

Allowance Method


Estimate amount of current period
credit sales that will not be collected.
• Historical % tempered by judgment.
• Historical % of aged receivables
(+judgment).




Adjusting entry at end of period.
When an uncollectible account is
identified, it is written off.
17

Example


Amount of revenue recognized:
• Sales for the year were Rs2,000 for
cash and Rs6,000 on credit.
• Historically we don’t collect about 5%
of our credit sales due to customer
bankruptcies or unable to locate
customer.
• A customer, The XYZ Company went
bankrupt. They owed us Rs175.







Entry for revenue?
Entry for bad debts - direct write-off
(not-GAAP)?
Entries for bad debts (allowance
method)?

18

Example






Balances in Accounts
• Accounts receivable dr 3,000.
 Consisting of 2,000 current and 1,000
overdue.
• Allowance for doubtful accounts cr 50.
Estimated amount of accounts that are
uncollectible:
• 2% for current and 10% for non-current
accounts.
What entry do we make at the end of the year
to accrue for bad debts?
19

Allowance Method (continued)




Allowance… is a contra-asset
account.
Collection of a bad debt that was
written-off:


Cash
 Allowance for Doubtful Accounts

20

Sales Discounts


Sales terms are “2/10 net 30”
• Customer gets 2% cash discount if paid
within 10 days.
• Otherwise, total amount is due within
30 days.




What does “1/15 net 45” mean?
What is the effective annual rate of
savings by taking advantage of
terms of “2/10 net 30”?
21

Alternative Methods of
Accounting for Sales Discounts


Record initial sale at gross.
 At collection of net amount record
discount as a reduction from gross
sales.



Record initial sale at gross.
 At collection of net amount record
discount as an expense of the period.



Record initial sale at net.
 Record amounts not taken as discounts
as additional revenue.

22

Example


We sold Rs10,000 of mdse. Sales
terms are 2/10, n/30.
Customers paid us for Rs8,000 of
the merchandise billed within 10
days. The remaining Rs2,000
was paid within 30 days.
• Record at gross.
• Record at net.
23

Credit Card Sales


If cash received by merchant
immediately (Bank plan, MC, Visa):




Cash
Sales discount
Sales revenue

970
30
1000

24

Credit Card Sales (continued)


If cash received by merchant in 30
days (American Express, Discover):




Accounts receivable
Sales discount
Sales revenue

970
30
1000

25

Sales Returns & Allowances


Similar to bad debt expense,
 Estimate percentage of revenues that
will eventually result in returns or
allowances.
 Adjusting entry at end of period.
 Actual return or allowance.

26

Example
 On average 2% of our Rs10,000 of sales
is returned. Adjusting entry at end of
period?
 Entry for return of Rs80 of goods?
 Same for direct write-off method?

27

Sales Returns & Allowances
(Continued)




Provision for Returns and Allowances
is a liability account.
Alternative:
 Not accrue for returns and allowances
but write them off as they occur.
 Is this GAAP?

28

Adjustment vs. Expense





Realization concept suggests
adjustment to revenue.
In practice both methods are found.
Consistency:
 Same handling from year to year.




Allows same company results to be
compared from year to year.
Comparisons between companies may be
distorted.
29

Warranty Costs








Amounts are estimated (usually as a
percentage of sales).
Part of Cost of goods sold.
Record accrual (adjusting entry)
Record the actual expenditures.
Allowance… is a liability account.
Est. warranty exp. Is part of costs of
sales.
30

Warranty Expenses Example




We estimate that warranty expenses
will be 4% of our Rs10,000 of sales.
Entry?
We spent Rs120 on parts and Rs250
on labor for repairs under warranty.
Entry?

31

Interest Revenue




Amount earned by lender during the
period.
2 approaches
• Interest paid at maturity.


Interest is explicit.

• Discounted loan.




Interest is implicit.

Accounted for separately from sale.
32

Example: Interest Revenue


On January 1, 19x1 sold a customer
Rs1,000 of mdse. We received a
promissory note for Rs1,000 plus 8%
interest to be paid in one year.
• Entry for sale?
• Entry for accrual of interest on December 31,
19x1?
• Entry for receipt of payment on note on
January 1, 19x2?



On January 1, 19x1, we sold mdse. and
received a promissory note for Rs5,000
with no interest. The note is due in one
year. The market rate of interest on such
a note is 9%.
• Entry at sale:
• Year end adjusting entry (12/31/19x1)
• Entry when customer pays note (1/1/19x2)

33

Monetary& Non-monetary
Assets







Monetary assets are money or claims to
receive fixed sums of money.
Non-monetary assets are items used in
future production and sales of goods
and services.
Balance sheet distinction
 Current and non-current assets.
 Not monetary and non-monetary.





Non-monetary assets (except
inventory) on BS at unexpired cost.
(Cost less depreciation)
Monetary assets: Cash reported at face.
AR at NRV. Other at fair value.

34

Cash



Funds available for disbursement.
May include liquid short term
investments.
• Highly liquid debt instruments with
original maturities of 90 days or less.

35

Receivables


Trade receivables
• Accounts receivables from usual sales of
products or services for non-financial
institutions.



Other receivables are shown
separately.
 E.g., Due from employees, advances or
loans.
36

Marketable Securities





Must be marketable.
E.g., commercial paper, treasury
bills, publicly traded stocks and
bonds issued by companies.
Also called “Temporary Investments.”

37

Accounting for Marketable
Securities


Three categories
 Held-to-maturity: debt securities,


Valued at cost.

 Trading securities: debt or equity held
for current resale, valued at market.


Realized (i.e., if sold during period) and
unrealized (not yet sold but market price
has changed) gain or loss included in
current year’s income.
38

Accounting for Marketable
Securities (Continued)


Available-for-sale securities:
 Debt or equity securities that do not fit
either of the other 2 categories.
 Reported at market value.
 Realized gains and losses go through
income.
 Unrealized gains and losses directly
credited (or debited) to a stockholders’
equity account.

39

Analysis of Monetary Assets





Current ratio = CA/CL
Acid-test ratio = quick ratio = monetary
CA/CL= (CA - inventories - prepaid
items) /CL.
Days cash = cash/(cash expenses 
365)
 Cash expenses  total expenses depreciation.





Days receivable = average collection
period = Receivables/(Sales  365)
Ratios differ by industry.

40

41


Slide 12

Revenue and Monetary
Assets
JOIN KHALID AZIZ
COACHING CLASSES
ICMAP STAGE 1,2,3,4,5
ICAP MODULE A,B,C,D
PIPFA
BBA & MBA
B.COM & M.COM
ACCOUNTING OF O/A LEVEL
MA-ECONOMICS
0322-3385752
KARACHI, PAKISTAN

Operating Cycle


Cash-to-cash.
• Receive cash from customer
• Purchase materials/services & pay cash
• Convert materials/services to salable
product
• Store product
• Sell product
• Receive cash from customer
2

Revenue Recognition:
When? (Timing) & How much? (Amt.)




At one point in revenue cycle
(objectivity).
Criteria:
• When? Earned (Conservatism)



Normally, goods shipped.
Service performed.

• How much? Realized or realizable
(Realization).





Already collected or collectible.
Amount can be measured reliably.

Next step: matching costs.

3

Basic Revenue Recognition Criteria


Recognize revenue in earliest period
in which:
• Entity has substantially performed what
is required in order to earn income and
• Amount of income can be reliably
measured.

4

Delivery Method




Recognize revenue when goods or
services are delivered.
For goods: when title transfers.
• FOB shipping point (when goods are
given to carrier).



Example 1:
• Order is received for Rs900. Sales
entry?
• Goods are produced. Sales entry?
• Goods are shipped. Sales entry?

5

Consignment Method


Consignor ships goods to
consignee.





Inventory on consignment
Merchandise inventory
1,000

1,000

Consignor retains title until goods
are sold to customer. At sale:





Accounts receivable
Sales revenue
COGS
Inventory on consignment

1,400
1,400
1,000
6

Franchise Revenue


Recognize:
• When earned.
• Not when agreement signed or fee
received.

7

Franchise Revenue First
Example


Tariq & Tariq’s charges a franchise
fee primarily for identifying the site,
designing the store, training
management and staff, and
otherwise helping to get the
franchise started in business.
Assume the initial fee is Rs100,000.
When should this Rs100,000 be
recorded as revenue?

8

Franchise Revenue Second
Example
• Golden, Inc. receives Rs6,000 from a
franchisee for the right to use its
trademark and have access to its
“know-how” for a period of 5 years.
This know-how includes training
sessions, and some one available to
answer questions. When should the
Rs6,000 be recognized as revenue?
9

Percentage-of-Completion Method








Design/development and
construction/production projects that
extends over several years.
Customer pays either fixed price or cost
reimbursement contract.
Reasonable assurance of profit margin and
ultimate realization.
Revenue recognized based on total
percentage of project work performed
during period.
10

Completed Contract Method


Percentage of completion method
required unless:
• Amount of income to be earned on
contract cannot reasonably be
determined.



Alternative is completed contract
method.
• Costs incurred are an asset (Contract
Work in Progress) until revenue is
recognized.

11

Production Method



Applies to agricultural and mining.
Criteria:
• Clear market determined price.
• Performance substantially complete.




Minimal remaining costs.

Permitted but not required by GAAP.

12

Installment Method






Customer pays a certain amount per
period.
Installment payment is recognized as
revenue and a proportional part of
cost of sales is recorded.
Under cost recovery method, cost is
recorded equal to installment
payment until total cost of sales is
covered.
13

Real Estate Sales





Developer often finances over many years.
Uncertainty of income due to uncertainty
of receipt of future payments.
Conditions required for revenue
recognition:
• Period allowing cancellation and refund to
buyer has expired.
• Cum payments equal to 10% of purchase
price.
• Seller has completed or is clearly capable of
completing required improvement.

14

Amount of Revenue
Recognized




Net realizable value (amount
reasonably estimated to be
collected).
2 approaches:
• Direct write-off method.
• Allowance method.



% of sales.
% of (analysis of) AR.
15

Direct Write-Off Method




Write-off when specific account that
is uncollectible is identified.
Why is this not acceptable under
GAAP?

16

Allowance Method


Estimate amount of current period
credit sales that will not be collected.
• Historical % tempered by judgment.
• Historical % of aged receivables
(+judgment).




Adjusting entry at end of period.
When an uncollectible account is
identified, it is written off.
17

Example


Amount of revenue recognized:
• Sales for the year were Rs2,000 for
cash and Rs6,000 on credit.
• Historically we don’t collect about 5%
of our credit sales due to customer
bankruptcies or unable to locate
customer.
• A customer, The XYZ Company went
bankrupt. They owed us Rs175.







Entry for revenue?
Entry for bad debts - direct write-off
(not-GAAP)?
Entries for bad debts (allowance
method)?

18

Example






Balances in Accounts
• Accounts receivable dr 3,000.
 Consisting of 2,000 current and 1,000
overdue.
• Allowance for doubtful accounts cr 50.
Estimated amount of accounts that are
uncollectible:
• 2% for current and 10% for non-current
accounts.
What entry do we make at the end of the year
to accrue for bad debts?
19

Allowance Method (continued)




Allowance… is a contra-asset
account.
Collection of a bad debt that was
written-off:


Cash
 Allowance for Doubtful Accounts

20

Sales Discounts


Sales terms are “2/10 net 30”
• Customer gets 2% cash discount if paid
within 10 days.
• Otherwise, total amount is due within
30 days.




What does “1/15 net 45” mean?
What is the effective annual rate of
savings by taking advantage of
terms of “2/10 net 30”?
21

Alternative Methods of
Accounting for Sales Discounts


Record initial sale at gross.
 At collection of net amount record
discount as a reduction from gross
sales.



Record initial sale at gross.
 At collection of net amount record
discount as an expense of the period.



Record initial sale at net.
 Record amounts not taken as discounts
as additional revenue.

22

Example


We sold Rs10,000 of mdse. Sales
terms are 2/10, n/30.
Customers paid us for Rs8,000 of
the merchandise billed within 10
days. The remaining Rs2,000
was paid within 30 days.
• Record at gross.
• Record at net.
23

Credit Card Sales


If cash received by merchant
immediately (Bank plan, MC, Visa):




Cash
Sales discount
Sales revenue

970
30
1000

24

Credit Card Sales (continued)


If cash received by merchant in 30
days (American Express, Discover):




Accounts receivable
Sales discount
Sales revenue

970
30
1000

25

Sales Returns & Allowances


Similar to bad debt expense,
 Estimate percentage of revenues that
will eventually result in returns or
allowances.
 Adjusting entry at end of period.
 Actual return or allowance.

26

Example
 On average 2% of our Rs10,000 of sales
is returned. Adjusting entry at end of
period?
 Entry for return of Rs80 of goods?
 Same for direct write-off method?

27

Sales Returns & Allowances
(Continued)




Provision for Returns and Allowances
is a liability account.
Alternative:
 Not accrue for returns and allowances
but write them off as they occur.
 Is this GAAP?

28

Adjustment vs. Expense





Realization concept suggests
adjustment to revenue.
In practice both methods are found.
Consistency:
 Same handling from year to year.




Allows same company results to be
compared from year to year.
Comparisons between companies may be
distorted.
29

Warranty Costs








Amounts are estimated (usually as a
percentage of sales).
Part of Cost of goods sold.
Record accrual (adjusting entry)
Record the actual expenditures.
Allowance… is a liability account.
Est. warranty exp. Is part of costs of
sales.
30

Warranty Expenses Example




We estimate that warranty expenses
will be 4% of our Rs10,000 of sales.
Entry?
We spent Rs120 on parts and Rs250
on labor for repairs under warranty.
Entry?

31

Interest Revenue




Amount earned by lender during the
period.
2 approaches
• Interest paid at maturity.


Interest is explicit.

• Discounted loan.




Interest is implicit.

Accounted for separately from sale.
32

Example: Interest Revenue


On January 1, 19x1 sold a customer
Rs1,000 of mdse. We received a
promissory note for Rs1,000 plus 8%
interest to be paid in one year.
• Entry for sale?
• Entry for accrual of interest on December 31,
19x1?
• Entry for receipt of payment on note on
January 1, 19x2?



On January 1, 19x1, we sold mdse. and
received a promissory note for Rs5,000
with no interest. The note is due in one
year. The market rate of interest on such
a note is 9%.
• Entry at sale:
• Year end adjusting entry (12/31/19x1)
• Entry when customer pays note (1/1/19x2)

33

Monetary& Non-monetary
Assets







Monetary assets are money or claims to
receive fixed sums of money.
Non-monetary assets are items used in
future production and sales of goods
and services.
Balance sheet distinction
 Current and non-current assets.
 Not monetary and non-monetary.





Non-monetary assets (except
inventory) on BS at unexpired cost.
(Cost less depreciation)
Monetary assets: Cash reported at face.
AR at NRV. Other at fair value.

34

Cash



Funds available for disbursement.
May include liquid short term
investments.
• Highly liquid debt instruments with
original maturities of 90 days or less.

35

Receivables


Trade receivables
• Accounts receivables from usual sales of
products or services for non-financial
institutions.



Other receivables are shown
separately.
 E.g., Due from employees, advances or
loans.
36

Marketable Securities





Must be marketable.
E.g., commercial paper, treasury
bills, publicly traded stocks and
bonds issued by companies.
Also called “Temporary Investments.”

37

Accounting for Marketable
Securities


Three categories
 Held-to-maturity: debt securities,


Valued at cost.

 Trading securities: debt or equity held
for current resale, valued at market.


Realized (i.e., if sold during period) and
unrealized (not yet sold but market price
has changed) gain or loss included in
current year’s income.
38

Accounting for Marketable
Securities (Continued)


Available-for-sale securities:
 Debt or equity securities that do not fit
either of the other 2 categories.
 Reported at market value.
 Realized gains and losses go through
income.
 Unrealized gains and losses directly
credited (or debited) to a stockholders’
equity account.

39

Analysis of Monetary Assets





Current ratio = CA/CL
Acid-test ratio = quick ratio = monetary
CA/CL= (CA - inventories - prepaid
items) /CL.
Days cash = cash/(cash expenses 
365)
 Cash expenses  total expenses depreciation.





Days receivable = average collection
period = Receivables/(Sales  365)
Ratios differ by industry.

40

41


Slide 13

Revenue and Monetary
Assets
JOIN KHALID AZIZ
COACHING CLASSES
ICMAP STAGE 1,2,3,4,5
ICAP MODULE A,B,C,D
PIPFA
BBA & MBA
B.COM & M.COM
ACCOUNTING OF O/A LEVEL
MA-ECONOMICS
0322-3385752
KARACHI, PAKISTAN

Operating Cycle


Cash-to-cash.
• Receive cash from customer
• Purchase materials/services & pay cash
• Convert materials/services to salable
product
• Store product
• Sell product
• Receive cash from customer
2

Revenue Recognition:
When? (Timing) & How much? (Amt.)




At one point in revenue cycle
(objectivity).
Criteria:
• When? Earned (Conservatism)



Normally, goods shipped.
Service performed.

• How much? Realized or realizable
(Realization).





Already collected or collectible.
Amount can be measured reliably.

Next step: matching costs.

3

Basic Revenue Recognition Criteria


Recognize revenue in earliest period
in which:
• Entity has substantially performed what
is required in order to earn income and
• Amount of income can be reliably
measured.

4

Delivery Method




Recognize revenue when goods or
services are delivered.
For goods: when title transfers.
• FOB shipping point (when goods are
given to carrier).



Example 1:
• Order is received for Rs900. Sales
entry?
• Goods are produced. Sales entry?
• Goods are shipped. Sales entry?

5

Consignment Method


Consignor ships goods to
consignee.





Inventory on consignment
Merchandise inventory
1,000

1,000

Consignor retains title until goods
are sold to customer. At sale:





Accounts receivable
Sales revenue
COGS
Inventory on consignment

1,400
1,400
1,000
6

Franchise Revenue


Recognize:
• When earned.
• Not when agreement signed or fee
received.

7

Franchise Revenue First
Example


Tariq & Tariq’s charges a franchise
fee primarily for identifying the site,
designing the store, training
management and staff, and
otherwise helping to get the
franchise started in business.
Assume the initial fee is Rs100,000.
When should this Rs100,000 be
recorded as revenue?

8

Franchise Revenue Second
Example
• Golden, Inc. receives Rs6,000 from a
franchisee for the right to use its
trademark and have access to its
“know-how” for a period of 5 years.
This know-how includes training
sessions, and some one available to
answer questions. When should the
Rs6,000 be recognized as revenue?
9

Percentage-of-Completion Method








Design/development and
construction/production projects that
extends over several years.
Customer pays either fixed price or cost
reimbursement contract.
Reasonable assurance of profit margin and
ultimate realization.
Revenue recognized based on total
percentage of project work performed
during period.
10

Completed Contract Method


Percentage of completion method
required unless:
• Amount of income to be earned on
contract cannot reasonably be
determined.



Alternative is completed contract
method.
• Costs incurred are an asset (Contract
Work in Progress) until revenue is
recognized.

11

Production Method



Applies to agricultural and mining.
Criteria:
• Clear market determined price.
• Performance substantially complete.




Minimal remaining costs.

Permitted but not required by GAAP.

12

Installment Method






Customer pays a certain amount per
period.
Installment payment is recognized as
revenue and a proportional part of
cost of sales is recorded.
Under cost recovery method, cost is
recorded equal to installment
payment until total cost of sales is
covered.
13

Real Estate Sales





Developer often finances over many years.
Uncertainty of income due to uncertainty
of receipt of future payments.
Conditions required for revenue
recognition:
• Period allowing cancellation and refund to
buyer has expired.
• Cum payments equal to 10% of purchase
price.
• Seller has completed or is clearly capable of
completing required improvement.

14

Amount of Revenue
Recognized




Net realizable value (amount
reasonably estimated to be
collected).
2 approaches:
• Direct write-off method.
• Allowance method.



% of sales.
% of (analysis of) AR.
15

Direct Write-Off Method




Write-off when specific account that
is uncollectible is identified.
Why is this not acceptable under
GAAP?

16

Allowance Method


Estimate amount of current period
credit sales that will not be collected.
• Historical % tempered by judgment.
• Historical % of aged receivables
(+judgment).




Adjusting entry at end of period.
When an uncollectible account is
identified, it is written off.
17

Example


Amount of revenue recognized:
• Sales for the year were Rs2,000 for
cash and Rs6,000 on credit.
• Historically we don’t collect about 5%
of our credit sales due to customer
bankruptcies or unable to locate
customer.
• A customer, The XYZ Company went
bankrupt. They owed us Rs175.







Entry for revenue?
Entry for bad debts - direct write-off
(not-GAAP)?
Entries for bad debts (allowance
method)?

18

Example






Balances in Accounts
• Accounts receivable dr 3,000.
 Consisting of 2,000 current and 1,000
overdue.
• Allowance for doubtful accounts cr 50.
Estimated amount of accounts that are
uncollectible:
• 2% for current and 10% for non-current
accounts.
What entry do we make at the end of the year
to accrue for bad debts?
19

Allowance Method (continued)




Allowance… is a contra-asset
account.
Collection of a bad debt that was
written-off:


Cash
 Allowance for Doubtful Accounts

20

Sales Discounts


Sales terms are “2/10 net 30”
• Customer gets 2% cash discount if paid
within 10 days.
• Otherwise, total amount is due within
30 days.




What does “1/15 net 45” mean?
What is the effective annual rate of
savings by taking advantage of
terms of “2/10 net 30”?
21

Alternative Methods of
Accounting for Sales Discounts


Record initial sale at gross.
 At collection of net amount record
discount as a reduction from gross
sales.



Record initial sale at gross.
 At collection of net amount record
discount as an expense of the period.



Record initial sale at net.
 Record amounts not taken as discounts
as additional revenue.

22

Example


We sold Rs10,000 of mdse. Sales
terms are 2/10, n/30.
Customers paid us for Rs8,000 of
the merchandise billed within 10
days. The remaining Rs2,000
was paid within 30 days.
• Record at gross.
• Record at net.
23

Credit Card Sales


If cash received by merchant
immediately (Bank plan, MC, Visa):




Cash
Sales discount
Sales revenue

970
30
1000

24

Credit Card Sales (continued)


If cash received by merchant in 30
days (American Express, Discover):




Accounts receivable
Sales discount
Sales revenue

970
30
1000

25

Sales Returns & Allowances


Similar to bad debt expense,
 Estimate percentage of revenues that
will eventually result in returns or
allowances.
 Adjusting entry at end of period.
 Actual return or allowance.

26

Example
 On average 2% of our Rs10,000 of sales
is returned. Adjusting entry at end of
period?
 Entry for return of Rs80 of goods?
 Same for direct write-off method?

27

Sales Returns & Allowances
(Continued)




Provision for Returns and Allowances
is a liability account.
Alternative:
 Not accrue for returns and allowances
but write them off as they occur.
 Is this GAAP?

28

Adjustment vs. Expense





Realization concept suggests
adjustment to revenue.
In practice both methods are found.
Consistency:
 Same handling from year to year.




Allows same company results to be
compared from year to year.
Comparisons between companies may be
distorted.
29

Warranty Costs








Amounts are estimated (usually as a
percentage of sales).
Part of Cost of goods sold.
Record accrual (adjusting entry)
Record the actual expenditures.
Allowance… is a liability account.
Est. warranty exp. Is part of costs of
sales.
30

Warranty Expenses Example




We estimate that warranty expenses
will be 4% of our Rs10,000 of sales.
Entry?
We spent Rs120 on parts and Rs250
on labor for repairs under warranty.
Entry?

31

Interest Revenue




Amount earned by lender during the
period.
2 approaches
• Interest paid at maturity.


Interest is explicit.

• Discounted loan.




Interest is implicit.

Accounted for separately from sale.
32

Example: Interest Revenue


On January 1, 19x1 sold a customer
Rs1,000 of mdse. We received a
promissory note for Rs1,000 plus 8%
interest to be paid in one year.
• Entry for sale?
• Entry for accrual of interest on December 31,
19x1?
• Entry for receipt of payment on note on
January 1, 19x2?



On January 1, 19x1, we sold mdse. and
received a promissory note for Rs5,000
with no interest. The note is due in one
year. The market rate of interest on such
a note is 9%.
• Entry at sale:
• Year end adjusting entry (12/31/19x1)
• Entry when customer pays note (1/1/19x2)

33

Monetary& Non-monetary
Assets







Monetary assets are money or claims to
receive fixed sums of money.
Non-monetary assets are items used in
future production and sales of goods
and services.
Balance sheet distinction
 Current and non-current assets.
 Not monetary and non-monetary.





Non-monetary assets (except
inventory) on BS at unexpired cost.
(Cost less depreciation)
Monetary assets: Cash reported at face.
AR at NRV. Other at fair value.

34

Cash



Funds available for disbursement.
May include liquid short term
investments.
• Highly liquid debt instruments with
original maturities of 90 days or less.

35

Receivables


Trade receivables
• Accounts receivables from usual sales of
products or services for non-financial
institutions.



Other receivables are shown
separately.
 E.g., Due from employees, advances or
loans.
36

Marketable Securities





Must be marketable.
E.g., commercial paper, treasury
bills, publicly traded stocks and
bonds issued by companies.
Also called “Temporary Investments.”

37

Accounting for Marketable
Securities


Three categories
 Held-to-maturity: debt securities,


Valued at cost.

 Trading securities: debt or equity held
for current resale, valued at market.


Realized (i.e., if sold during period) and
unrealized (not yet sold but market price
has changed) gain or loss included in
current year’s income.
38

Accounting for Marketable
Securities (Continued)


Available-for-sale securities:
 Debt or equity securities that do not fit
either of the other 2 categories.
 Reported at market value.
 Realized gains and losses go through
income.
 Unrealized gains and losses directly
credited (or debited) to a stockholders’
equity account.

39

Analysis of Monetary Assets





Current ratio = CA/CL
Acid-test ratio = quick ratio = monetary
CA/CL= (CA - inventories - prepaid
items) /CL.
Days cash = cash/(cash expenses 
365)
 Cash expenses  total expenses depreciation.





Days receivable = average collection
period = Receivables/(Sales  365)
Ratios differ by industry.

40

41


Slide 14

Revenue and Monetary
Assets
JOIN KHALID AZIZ
COACHING CLASSES
ICMAP STAGE 1,2,3,4,5
ICAP MODULE A,B,C,D
PIPFA
BBA & MBA
B.COM & M.COM
ACCOUNTING OF O/A LEVEL
MA-ECONOMICS
0322-3385752
KARACHI, PAKISTAN

Operating Cycle


Cash-to-cash.
• Receive cash from customer
• Purchase materials/services & pay cash
• Convert materials/services to salable
product
• Store product
• Sell product
• Receive cash from customer
2

Revenue Recognition:
When? (Timing) & How much? (Amt.)




At one point in revenue cycle
(objectivity).
Criteria:
• When? Earned (Conservatism)



Normally, goods shipped.
Service performed.

• How much? Realized or realizable
(Realization).





Already collected or collectible.
Amount can be measured reliably.

Next step: matching costs.

3

Basic Revenue Recognition Criteria


Recognize revenue in earliest period
in which:
• Entity has substantially performed what
is required in order to earn income and
• Amount of income can be reliably
measured.

4

Delivery Method




Recognize revenue when goods or
services are delivered.
For goods: when title transfers.
• FOB shipping point (when goods are
given to carrier).



Example 1:
• Order is received for Rs900. Sales
entry?
• Goods are produced. Sales entry?
• Goods are shipped. Sales entry?

5

Consignment Method


Consignor ships goods to
consignee.





Inventory on consignment
Merchandise inventory
1,000

1,000

Consignor retains title until goods
are sold to customer. At sale:





Accounts receivable
Sales revenue
COGS
Inventory on consignment

1,400
1,400
1,000
6

Franchise Revenue


Recognize:
• When earned.
• Not when agreement signed or fee
received.

7

Franchise Revenue First
Example


Tariq & Tariq’s charges a franchise
fee primarily for identifying the site,
designing the store, training
management and staff, and
otherwise helping to get the
franchise started in business.
Assume the initial fee is Rs100,000.
When should this Rs100,000 be
recorded as revenue?

8

Franchise Revenue Second
Example
• Golden, Inc. receives Rs6,000 from a
franchisee for the right to use its
trademark and have access to its
“know-how” for a period of 5 years.
This know-how includes training
sessions, and some one available to
answer questions. When should the
Rs6,000 be recognized as revenue?
9

Percentage-of-Completion Method








Design/development and
construction/production projects that
extends over several years.
Customer pays either fixed price or cost
reimbursement contract.
Reasonable assurance of profit margin and
ultimate realization.
Revenue recognized based on total
percentage of project work performed
during period.
10

Completed Contract Method


Percentage of completion method
required unless:
• Amount of income to be earned on
contract cannot reasonably be
determined.



Alternative is completed contract
method.
• Costs incurred are an asset (Contract
Work in Progress) until revenue is
recognized.

11

Production Method



Applies to agricultural and mining.
Criteria:
• Clear market determined price.
• Performance substantially complete.




Minimal remaining costs.

Permitted but not required by GAAP.

12

Installment Method






Customer pays a certain amount per
period.
Installment payment is recognized as
revenue and a proportional part of
cost of sales is recorded.
Under cost recovery method, cost is
recorded equal to installment
payment until total cost of sales is
covered.
13

Real Estate Sales





Developer often finances over many years.
Uncertainty of income due to uncertainty
of receipt of future payments.
Conditions required for revenue
recognition:
• Period allowing cancellation and refund to
buyer has expired.
• Cum payments equal to 10% of purchase
price.
• Seller has completed or is clearly capable of
completing required improvement.

14

Amount of Revenue
Recognized




Net realizable value (amount
reasonably estimated to be
collected).
2 approaches:
• Direct write-off method.
• Allowance method.



% of sales.
% of (analysis of) AR.
15

Direct Write-Off Method




Write-off when specific account that
is uncollectible is identified.
Why is this not acceptable under
GAAP?

16

Allowance Method


Estimate amount of current period
credit sales that will not be collected.
• Historical % tempered by judgment.
• Historical % of aged receivables
(+judgment).




Adjusting entry at end of period.
When an uncollectible account is
identified, it is written off.
17

Example


Amount of revenue recognized:
• Sales for the year were Rs2,000 for
cash and Rs6,000 on credit.
• Historically we don’t collect about 5%
of our credit sales due to customer
bankruptcies or unable to locate
customer.
• A customer, The XYZ Company went
bankrupt. They owed us Rs175.







Entry for revenue?
Entry for bad debts - direct write-off
(not-GAAP)?
Entries for bad debts (allowance
method)?

18

Example






Balances in Accounts
• Accounts receivable dr 3,000.
 Consisting of 2,000 current and 1,000
overdue.
• Allowance for doubtful accounts cr 50.
Estimated amount of accounts that are
uncollectible:
• 2% for current and 10% for non-current
accounts.
What entry do we make at the end of the year
to accrue for bad debts?
19

Allowance Method (continued)




Allowance… is a contra-asset
account.
Collection of a bad debt that was
written-off:


Cash
 Allowance for Doubtful Accounts

20

Sales Discounts


Sales terms are “2/10 net 30”
• Customer gets 2% cash discount if paid
within 10 days.
• Otherwise, total amount is due within
30 days.




What does “1/15 net 45” mean?
What is the effective annual rate of
savings by taking advantage of
terms of “2/10 net 30”?
21

Alternative Methods of
Accounting for Sales Discounts


Record initial sale at gross.
 At collection of net amount record
discount as a reduction from gross
sales.



Record initial sale at gross.
 At collection of net amount record
discount as an expense of the period.



Record initial sale at net.
 Record amounts not taken as discounts
as additional revenue.

22

Example


We sold Rs10,000 of mdse. Sales
terms are 2/10, n/30.
Customers paid us for Rs8,000 of
the merchandise billed within 10
days. The remaining Rs2,000
was paid within 30 days.
• Record at gross.
• Record at net.
23

Credit Card Sales


If cash received by merchant
immediately (Bank plan, MC, Visa):




Cash
Sales discount
Sales revenue

970
30
1000

24

Credit Card Sales (continued)


If cash received by merchant in 30
days (American Express, Discover):




Accounts receivable
Sales discount
Sales revenue

970
30
1000

25

Sales Returns & Allowances


Similar to bad debt expense,
 Estimate percentage of revenues that
will eventually result in returns or
allowances.
 Adjusting entry at end of period.
 Actual return or allowance.

26

Example
 On average 2% of our Rs10,000 of sales
is returned. Adjusting entry at end of
period?
 Entry for return of Rs80 of goods?
 Same for direct write-off method?

27

Sales Returns & Allowances
(Continued)




Provision for Returns and Allowances
is a liability account.
Alternative:
 Not accrue for returns and allowances
but write them off as they occur.
 Is this GAAP?

28

Adjustment vs. Expense





Realization concept suggests
adjustment to revenue.
In practice both methods are found.
Consistency:
 Same handling from year to year.




Allows same company results to be
compared from year to year.
Comparisons between companies may be
distorted.
29

Warranty Costs








Amounts are estimated (usually as a
percentage of sales).
Part of Cost of goods sold.
Record accrual (adjusting entry)
Record the actual expenditures.
Allowance… is a liability account.
Est. warranty exp. Is part of costs of
sales.
30

Warranty Expenses Example




We estimate that warranty expenses
will be 4% of our Rs10,000 of sales.
Entry?
We spent Rs120 on parts and Rs250
on labor for repairs under warranty.
Entry?

31

Interest Revenue




Amount earned by lender during the
period.
2 approaches
• Interest paid at maturity.


Interest is explicit.

• Discounted loan.




Interest is implicit.

Accounted for separately from sale.
32

Example: Interest Revenue


On January 1, 19x1 sold a customer
Rs1,000 of mdse. We received a
promissory note for Rs1,000 plus 8%
interest to be paid in one year.
• Entry for sale?
• Entry for accrual of interest on December 31,
19x1?
• Entry for receipt of payment on note on
January 1, 19x2?



On January 1, 19x1, we sold mdse. and
received a promissory note for Rs5,000
with no interest. The note is due in one
year. The market rate of interest on such
a note is 9%.
• Entry at sale:
• Year end adjusting entry (12/31/19x1)
• Entry when customer pays note (1/1/19x2)

33

Monetary& Non-monetary
Assets







Monetary assets are money or claims to
receive fixed sums of money.
Non-monetary assets are items used in
future production and sales of goods
and services.
Balance sheet distinction
 Current and non-current assets.
 Not monetary and non-monetary.





Non-monetary assets (except
inventory) on BS at unexpired cost.
(Cost less depreciation)
Monetary assets: Cash reported at face.
AR at NRV. Other at fair value.

34

Cash



Funds available for disbursement.
May include liquid short term
investments.
• Highly liquid debt instruments with
original maturities of 90 days or less.

35

Receivables


Trade receivables
• Accounts receivables from usual sales of
products or services for non-financial
institutions.



Other receivables are shown
separately.
 E.g., Due from employees, advances or
loans.
36

Marketable Securities





Must be marketable.
E.g., commercial paper, treasury
bills, publicly traded stocks and
bonds issued by companies.
Also called “Temporary Investments.”

37

Accounting for Marketable
Securities


Three categories
 Held-to-maturity: debt securities,


Valued at cost.

 Trading securities: debt or equity held
for current resale, valued at market.


Realized (i.e., if sold during period) and
unrealized (not yet sold but market price
has changed) gain or loss included in
current year’s income.
38

Accounting for Marketable
Securities (Continued)


Available-for-sale securities:
 Debt or equity securities that do not fit
either of the other 2 categories.
 Reported at market value.
 Realized gains and losses go through
income.
 Unrealized gains and losses directly
credited (or debited) to a stockholders’
equity account.

39

Analysis of Monetary Assets





Current ratio = CA/CL
Acid-test ratio = quick ratio = monetary
CA/CL= (CA - inventories - prepaid
items) /CL.
Days cash = cash/(cash expenses 
365)
 Cash expenses  total expenses depreciation.





Days receivable = average collection
period = Receivables/(Sales  365)
Ratios differ by industry.

40

41


Slide 15

Revenue and Monetary
Assets
JOIN KHALID AZIZ
COACHING CLASSES
ICMAP STAGE 1,2,3,4,5
ICAP MODULE A,B,C,D
PIPFA
BBA & MBA
B.COM & M.COM
ACCOUNTING OF O/A LEVEL
MA-ECONOMICS
0322-3385752
KARACHI, PAKISTAN

Operating Cycle


Cash-to-cash.
• Receive cash from customer
• Purchase materials/services & pay cash
• Convert materials/services to salable
product
• Store product
• Sell product
• Receive cash from customer
2

Revenue Recognition:
When? (Timing) & How much? (Amt.)




At one point in revenue cycle
(objectivity).
Criteria:
• When? Earned (Conservatism)



Normally, goods shipped.
Service performed.

• How much? Realized or realizable
(Realization).





Already collected or collectible.
Amount can be measured reliably.

Next step: matching costs.

3

Basic Revenue Recognition Criteria


Recognize revenue in earliest period
in which:
• Entity has substantially performed what
is required in order to earn income and
• Amount of income can be reliably
measured.

4

Delivery Method




Recognize revenue when goods or
services are delivered.
For goods: when title transfers.
• FOB shipping point (when goods are
given to carrier).



Example 1:
• Order is received for Rs900. Sales
entry?
• Goods are produced. Sales entry?
• Goods are shipped. Sales entry?

5

Consignment Method


Consignor ships goods to
consignee.





Inventory on consignment
Merchandise inventory
1,000

1,000

Consignor retains title until goods
are sold to customer. At sale:





Accounts receivable
Sales revenue
COGS
Inventory on consignment

1,400
1,400
1,000
6

Franchise Revenue


Recognize:
• When earned.
• Not when agreement signed or fee
received.

7

Franchise Revenue First
Example


Tariq & Tariq’s charges a franchise
fee primarily for identifying the site,
designing the store, training
management and staff, and
otherwise helping to get the
franchise started in business.
Assume the initial fee is Rs100,000.
When should this Rs100,000 be
recorded as revenue?

8

Franchise Revenue Second
Example
• Golden, Inc. receives Rs6,000 from a
franchisee for the right to use its
trademark and have access to its
“know-how” for a period of 5 years.
This know-how includes training
sessions, and some one available to
answer questions. When should the
Rs6,000 be recognized as revenue?
9

Percentage-of-Completion Method








Design/development and
construction/production projects that
extends over several years.
Customer pays either fixed price or cost
reimbursement contract.
Reasonable assurance of profit margin and
ultimate realization.
Revenue recognized based on total
percentage of project work performed
during period.
10

Completed Contract Method


Percentage of completion method
required unless:
• Amount of income to be earned on
contract cannot reasonably be
determined.



Alternative is completed contract
method.
• Costs incurred are an asset (Contract
Work in Progress) until revenue is
recognized.

11

Production Method



Applies to agricultural and mining.
Criteria:
• Clear market determined price.
• Performance substantially complete.




Minimal remaining costs.

Permitted but not required by GAAP.

12

Installment Method






Customer pays a certain amount per
period.
Installment payment is recognized as
revenue and a proportional part of
cost of sales is recorded.
Under cost recovery method, cost is
recorded equal to installment
payment until total cost of sales is
covered.
13

Real Estate Sales





Developer often finances over many years.
Uncertainty of income due to uncertainty
of receipt of future payments.
Conditions required for revenue
recognition:
• Period allowing cancellation and refund to
buyer has expired.
• Cum payments equal to 10% of purchase
price.
• Seller has completed or is clearly capable of
completing required improvement.

14

Amount of Revenue
Recognized




Net realizable value (amount
reasonably estimated to be
collected).
2 approaches:
• Direct write-off method.
• Allowance method.



% of sales.
% of (analysis of) AR.
15

Direct Write-Off Method




Write-off when specific account that
is uncollectible is identified.
Why is this not acceptable under
GAAP?

16

Allowance Method


Estimate amount of current period
credit sales that will not be collected.
• Historical % tempered by judgment.
• Historical % of aged receivables
(+judgment).




Adjusting entry at end of period.
When an uncollectible account is
identified, it is written off.
17

Example


Amount of revenue recognized:
• Sales for the year were Rs2,000 for
cash and Rs6,000 on credit.
• Historically we don’t collect about 5%
of our credit sales due to customer
bankruptcies or unable to locate
customer.
• A customer, The XYZ Company went
bankrupt. They owed us Rs175.







Entry for revenue?
Entry for bad debts - direct write-off
(not-GAAP)?
Entries for bad debts (allowance
method)?

18

Example






Balances in Accounts
• Accounts receivable dr 3,000.
 Consisting of 2,000 current and 1,000
overdue.
• Allowance for doubtful accounts cr 50.
Estimated amount of accounts that are
uncollectible:
• 2% for current and 10% for non-current
accounts.
What entry do we make at the end of the year
to accrue for bad debts?
19

Allowance Method (continued)




Allowance… is a contra-asset
account.
Collection of a bad debt that was
written-off:


Cash
 Allowance for Doubtful Accounts

20

Sales Discounts


Sales terms are “2/10 net 30”
• Customer gets 2% cash discount if paid
within 10 days.
• Otherwise, total amount is due within
30 days.




What does “1/15 net 45” mean?
What is the effective annual rate of
savings by taking advantage of
terms of “2/10 net 30”?
21

Alternative Methods of
Accounting for Sales Discounts


Record initial sale at gross.
 At collection of net amount record
discount as a reduction from gross
sales.



Record initial sale at gross.
 At collection of net amount record
discount as an expense of the period.



Record initial sale at net.
 Record amounts not taken as discounts
as additional revenue.

22

Example


We sold Rs10,000 of mdse. Sales
terms are 2/10, n/30.
Customers paid us for Rs8,000 of
the merchandise billed within 10
days. The remaining Rs2,000
was paid within 30 days.
• Record at gross.
• Record at net.
23

Credit Card Sales


If cash received by merchant
immediately (Bank plan, MC, Visa):




Cash
Sales discount
Sales revenue

970
30
1000

24

Credit Card Sales (continued)


If cash received by merchant in 30
days (American Express, Discover):




Accounts receivable
Sales discount
Sales revenue

970
30
1000

25

Sales Returns & Allowances


Similar to bad debt expense,
 Estimate percentage of revenues that
will eventually result in returns or
allowances.
 Adjusting entry at end of period.
 Actual return or allowance.

26

Example
 On average 2% of our Rs10,000 of sales
is returned. Adjusting entry at end of
period?
 Entry for return of Rs80 of goods?
 Same for direct write-off method?

27

Sales Returns & Allowances
(Continued)




Provision for Returns and Allowances
is a liability account.
Alternative:
 Not accrue for returns and allowances
but write them off as they occur.
 Is this GAAP?

28

Adjustment vs. Expense





Realization concept suggests
adjustment to revenue.
In practice both methods are found.
Consistency:
 Same handling from year to year.




Allows same company results to be
compared from year to year.
Comparisons between companies may be
distorted.
29

Warranty Costs








Amounts are estimated (usually as a
percentage of sales).
Part of Cost of goods sold.
Record accrual (adjusting entry)
Record the actual expenditures.
Allowance… is a liability account.
Est. warranty exp. Is part of costs of
sales.
30

Warranty Expenses Example




We estimate that warranty expenses
will be 4% of our Rs10,000 of sales.
Entry?
We spent Rs120 on parts and Rs250
on labor for repairs under warranty.
Entry?

31

Interest Revenue




Amount earned by lender during the
period.
2 approaches
• Interest paid at maturity.


Interest is explicit.

• Discounted loan.




Interest is implicit.

Accounted for separately from sale.
32

Example: Interest Revenue


On January 1, 19x1 sold a customer
Rs1,000 of mdse. We received a
promissory note for Rs1,000 plus 8%
interest to be paid in one year.
• Entry for sale?
• Entry for accrual of interest on December 31,
19x1?
• Entry for receipt of payment on note on
January 1, 19x2?



On January 1, 19x1, we sold mdse. and
received a promissory note for Rs5,000
with no interest. The note is due in one
year. The market rate of interest on such
a note is 9%.
• Entry at sale:
• Year end adjusting entry (12/31/19x1)
• Entry when customer pays note (1/1/19x2)

33

Monetary& Non-monetary
Assets







Monetary assets are money or claims to
receive fixed sums of money.
Non-monetary assets are items used in
future production and sales of goods
and services.
Balance sheet distinction
 Current and non-current assets.
 Not monetary and non-monetary.





Non-monetary assets (except
inventory) on BS at unexpired cost.
(Cost less depreciation)
Monetary assets: Cash reported at face.
AR at NRV. Other at fair value.

34

Cash



Funds available for disbursement.
May include liquid short term
investments.
• Highly liquid debt instruments with
original maturities of 90 days or less.

35

Receivables


Trade receivables
• Accounts receivables from usual sales of
products or services for non-financial
institutions.



Other receivables are shown
separately.
 E.g., Due from employees, advances or
loans.
36

Marketable Securities





Must be marketable.
E.g., commercial paper, treasury
bills, publicly traded stocks and
bonds issued by companies.
Also called “Temporary Investments.”

37

Accounting for Marketable
Securities


Three categories
 Held-to-maturity: debt securities,


Valued at cost.

 Trading securities: debt or equity held
for current resale, valued at market.


Realized (i.e., if sold during period) and
unrealized (not yet sold but market price
has changed) gain or loss included in
current year’s income.
38

Accounting for Marketable
Securities (Continued)


Available-for-sale securities:
 Debt or equity securities that do not fit
either of the other 2 categories.
 Reported at market value.
 Realized gains and losses go through
income.
 Unrealized gains and losses directly
credited (or debited) to a stockholders’
equity account.

39

Analysis of Monetary Assets





Current ratio = CA/CL
Acid-test ratio = quick ratio = monetary
CA/CL= (CA - inventories - prepaid
items) /CL.
Days cash = cash/(cash expenses 
365)
 Cash expenses  total expenses depreciation.





Days receivable = average collection
period = Receivables/(Sales  365)
Ratios differ by industry.

40

41


Slide 16

Revenue and Monetary
Assets
JOIN KHALID AZIZ
COACHING CLASSES
ICMAP STAGE 1,2,3,4,5
ICAP MODULE A,B,C,D
PIPFA
BBA & MBA
B.COM & M.COM
ACCOUNTING OF O/A LEVEL
MA-ECONOMICS
0322-3385752
KARACHI, PAKISTAN

Operating Cycle


Cash-to-cash.
• Receive cash from customer
• Purchase materials/services & pay cash
• Convert materials/services to salable
product
• Store product
• Sell product
• Receive cash from customer
2

Revenue Recognition:
When? (Timing) & How much? (Amt.)




At one point in revenue cycle
(objectivity).
Criteria:
• When? Earned (Conservatism)



Normally, goods shipped.
Service performed.

• How much? Realized or realizable
(Realization).





Already collected or collectible.
Amount can be measured reliably.

Next step: matching costs.

3

Basic Revenue Recognition Criteria


Recognize revenue in earliest period
in which:
• Entity has substantially performed what
is required in order to earn income and
• Amount of income can be reliably
measured.

4

Delivery Method




Recognize revenue when goods or
services are delivered.
For goods: when title transfers.
• FOB shipping point (when goods are
given to carrier).



Example 1:
• Order is received for Rs900. Sales
entry?
• Goods are produced. Sales entry?
• Goods are shipped. Sales entry?

5

Consignment Method


Consignor ships goods to
consignee.





Inventory on consignment
Merchandise inventory
1,000

1,000

Consignor retains title until goods
are sold to customer. At sale:





Accounts receivable
Sales revenue
COGS
Inventory on consignment

1,400
1,400
1,000
6

Franchise Revenue


Recognize:
• When earned.
• Not when agreement signed or fee
received.

7

Franchise Revenue First
Example


Tariq & Tariq’s charges a franchise
fee primarily for identifying the site,
designing the store, training
management and staff, and
otherwise helping to get the
franchise started in business.
Assume the initial fee is Rs100,000.
When should this Rs100,000 be
recorded as revenue?

8

Franchise Revenue Second
Example
• Golden, Inc. receives Rs6,000 from a
franchisee for the right to use its
trademark and have access to its
“know-how” for a period of 5 years.
This know-how includes training
sessions, and some one available to
answer questions. When should the
Rs6,000 be recognized as revenue?
9

Percentage-of-Completion Method








Design/development and
construction/production projects that
extends over several years.
Customer pays either fixed price or cost
reimbursement contract.
Reasonable assurance of profit margin and
ultimate realization.
Revenue recognized based on total
percentage of project work performed
during period.
10

Completed Contract Method


Percentage of completion method
required unless:
• Amount of income to be earned on
contract cannot reasonably be
determined.



Alternative is completed contract
method.
• Costs incurred are an asset (Contract
Work in Progress) until revenue is
recognized.

11

Production Method



Applies to agricultural and mining.
Criteria:
• Clear market determined price.
• Performance substantially complete.




Minimal remaining costs.

Permitted but not required by GAAP.

12

Installment Method






Customer pays a certain amount per
period.
Installment payment is recognized as
revenue and a proportional part of
cost of sales is recorded.
Under cost recovery method, cost is
recorded equal to installment
payment until total cost of sales is
covered.
13

Real Estate Sales





Developer often finances over many years.
Uncertainty of income due to uncertainty
of receipt of future payments.
Conditions required for revenue
recognition:
• Period allowing cancellation and refund to
buyer has expired.
• Cum payments equal to 10% of purchase
price.
• Seller has completed or is clearly capable of
completing required improvement.

14

Amount of Revenue
Recognized




Net realizable value (amount
reasonably estimated to be
collected).
2 approaches:
• Direct write-off method.
• Allowance method.



% of sales.
% of (analysis of) AR.
15

Direct Write-Off Method




Write-off when specific account that
is uncollectible is identified.
Why is this not acceptable under
GAAP?

16

Allowance Method


Estimate amount of current period
credit sales that will not be collected.
• Historical % tempered by judgment.
• Historical % of aged receivables
(+judgment).




Adjusting entry at end of period.
When an uncollectible account is
identified, it is written off.
17

Example


Amount of revenue recognized:
• Sales for the year were Rs2,000 for
cash and Rs6,000 on credit.
• Historically we don’t collect about 5%
of our credit sales due to customer
bankruptcies or unable to locate
customer.
• A customer, The XYZ Company went
bankrupt. They owed us Rs175.







Entry for revenue?
Entry for bad debts - direct write-off
(not-GAAP)?
Entries for bad debts (allowance
method)?

18

Example






Balances in Accounts
• Accounts receivable dr 3,000.
 Consisting of 2,000 current and 1,000
overdue.
• Allowance for doubtful accounts cr 50.
Estimated amount of accounts that are
uncollectible:
• 2% for current and 10% for non-current
accounts.
What entry do we make at the end of the year
to accrue for bad debts?
19

Allowance Method (continued)




Allowance… is a contra-asset
account.
Collection of a bad debt that was
written-off:


Cash
 Allowance for Doubtful Accounts

20

Sales Discounts


Sales terms are “2/10 net 30”
• Customer gets 2% cash discount if paid
within 10 days.
• Otherwise, total amount is due within
30 days.




What does “1/15 net 45” mean?
What is the effective annual rate of
savings by taking advantage of
terms of “2/10 net 30”?
21

Alternative Methods of
Accounting for Sales Discounts


Record initial sale at gross.
 At collection of net amount record
discount as a reduction from gross
sales.



Record initial sale at gross.
 At collection of net amount record
discount as an expense of the period.



Record initial sale at net.
 Record amounts not taken as discounts
as additional revenue.

22

Example


We sold Rs10,000 of mdse. Sales
terms are 2/10, n/30.
Customers paid us for Rs8,000 of
the merchandise billed within 10
days. The remaining Rs2,000
was paid within 30 days.
• Record at gross.
• Record at net.
23

Credit Card Sales


If cash received by merchant
immediately (Bank plan, MC, Visa):




Cash
Sales discount
Sales revenue

970
30
1000

24

Credit Card Sales (continued)


If cash received by merchant in 30
days (American Express, Discover):




Accounts receivable
Sales discount
Sales revenue

970
30
1000

25

Sales Returns & Allowances


Similar to bad debt expense,
 Estimate percentage of revenues that
will eventually result in returns or
allowances.
 Adjusting entry at end of period.
 Actual return or allowance.

26

Example
 On average 2% of our Rs10,000 of sales
is returned. Adjusting entry at end of
period?
 Entry for return of Rs80 of goods?
 Same for direct write-off method?

27

Sales Returns & Allowances
(Continued)




Provision for Returns and Allowances
is a liability account.
Alternative:
 Not accrue for returns and allowances
but write them off as they occur.
 Is this GAAP?

28

Adjustment vs. Expense





Realization concept suggests
adjustment to revenue.
In practice both methods are found.
Consistency:
 Same handling from year to year.




Allows same company results to be
compared from year to year.
Comparisons between companies may be
distorted.
29

Warranty Costs








Amounts are estimated (usually as a
percentage of sales).
Part of Cost of goods sold.
Record accrual (adjusting entry)
Record the actual expenditures.
Allowance… is a liability account.
Est. warranty exp. Is part of costs of
sales.
30

Warranty Expenses Example




We estimate that warranty expenses
will be 4% of our Rs10,000 of sales.
Entry?
We spent Rs120 on parts and Rs250
on labor for repairs under warranty.
Entry?

31

Interest Revenue




Amount earned by lender during the
period.
2 approaches
• Interest paid at maturity.


Interest is explicit.

• Discounted loan.




Interest is implicit.

Accounted for separately from sale.
32

Example: Interest Revenue


On January 1, 19x1 sold a customer
Rs1,000 of mdse. We received a
promissory note for Rs1,000 plus 8%
interest to be paid in one year.
• Entry for sale?
• Entry for accrual of interest on December 31,
19x1?
• Entry for receipt of payment on note on
January 1, 19x2?



On January 1, 19x1, we sold mdse. and
received a promissory note for Rs5,000
with no interest. The note is due in one
year. The market rate of interest on such
a note is 9%.
• Entry at sale:
• Year end adjusting entry (12/31/19x1)
• Entry when customer pays note (1/1/19x2)

33

Monetary& Non-monetary
Assets







Monetary assets are money or claims to
receive fixed sums of money.
Non-monetary assets are items used in
future production and sales of goods
and services.
Balance sheet distinction
 Current and non-current assets.
 Not monetary and non-monetary.





Non-monetary assets (except
inventory) on BS at unexpired cost.
(Cost less depreciation)
Monetary assets: Cash reported at face.
AR at NRV. Other at fair value.

34

Cash



Funds available for disbursement.
May include liquid short term
investments.
• Highly liquid debt instruments with
original maturities of 90 days or less.

35

Receivables


Trade receivables
• Accounts receivables from usual sales of
products or services for non-financial
institutions.



Other receivables are shown
separately.
 E.g., Due from employees, advances or
loans.
36

Marketable Securities





Must be marketable.
E.g., commercial paper, treasury
bills, publicly traded stocks and
bonds issued by companies.
Also called “Temporary Investments.”

37

Accounting for Marketable
Securities


Three categories
 Held-to-maturity: debt securities,


Valued at cost.

 Trading securities: debt or equity held
for current resale, valued at market.


Realized (i.e., if sold during period) and
unrealized (not yet sold but market price
has changed) gain or loss included in
current year’s income.
38

Accounting for Marketable
Securities (Continued)


Available-for-sale securities:
 Debt or equity securities that do not fit
either of the other 2 categories.
 Reported at market value.
 Realized gains and losses go through
income.
 Unrealized gains and losses directly
credited (or debited) to a stockholders’
equity account.

39

Analysis of Monetary Assets





Current ratio = CA/CL
Acid-test ratio = quick ratio = monetary
CA/CL= (CA - inventories - prepaid
items) /CL.
Days cash = cash/(cash expenses 
365)
 Cash expenses  total expenses depreciation.





Days receivable = average collection
period = Receivables/(Sales  365)
Ratios differ by industry.

40

41


Slide 17

Revenue and Monetary
Assets
JOIN KHALID AZIZ
COACHING CLASSES
ICMAP STAGE 1,2,3,4,5
ICAP MODULE A,B,C,D
PIPFA
BBA & MBA
B.COM & M.COM
ACCOUNTING OF O/A LEVEL
MA-ECONOMICS
0322-3385752
KARACHI, PAKISTAN

Operating Cycle


Cash-to-cash.
• Receive cash from customer
• Purchase materials/services & pay cash
• Convert materials/services to salable
product
• Store product
• Sell product
• Receive cash from customer
2

Revenue Recognition:
When? (Timing) & How much? (Amt.)




At one point in revenue cycle
(objectivity).
Criteria:
• When? Earned (Conservatism)



Normally, goods shipped.
Service performed.

• How much? Realized or realizable
(Realization).





Already collected or collectible.
Amount can be measured reliably.

Next step: matching costs.

3

Basic Revenue Recognition Criteria


Recognize revenue in earliest period
in which:
• Entity has substantially performed what
is required in order to earn income and
• Amount of income can be reliably
measured.

4

Delivery Method




Recognize revenue when goods or
services are delivered.
For goods: when title transfers.
• FOB shipping point (when goods are
given to carrier).



Example 1:
• Order is received for Rs900. Sales
entry?
• Goods are produced. Sales entry?
• Goods are shipped. Sales entry?

5

Consignment Method


Consignor ships goods to
consignee.





Inventory on consignment
Merchandise inventory
1,000

1,000

Consignor retains title until goods
are sold to customer. At sale:





Accounts receivable
Sales revenue
COGS
Inventory on consignment

1,400
1,400
1,000
6

Franchise Revenue


Recognize:
• When earned.
• Not when agreement signed or fee
received.

7

Franchise Revenue First
Example


Tariq & Tariq’s charges a franchise
fee primarily for identifying the site,
designing the store, training
management and staff, and
otherwise helping to get the
franchise started in business.
Assume the initial fee is Rs100,000.
When should this Rs100,000 be
recorded as revenue?

8

Franchise Revenue Second
Example
• Golden, Inc. receives Rs6,000 from a
franchisee for the right to use its
trademark and have access to its
“know-how” for a period of 5 years.
This know-how includes training
sessions, and some one available to
answer questions. When should the
Rs6,000 be recognized as revenue?
9

Percentage-of-Completion Method








Design/development and
construction/production projects that
extends over several years.
Customer pays either fixed price or cost
reimbursement contract.
Reasonable assurance of profit margin and
ultimate realization.
Revenue recognized based on total
percentage of project work performed
during period.
10

Completed Contract Method


Percentage of completion method
required unless:
• Amount of income to be earned on
contract cannot reasonably be
determined.



Alternative is completed contract
method.
• Costs incurred are an asset (Contract
Work in Progress) until revenue is
recognized.

11

Production Method



Applies to agricultural and mining.
Criteria:
• Clear market determined price.
• Performance substantially complete.




Minimal remaining costs.

Permitted but not required by GAAP.

12

Installment Method






Customer pays a certain amount per
period.
Installment payment is recognized as
revenue and a proportional part of
cost of sales is recorded.
Under cost recovery method, cost is
recorded equal to installment
payment until total cost of sales is
covered.
13

Real Estate Sales





Developer often finances over many years.
Uncertainty of income due to uncertainty
of receipt of future payments.
Conditions required for revenue
recognition:
• Period allowing cancellation and refund to
buyer has expired.
• Cum payments equal to 10% of purchase
price.
• Seller has completed or is clearly capable of
completing required improvement.

14

Amount of Revenue
Recognized




Net realizable value (amount
reasonably estimated to be
collected).
2 approaches:
• Direct write-off method.
• Allowance method.



% of sales.
% of (analysis of) AR.
15

Direct Write-Off Method




Write-off when specific account that
is uncollectible is identified.
Why is this not acceptable under
GAAP?

16

Allowance Method


Estimate amount of current period
credit sales that will not be collected.
• Historical % tempered by judgment.
• Historical % of aged receivables
(+judgment).




Adjusting entry at end of period.
When an uncollectible account is
identified, it is written off.
17

Example


Amount of revenue recognized:
• Sales for the year were Rs2,000 for
cash and Rs6,000 on credit.
• Historically we don’t collect about 5%
of our credit sales due to customer
bankruptcies or unable to locate
customer.
• A customer, The XYZ Company went
bankrupt. They owed us Rs175.







Entry for revenue?
Entry for bad debts - direct write-off
(not-GAAP)?
Entries for bad debts (allowance
method)?

18

Example






Balances in Accounts
• Accounts receivable dr 3,000.
 Consisting of 2,000 current and 1,000
overdue.
• Allowance for doubtful accounts cr 50.
Estimated amount of accounts that are
uncollectible:
• 2% for current and 10% for non-current
accounts.
What entry do we make at the end of the year
to accrue for bad debts?
19

Allowance Method (continued)




Allowance… is a contra-asset
account.
Collection of a bad debt that was
written-off:


Cash
 Allowance for Doubtful Accounts

20

Sales Discounts


Sales terms are “2/10 net 30”
• Customer gets 2% cash discount if paid
within 10 days.
• Otherwise, total amount is due within
30 days.




What does “1/15 net 45” mean?
What is the effective annual rate of
savings by taking advantage of
terms of “2/10 net 30”?
21

Alternative Methods of
Accounting for Sales Discounts


Record initial sale at gross.
 At collection of net amount record
discount as a reduction from gross
sales.



Record initial sale at gross.
 At collection of net amount record
discount as an expense of the period.



Record initial sale at net.
 Record amounts not taken as discounts
as additional revenue.

22

Example


We sold Rs10,000 of mdse. Sales
terms are 2/10, n/30.
Customers paid us for Rs8,000 of
the merchandise billed within 10
days. The remaining Rs2,000
was paid within 30 days.
• Record at gross.
• Record at net.
23

Credit Card Sales


If cash received by merchant
immediately (Bank plan, MC, Visa):




Cash
Sales discount
Sales revenue

970
30
1000

24

Credit Card Sales (continued)


If cash received by merchant in 30
days (American Express, Discover):




Accounts receivable
Sales discount
Sales revenue

970
30
1000

25

Sales Returns & Allowances


Similar to bad debt expense,
 Estimate percentage of revenues that
will eventually result in returns or
allowances.
 Adjusting entry at end of period.
 Actual return or allowance.

26

Example
 On average 2% of our Rs10,000 of sales
is returned. Adjusting entry at end of
period?
 Entry for return of Rs80 of goods?
 Same for direct write-off method?

27

Sales Returns & Allowances
(Continued)




Provision for Returns and Allowances
is a liability account.
Alternative:
 Not accrue for returns and allowances
but write them off as they occur.
 Is this GAAP?

28

Adjustment vs. Expense





Realization concept suggests
adjustment to revenue.
In practice both methods are found.
Consistency:
 Same handling from year to year.




Allows same company results to be
compared from year to year.
Comparisons between companies may be
distorted.
29

Warranty Costs








Amounts are estimated (usually as a
percentage of sales).
Part of Cost of goods sold.
Record accrual (adjusting entry)
Record the actual expenditures.
Allowance… is a liability account.
Est. warranty exp. Is part of costs of
sales.
30

Warranty Expenses Example




We estimate that warranty expenses
will be 4% of our Rs10,000 of sales.
Entry?
We spent Rs120 on parts and Rs250
on labor for repairs under warranty.
Entry?

31

Interest Revenue




Amount earned by lender during the
period.
2 approaches
• Interest paid at maturity.


Interest is explicit.

• Discounted loan.




Interest is implicit.

Accounted for separately from sale.
32

Example: Interest Revenue


On January 1, 19x1 sold a customer
Rs1,000 of mdse. We received a
promissory note for Rs1,000 plus 8%
interest to be paid in one year.
• Entry for sale?
• Entry for accrual of interest on December 31,
19x1?
• Entry for receipt of payment on note on
January 1, 19x2?



On January 1, 19x1, we sold mdse. and
received a promissory note for Rs5,000
with no interest. The note is due in one
year. The market rate of interest on such
a note is 9%.
• Entry at sale:
• Year end adjusting entry (12/31/19x1)
• Entry when customer pays note (1/1/19x2)

33

Monetary& Non-monetary
Assets







Monetary assets are money or claims to
receive fixed sums of money.
Non-monetary assets are items used in
future production and sales of goods
and services.
Balance sheet distinction
 Current and non-current assets.
 Not monetary and non-monetary.





Non-monetary assets (except
inventory) on BS at unexpired cost.
(Cost less depreciation)
Monetary assets: Cash reported at face.
AR at NRV. Other at fair value.

34

Cash



Funds available for disbursement.
May include liquid short term
investments.
• Highly liquid debt instruments with
original maturities of 90 days or less.

35

Receivables


Trade receivables
• Accounts receivables from usual sales of
products or services for non-financial
institutions.



Other receivables are shown
separately.
 E.g., Due from employees, advances or
loans.
36

Marketable Securities





Must be marketable.
E.g., commercial paper, treasury
bills, publicly traded stocks and
bonds issued by companies.
Also called “Temporary Investments.”

37

Accounting for Marketable
Securities


Three categories
 Held-to-maturity: debt securities,


Valued at cost.

 Trading securities: debt or equity held
for current resale, valued at market.


Realized (i.e., if sold during period) and
unrealized (not yet sold but market price
has changed) gain or loss included in
current year’s income.
38

Accounting for Marketable
Securities (Continued)


Available-for-sale securities:
 Debt or equity securities that do not fit
either of the other 2 categories.
 Reported at market value.
 Realized gains and losses go through
income.
 Unrealized gains and losses directly
credited (or debited) to a stockholders’
equity account.

39

Analysis of Monetary Assets





Current ratio = CA/CL
Acid-test ratio = quick ratio = monetary
CA/CL= (CA - inventories - prepaid
items) /CL.
Days cash = cash/(cash expenses 
365)
 Cash expenses  total expenses depreciation.





Days receivable = average collection
period = Receivables/(Sales  365)
Ratios differ by industry.

40

41


Slide 18

Revenue and Monetary
Assets
JOIN KHALID AZIZ
COACHING CLASSES
ICMAP STAGE 1,2,3,4,5
ICAP MODULE A,B,C,D
PIPFA
BBA & MBA
B.COM & M.COM
ACCOUNTING OF O/A LEVEL
MA-ECONOMICS
0322-3385752
KARACHI, PAKISTAN

Operating Cycle


Cash-to-cash.
• Receive cash from customer
• Purchase materials/services & pay cash
• Convert materials/services to salable
product
• Store product
• Sell product
• Receive cash from customer
2

Revenue Recognition:
When? (Timing) & How much? (Amt.)




At one point in revenue cycle
(objectivity).
Criteria:
• When? Earned (Conservatism)



Normally, goods shipped.
Service performed.

• How much? Realized or realizable
(Realization).





Already collected or collectible.
Amount can be measured reliably.

Next step: matching costs.

3

Basic Revenue Recognition Criteria


Recognize revenue in earliest period
in which:
• Entity has substantially performed what
is required in order to earn income and
• Amount of income can be reliably
measured.

4

Delivery Method




Recognize revenue when goods or
services are delivered.
For goods: when title transfers.
• FOB shipping point (when goods are
given to carrier).



Example 1:
• Order is received for Rs900. Sales
entry?
• Goods are produced. Sales entry?
• Goods are shipped. Sales entry?

5

Consignment Method


Consignor ships goods to
consignee.





Inventory on consignment
Merchandise inventory
1,000

1,000

Consignor retains title until goods
are sold to customer. At sale:





Accounts receivable
Sales revenue
COGS
Inventory on consignment

1,400
1,400
1,000
6

Franchise Revenue


Recognize:
• When earned.
• Not when agreement signed or fee
received.

7

Franchise Revenue First
Example


Tariq & Tariq’s charges a franchise
fee primarily for identifying the site,
designing the store, training
management and staff, and
otherwise helping to get the
franchise started in business.
Assume the initial fee is Rs100,000.
When should this Rs100,000 be
recorded as revenue?

8

Franchise Revenue Second
Example
• Golden, Inc. receives Rs6,000 from a
franchisee for the right to use its
trademark and have access to its
“know-how” for a period of 5 years.
This know-how includes training
sessions, and some one available to
answer questions. When should the
Rs6,000 be recognized as revenue?
9

Percentage-of-Completion Method








Design/development and
construction/production projects that
extends over several years.
Customer pays either fixed price or cost
reimbursement contract.
Reasonable assurance of profit margin and
ultimate realization.
Revenue recognized based on total
percentage of project work performed
during period.
10

Completed Contract Method


Percentage of completion method
required unless:
• Amount of income to be earned on
contract cannot reasonably be
determined.



Alternative is completed contract
method.
• Costs incurred are an asset (Contract
Work in Progress) until revenue is
recognized.

11

Production Method



Applies to agricultural and mining.
Criteria:
• Clear market determined price.
• Performance substantially complete.




Minimal remaining costs.

Permitted but not required by GAAP.

12

Installment Method






Customer pays a certain amount per
period.
Installment payment is recognized as
revenue and a proportional part of
cost of sales is recorded.
Under cost recovery method, cost is
recorded equal to installment
payment until total cost of sales is
covered.
13

Real Estate Sales





Developer often finances over many years.
Uncertainty of income due to uncertainty
of receipt of future payments.
Conditions required for revenue
recognition:
• Period allowing cancellation and refund to
buyer has expired.
• Cum payments equal to 10% of purchase
price.
• Seller has completed or is clearly capable of
completing required improvement.

14

Amount of Revenue
Recognized




Net realizable value (amount
reasonably estimated to be
collected).
2 approaches:
• Direct write-off method.
• Allowance method.



% of sales.
% of (analysis of) AR.
15

Direct Write-Off Method




Write-off when specific account that
is uncollectible is identified.
Why is this not acceptable under
GAAP?

16

Allowance Method


Estimate amount of current period
credit sales that will not be collected.
• Historical % tempered by judgment.
• Historical % of aged receivables
(+judgment).




Adjusting entry at end of period.
When an uncollectible account is
identified, it is written off.
17

Example


Amount of revenue recognized:
• Sales for the year were Rs2,000 for
cash and Rs6,000 on credit.
• Historically we don’t collect about 5%
of our credit sales due to customer
bankruptcies or unable to locate
customer.
• A customer, The XYZ Company went
bankrupt. They owed us Rs175.







Entry for revenue?
Entry for bad debts - direct write-off
(not-GAAP)?
Entries for bad debts (allowance
method)?

18

Example






Balances in Accounts
• Accounts receivable dr 3,000.
 Consisting of 2,000 current and 1,000
overdue.
• Allowance for doubtful accounts cr 50.
Estimated amount of accounts that are
uncollectible:
• 2% for current and 10% for non-current
accounts.
What entry do we make at the end of the year
to accrue for bad debts?
19

Allowance Method (continued)




Allowance… is a contra-asset
account.
Collection of a bad debt that was
written-off:


Cash
 Allowance for Doubtful Accounts

20

Sales Discounts


Sales terms are “2/10 net 30”
• Customer gets 2% cash discount if paid
within 10 days.
• Otherwise, total amount is due within
30 days.




What does “1/15 net 45” mean?
What is the effective annual rate of
savings by taking advantage of
terms of “2/10 net 30”?
21

Alternative Methods of
Accounting for Sales Discounts


Record initial sale at gross.
 At collection of net amount record
discount as a reduction from gross
sales.



Record initial sale at gross.
 At collection of net amount record
discount as an expense of the period.



Record initial sale at net.
 Record amounts not taken as discounts
as additional revenue.

22

Example


We sold Rs10,000 of mdse. Sales
terms are 2/10, n/30.
Customers paid us for Rs8,000 of
the merchandise billed within 10
days. The remaining Rs2,000
was paid within 30 days.
• Record at gross.
• Record at net.
23

Credit Card Sales


If cash received by merchant
immediately (Bank plan, MC, Visa):




Cash
Sales discount
Sales revenue

970
30
1000

24

Credit Card Sales (continued)


If cash received by merchant in 30
days (American Express, Discover):




Accounts receivable
Sales discount
Sales revenue

970
30
1000

25

Sales Returns & Allowances


Similar to bad debt expense,
 Estimate percentage of revenues that
will eventually result in returns or
allowances.
 Adjusting entry at end of period.
 Actual return or allowance.

26

Example
 On average 2% of our Rs10,000 of sales
is returned. Adjusting entry at end of
period?
 Entry for return of Rs80 of goods?
 Same for direct write-off method?

27

Sales Returns & Allowances
(Continued)




Provision for Returns and Allowances
is a liability account.
Alternative:
 Not accrue for returns and allowances
but write them off as they occur.
 Is this GAAP?

28

Adjustment vs. Expense





Realization concept suggests
adjustment to revenue.
In practice both methods are found.
Consistency:
 Same handling from year to year.




Allows same company results to be
compared from year to year.
Comparisons between companies may be
distorted.
29

Warranty Costs








Amounts are estimated (usually as a
percentage of sales).
Part of Cost of goods sold.
Record accrual (adjusting entry)
Record the actual expenditures.
Allowance… is a liability account.
Est. warranty exp. Is part of costs of
sales.
30

Warranty Expenses Example




We estimate that warranty expenses
will be 4% of our Rs10,000 of sales.
Entry?
We spent Rs120 on parts and Rs250
on labor for repairs under warranty.
Entry?

31

Interest Revenue




Amount earned by lender during the
period.
2 approaches
• Interest paid at maturity.


Interest is explicit.

• Discounted loan.




Interest is implicit.

Accounted for separately from sale.
32

Example: Interest Revenue


On January 1, 19x1 sold a customer
Rs1,000 of mdse. We received a
promissory note for Rs1,000 plus 8%
interest to be paid in one year.
• Entry for sale?
• Entry for accrual of interest on December 31,
19x1?
• Entry for receipt of payment on note on
January 1, 19x2?



On January 1, 19x1, we sold mdse. and
received a promissory note for Rs5,000
with no interest. The note is due in one
year. The market rate of interest on such
a note is 9%.
• Entry at sale:
• Year end adjusting entry (12/31/19x1)
• Entry when customer pays note (1/1/19x2)

33

Monetary& Non-monetary
Assets







Monetary assets are money or claims to
receive fixed sums of money.
Non-monetary assets are items used in
future production and sales of goods
and services.
Balance sheet distinction
 Current and non-current assets.
 Not monetary and non-monetary.





Non-monetary assets (except
inventory) on BS at unexpired cost.
(Cost less depreciation)
Monetary assets: Cash reported at face.
AR at NRV. Other at fair value.

34

Cash



Funds available for disbursement.
May include liquid short term
investments.
• Highly liquid debt instruments with
original maturities of 90 days or less.

35

Receivables


Trade receivables
• Accounts receivables from usual sales of
products or services for non-financial
institutions.



Other receivables are shown
separately.
 E.g., Due from employees, advances or
loans.
36

Marketable Securities





Must be marketable.
E.g., commercial paper, treasury
bills, publicly traded stocks and
bonds issued by companies.
Also called “Temporary Investments.”

37

Accounting for Marketable
Securities


Three categories
 Held-to-maturity: debt securities,


Valued at cost.

 Trading securities: debt or equity held
for current resale, valued at market.


Realized (i.e., if sold during period) and
unrealized (not yet sold but market price
has changed) gain or loss included in
current year’s income.
38

Accounting for Marketable
Securities (Continued)


Available-for-sale securities:
 Debt or equity securities that do not fit
either of the other 2 categories.
 Reported at market value.
 Realized gains and losses go through
income.
 Unrealized gains and losses directly
credited (or debited) to a stockholders’
equity account.

39

Analysis of Monetary Assets





Current ratio = CA/CL
Acid-test ratio = quick ratio = monetary
CA/CL= (CA - inventories - prepaid
items) /CL.
Days cash = cash/(cash expenses 
365)
 Cash expenses  total expenses depreciation.





Days receivable = average collection
period = Receivables/(Sales  365)
Ratios differ by industry.

40

41


Slide 19

Revenue and Monetary
Assets
JOIN KHALID AZIZ
COACHING CLASSES
ICMAP STAGE 1,2,3,4,5
ICAP MODULE A,B,C,D
PIPFA
BBA & MBA
B.COM & M.COM
ACCOUNTING OF O/A LEVEL
MA-ECONOMICS
0322-3385752
KARACHI, PAKISTAN

Operating Cycle


Cash-to-cash.
• Receive cash from customer
• Purchase materials/services & pay cash
• Convert materials/services to salable
product
• Store product
• Sell product
• Receive cash from customer
2

Revenue Recognition:
When? (Timing) & How much? (Amt.)




At one point in revenue cycle
(objectivity).
Criteria:
• When? Earned (Conservatism)



Normally, goods shipped.
Service performed.

• How much? Realized or realizable
(Realization).





Already collected or collectible.
Amount can be measured reliably.

Next step: matching costs.

3

Basic Revenue Recognition Criteria


Recognize revenue in earliest period
in which:
• Entity has substantially performed what
is required in order to earn income and
• Amount of income can be reliably
measured.

4

Delivery Method




Recognize revenue when goods or
services are delivered.
For goods: when title transfers.
• FOB shipping point (when goods are
given to carrier).



Example 1:
• Order is received for Rs900. Sales
entry?
• Goods are produced. Sales entry?
• Goods are shipped. Sales entry?

5

Consignment Method


Consignor ships goods to
consignee.





Inventory on consignment
Merchandise inventory
1,000

1,000

Consignor retains title until goods
are sold to customer. At sale:





Accounts receivable
Sales revenue
COGS
Inventory on consignment

1,400
1,400
1,000
6

Franchise Revenue


Recognize:
• When earned.
• Not when agreement signed or fee
received.

7

Franchise Revenue First
Example


Tariq & Tariq’s charges a franchise
fee primarily for identifying the site,
designing the store, training
management and staff, and
otherwise helping to get the
franchise started in business.
Assume the initial fee is Rs100,000.
When should this Rs100,000 be
recorded as revenue?

8

Franchise Revenue Second
Example
• Golden, Inc. receives Rs6,000 from a
franchisee for the right to use its
trademark and have access to its
“know-how” for a period of 5 years.
This know-how includes training
sessions, and some one available to
answer questions. When should the
Rs6,000 be recognized as revenue?
9

Percentage-of-Completion Method








Design/development and
construction/production projects that
extends over several years.
Customer pays either fixed price or cost
reimbursement contract.
Reasonable assurance of profit margin and
ultimate realization.
Revenue recognized based on total
percentage of project work performed
during period.
10

Completed Contract Method


Percentage of completion method
required unless:
• Amount of income to be earned on
contract cannot reasonably be
determined.



Alternative is completed contract
method.
• Costs incurred are an asset (Contract
Work in Progress) until revenue is
recognized.

11

Production Method



Applies to agricultural and mining.
Criteria:
• Clear market determined price.
• Performance substantially complete.




Minimal remaining costs.

Permitted but not required by GAAP.

12

Installment Method






Customer pays a certain amount per
period.
Installment payment is recognized as
revenue and a proportional part of
cost of sales is recorded.
Under cost recovery method, cost is
recorded equal to installment
payment until total cost of sales is
covered.
13

Real Estate Sales





Developer often finances over many years.
Uncertainty of income due to uncertainty
of receipt of future payments.
Conditions required for revenue
recognition:
• Period allowing cancellation and refund to
buyer has expired.
• Cum payments equal to 10% of purchase
price.
• Seller has completed or is clearly capable of
completing required improvement.

14

Amount of Revenue
Recognized




Net realizable value (amount
reasonably estimated to be
collected).
2 approaches:
• Direct write-off method.
• Allowance method.



% of sales.
% of (analysis of) AR.
15

Direct Write-Off Method




Write-off when specific account that
is uncollectible is identified.
Why is this not acceptable under
GAAP?

16

Allowance Method


Estimate amount of current period
credit sales that will not be collected.
• Historical % tempered by judgment.
• Historical % of aged receivables
(+judgment).




Adjusting entry at end of period.
When an uncollectible account is
identified, it is written off.
17

Example


Amount of revenue recognized:
• Sales for the year were Rs2,000 for
cash and Rs6,000 on credit.
• Historically we don’t collect about 5%
of our credit sales due to customer
bankruptcies or unable to locate
customer.
• A customer, The XYZ Company went
bankrupt. They owed us Rs175.







Entry for revenue?
Entry for bad debts - direct write-off
(not-GAAP)?
Entries for bad debts (allowance
method)?

18

Example






Balances in Accounts
• Accounts receivable dr 3,000.
 Consisting of 2,000 current and 1,000
overdue.
• Allowance for doubtful accounts cr 50.
Estimated amount of accounts that are
uncollectible:
• 2% for current and 10% for non-current
accounts.
What entry do we make at the end of the year
to accrue for bad debts?
19

Allowance Method (continued)




Allowance… is a contra-asset
account.
Collection of a bad debt that was
written-off:


Cash
 Allowance for Doubtful Accounts

20

Sales Discounts


Sales terms are “2/10 net 30”
• Customer gets 2% cash discount if paid
within 10 days.
• Otherwise, total amount is due within
30 days.




What does “1/15 net 45” mean?
What is the effective annual rate of
savings by taking advantage of
terms of “2/10 net 30”?
21

Alternative Methods of
Accounting for Sales Discounts


Record initial sale at gross.
 At collection of net amount record
discount as a reduction from gross
sales.



Record initial sale at gross.
 At collection of net amount record
discount as an expense of the period.



Record initial sale at net.
 Record amounts not taken as discounts
as additional revenue.

22

Example


We sold Rs10,000 of mdse. Sales
terms are 2/10, n/30.
Customers paid us for Rs8,000 of
the merchandise billed within 10
days. The remaining Rs2,000
was paid within 30 days.
• Record at gross.
• Record at net.
23

Credit Card Sales


If cash received by merchant
immediately (Bank plan, MC, Visa):




Cash
Sales discount
Sales revenue

970
30
1000

24

Credit Card Sales (continued)


If cash received by merchant in 30
days (American Express, Discover):




Accounts receivable
Sales discount
Sales revenue

970
30
1000

25

Sales Returns & Allowances


Similar to bad debt expense,
 Estimate percentage of revenues that
will eventually result in returns or
allowances.
 Adjusting entry at end of period.
 Actual return or allowance.

26

Example
 On average 2% of our Rs10,000 of sales
is returned. Adjusting entry at end of
period?
 Entry for return of Rs80 of goods?
 Same for direct write-off method?

27

Sales Returns & Allowances
(Continued)




Provision for Returns and Allowances
is a liability account.
Alternative:
 Not accrue for returns and allowances
but write them off as they occur.
 Is this GAAP?

28

Adjustment vs. Expense





Realization concept suggests
adjustment to revenue.
In practice both methods are found.
Consistency:
 Same handling from year to year.




Allows same company results to be
compared from year to year.
Comparisons between companies may be
distorted.
29

Warranty Costs








Amounts are estimated (usually as a
percentage of sales).
Part of Cost of goods sold.
Record accrual (adjusting entry)
Record the actual expenditures.
Allowance… is a liability account.
Est. warranty exp. Is part of costs of
sales.
30

Warranty Expenses Example




We estimate that warranty expenses
will be 4% of our Rs10,000 of sales.
Entry?
We spent Rs120 on parts and Rs250
on labor for repairs under warranty.
Entry?

31

Interest Revenue




Amount earned by lender during the
period.
2 approaches
• Interest paid at maturity.


Interest is explicit.

• Discounted loan.




Interest is implicit.

Accounted for separately from sale.
32

Example: Interest Revenue


On January 1, 19x1 sold a customer
Rs1,000 of mdse. We received a
promissory note for Rs1,000 plus 8%
interest to be paid in one year.
• Entry for sale?
• Entry for accrual of interest on December 31,
19x1?
• Entry for receipt of payment on note on
January 1, 19x2?



On January 1, 19x1, we sold mdse. and
received a promissory note for Rs5,000
with no interest. The note is due in one
year. The market rate of interest on such
a note is 9%.
• Entry at sale:
• Year end adjusting entry (12/31/19x1)
• Entry when customer pays note (1/1/19x2)

33

Monetary& Non-monetary
Assets







Monetary assets are money or claims to
receive fixed sums of money.
Non-monetary assets are items used in
future production and sales of goods
and services.
Balance sheet distinction
 Current and non-current assets.
 Not monetary and non-monetary.





Non-monetary assets (except
inventory) on BS at unexpired cost.
(Cost less depreciation)
Monetary assets: Cash reported at face.
AR at NRV. Other at fair value.

34

Cash



Funds available for disbursement.
May include liquid short term
investments.
• Highly liquid debt instruments with
original maturities of 90 days or less.

35

Receivables


Trade receivables
• Accounts receivables from usual sales of
products or services for non-financial
institutions.



Other receivables are shown
separately.
 E.g., Due from employees, advances or
loans.
36

Marketable Securities





Must be marketable.
E.g., commercial paper, treasury
bills, publicly traded stocks and
bonds issued by companies.
Also called “Temporary Investments.”

37

Accounting for Marketable
Securities


Three categories
 Held-to-maturity: debt securities,


Valued at cost.

 Trading securities: debt or equity held
for current resale, valued at market.


Realized (i.e., if sold during period) and
unrealized (not yet sold but market price
has changed) gain or loss included in
current year’s income.
38

Accounting for Marketable
Securities (Continued)


Available-for-sale securities:
 Debt or equity securities that do not fit
either of the other 2 categories.
 Reported at market value.
 Realized gains and losses go through
income.
 Unrealized gains and losses directly
credited (or debited) to a stockholders’
equity account.

39

Analysis of Monetary Assets





Current ratio = CA/CL
Acid-test ratio = quick ratio = monetary
CA/CL= (CA - inventories - prepaid
items) /CL.
Days cash = cash/(cash expenses 
365)
 Cash expenses  total expenses depreciation.





Days receivable = average collection
period = Receivables/(Sales  365)
Ratios differ by industry.

40

41


Slide 20

Revenue and Monetary
Assets
JOIN KHALID AZIZ
COACHING CLASSES
ICMAP STAGE 1,2,3,4,5
ICAP MODULE A,B,C,D
PIPFA
BBA & MBA
B.COM & M.COM
ACCOUNTING OF O/A LEVEL
MA-ECONOMICS
0322-3385752
KARACHI, PAKISTAN

Operating Cycle


Cash-to-cash.
• Receive cash from customer
• Purchase materials/services & pay cash
• Convert materials/services to salable
product
• Store product
• Sell product
• Receive cash from customer
2

Revenue Recognition:
When? (Timing) & How much? (Amt.)




At one point in revenue cycle
(objectivity).
Criteria:
• When? Earned (Conservatism)



Normally, goods shipped.
Service performed.

• How much? Realized or realizable
(Realization).





Already collected or collectible.
Amount can be measured reliably.

Next step: matching costs.

3

Basic Revenue Recognition Criteria


Recognize revenue in earliest period
in which:
• Entity has substantially performed what
is required in order to earn income and
• Amount of income can be reliably
measured.

4

Delivery Method




Recognize revenue when goods or
services are delivered.
For goods: when title transfers.
• FOB shipping point (when goods are
given to carrier).



Example 1:
• Order is received for Rs900. Sales
entry?
• Goods are produced. Sales entry?
• Goods are shipped. Sales entry?

5

Consignment Method


Consignor ships goods to
consignee.





Inventory on consignment
Merchandise inventory
1,000

1,000

Consignor retains title until goods
are sold to customer. At sale:





Accounts receivable
Sales revenue
COGS
Inventory on consignment

1,400
1,400
1,000
6

Franchise Revenue


Recognize:
• When earned.
• Not when agreement signed or fee
received.

7

Franchise Revenue First
Example


Tariq & Tariq’s charges a franchise
fee primarily for identifying the site,
designing the store, training
management and staff, and
otherwise helping to get the
franchise started in business.
Assume the initial fee is Rs100,000.
When should this Rs100,000 be
recorded as revenue?

8

Franchise Revenue Second
Example
• Golden, Inc. receives Rs6,000 from a
franchisee for the right to use its
trademark and have access to its
“know-how” for a period of 5 years.
This know-how includes training
sessions, and some one available to
answer questions. When should the
Rs6,000 be recognized as revenue?
9

Percentage-of-Completion Method








Design/development and
construction/production projects that
extends over several years.
Customer pays either fixed price or cost
reimbursement contract.
Reasonable assurance of profit margin and
ultimate realization.
Revenue recognized based on total
percentage of project work performed
during period.
10

Completed Contract Method


Percentage of completion method
required unless:
• Amount of income to be earned on
contract cannot reasonably be
determined.



Alternative is completed contract
method.
• Costs incurred are an asset (Contract
Work in Progress) until revenue is
recognized.

11

Production Method



Applies to agricultural and mining.
Criteria:
• Clear market determined price.
• Performance substantially complete.




Minimal remaining costs.

Permitted but not required by GAAP.

12

Installment Method






Customer pays a certain amount per
period.
Installment payment is recognized as
revenue and a proportional part of
cost of sales is recorded.
Under cost recovery method, cost is
recorded equal to installment
payment until total cost of sales is
covered.
13

Real Estate Sales





Developer often finances over many years.
Uncertainty of income due to uncertainty
of receipt of future payments.
Conditions required for revenue
recognition:
• Period allowing cancellation and refund to
buyer has expired.
• Cum payments equal to 10% of purchase
price.
• Seller has completed or is clearly capable of
completing required improvement.

14

Amount of Revenue
Recognized




Net realizable value (amount
reasonably estimated to be
collected).
2 approaches:
• Direct write-off method.
• Allowance method.



% of sales.
% of (analysis of) AR.
15

Direct Write-Off Method




Write-off when specific account that
is uncollectible is identified.
Why is this not acceptable under
GAAP?

16

Allowance Method


Estimate amount of current period
credit sales that will not be collected.
• Historical % tempered by judgment.
• Historical % of aged receivables
(+judgment).




Adjusting entry at end of period.
When an uncollectible account is
identified, it is written off.
17

Example


Amount of revenue recognized:
• Sales for the year were Rs2,000 for
cash and Rs6,000 on credit.
• Historically we don’t collect about 5%
of our credit sales due to customer
bankruptcies or unable to locate
customer.
• A customer, The XYZ Company went
bankrupt. They owed us Rs175.







Entry for revenue?
Entry for bad debts - direct write-off
(not-GAAP)?
Entries for bad debts (allowance
method)?

18

Example






Balances in Accounts
• Accounts receivable dr 3,000.
 Consisting of 2,000 current and 1,000
overdue.
• Allowance for doubtful accounts cr 50.
Estimated amount of accounts that are
uncollectible:
• 2% for current and 10% for non-current
accounts.
What entry do we make at the end of the year
to accrue for bad debts?
19

Allowance Method (continued)




Allowance… is a contra-asset
account.
Collection of a bad debt that was
written-off:


Cash
 Allowance for Doubtful Accounts

20

Sales Discounts


Sales terms are “2/10 net 30”
• Customer gets 2% cash discount if paid
within 10 days.
• Otherwise, total amount is due within
30 days.




What does “1/15 net 45” mean?
What is the effective annual rate of
savings by taking advantage of
terms of “2/10 net 30”?
21

Alternative Methods of
Accounting for Sales Discounts


Record initial sale at gross.
 At collection of net amount record
discount as a reduction from gross
sales.



Record initial sale at gross.
 At collection of net amount record
discount as an expense of the period.



Record initial sale at net.
 Record amounts not taken as discounts
as additional revenue.

22

Example


We sold Rs10,000 of mdse. Sales
terms are 2/10, n/30.
Customers paid us for Rs8,000 of
the merchandise billed within 10
days. The remaining Rs2,000
was paid within 30 days.
• Record at gross.
• Record at net.
23

Credit Card Sales


If cash received by merchant
immediately (Bank plan, MC, Visa):




Cash
Sales discount
Sales revenue

970
30
1000

24

Credit Card Sales (continued)


If cash received by merchant in 30
days (American Express, Discover):




Accounts receivable
Sales discount
Sales revenue

970
30
1000

25

Sales Returns & Allowances


Similar to bad debt expense,
 Estimate percentage of revenues that
will eventually result in returns or
allowances.
 Adjusting entry at end of period.
 Actual return or allowance.

26

Example
 On average 2% of our Rs10,000 of sales
is returned. Adjusting entry at end of
period?
 Entry for return of Rs80 of goods?
 Same for direct write-off method?

27

Sales Returns & Allowances
(Continued)




Provision for Returns and Allowances
is a liability account.
Alternative:
 Not accrue for returns and allowances
but write them off as they occur.
 Is this GAAP?

28

Adjustment vs. Expense





Realization concept suggests
adjustment to revenue.
In practice both methods are found.
Consistency:
 Same handling from year to year.




Allows same company results to be
compared from year to year.
Comparisons between companies may be
distorted.
29

Warranty Costs








Amounts are estimated (usually as a
percentage of sales).
Part of Cost of goods sold.
Record accrual (adjusting entry)
Record the actual expenditures.
Allowance… is a liability account.
Est. warranty exp. Is part of costs of
sales.
30

Warranty Expenses Example




We estimate that warranty expenses
will be 4% of our Rs10,000 of sales.
Entry?
We spent Rs120 on parts and Rs250
on labor for repairs under warranty.
Entry?

31

Interest Revenue




Amount earned by lender during the
period.
2 approaches
• Interest paid at maturity.


Interest is explicit.

• Discounted loan.




Interest is implicit.

Accounted for separately from sale.
32

Example: Interest Revenue


On January 1, 19x1 sold a customer
Rs1,000 of mdse. We received a
promissory note for Rs1,000 plus 8%
interest to be paid in one year.
• Entry for sale?
• Entry for accrual of interest on December 31,
19x1?
• Entry for receipt of payment on note on
January 1, 19x2?



On January 1, 19x1, we sold mdse. and
received a promissory note for Rs5,000
with no interest. The note is due in one
year. The market rate of interest on such
a note is 9%.
• Entry at sale:
• Year end adjusting entry (12/31/19x1)
• Entry when customer pays note (1/1/19x2)

33

Monetary& Non-monetary
Assets







Monetary assets are money or claims to
receive fixed sums of money.
Non-monetary assets are items used in
future production and sales of goods
and services.
Balance sheet distinction
 Current and non-current assets.
 Not monetary and non-monetary.





Non-monetary assets (except
inventory) on BS at unexpired cost.
(Cost less depreciation)
Monetary assets: Cash reported at face.
AR at NRV. Other at fair value.

34

Cash



Funds available for disbursement.
May include liquid short term
investments.
• Highly liquid debt instruments with
original maturities of 90 days or less.

35

Receivables


Trade receivables
• Accounts receivables from usual sales of
products or services for non-financial
institutions.



Other receivables are shown
separately.
 E.g., Due from employees, advances or
loans.
36

Marketable Securities





Must be marketable.
E.g., commercial paper, treasury
bills, publicly traded stocks and
bonds issued by companies.
Also called “Temporary Investments.”

37

Accounting for Marketable
Securities


Three categories
 Held-to-maturity: debt securities,


Valued at cost.

 Trading securities: debt or equity held
for current resale, valued at market.


Realized (i.e., if sold during period) and
unrealized (not yet sold but market price
has changed) gain or loss included in
current year’s income.
38

Accounting for Marketable
Securities (Continued)


Available-for-sale securities:
 Debt or equity securities that do not fit
either of the other 2 categories.
 Reported at market value.
 Realized gains and losses go through
income.
 Unrealized gains and losses directly
credited (or debited) to a stockholders’
equity account.

39

Analysis of Monetary Assets





Current ratio = CA/CL
Acid-test ratio = quick ratio = monetary
CA/CL= (CA - inventories - prepaid
items) /CL.
Days cash = cash/(cash expenses 
365)
 Cash expenses  total expenses depreciation.





Days receivable = average collection
period = Receivables/(Sales  365)
Ratios differ by industry.

40

41


Slide 21

Revenue and Monetary
Assets
JOIN KHALID AZIZ
COACHING CLASSES
ICMAP STAGE 1,2,3,4,5
ICAP MODULE A,B,C,D
PIPFA
BBA & MBA
B.COM & M.COM
ACCOUNTING OF O/A LEVEL
MA-ECONOMICS
0322-3385752
KARACHI, PAKISTAN

Operating Cycle


Cash-to-cash.
• Receive cash from customer
• Purchase materials/services & pay cash
• Convert materials/services to salable
product
• Store product
• Sell product
• Receive cash from customer
2

Revenue Recognition:
When? (Timing) & How much? (Amt.)




At one point in revenue cycle
(objectivity).
Criteria:
• When? Earned (Conservatism)



Normally, goods shipped.
Service performed.

• How much? Realized or realizable
(Realization).





Already collected or collectible.
Amount can be measured reliably.

Next step: matching costs.

3

Basic Revenue Recognition Criteria


Recognize revenue in earliest period
in which:
• Entity has substantially performed what
is required in order to earn income and
• Amount of income can be reliably
measured.

4

Delivery Method




Recognize revenue when goods or
services are delivered.
For goods: when title transfers.
• FOB shipping point (when goods are
given to carrier).



Example 1:
• Order is received for Rs900. Sales
entry?
• Goods are produced. Sales entry?
• Goods are shipped. Sales entry?

5

Consignment Method


Consignor ships goods to
consignee.





Inventory on consignment
Merchandise inventory
1,000

1,000

Consignor retains title until goods
are sold to customer. At sale:





Accounts receivable
Sales revenue
COGS
Inventory on consignment

1,400
1,400
1,000
6

Franchise Revenue


Recognize:
• When earned.
• Not when agreement signed or fee
received.

7

Franchise Revenue First
Example


Tariq & Tariq’s charges a franchise
fee primarily for identifying the site,
designing the store, training
management and staff, and
otherwise helping to get the
franchise started in business.
Assume the initial fee is Rs100,000.
When should this Rs100,000 be
recorded as revenue?

8

Franchise Revenue Second
Example
• Golden, Inc. receives Rs6,000 from a
franchisee for the right to use its
trademark and have access to its
“know-how” for a period of 5 years.
This know-how includes training
sessions, and some one available to
answer questions. When should the
Rs6,000 be recognized as revenue?
9

Percentage-of-Completion Method








Design/development and
construction/production projects that
extends over several years.
Customer pays either fixed price or cost
reimbursement contract.
Reasonable assurance of profit margin and
ultimate realization.
Revenue recognized based on total
percentage of project work performed
during period.
10

Completed Contract Method


Percentage of completion method
required unless:
• Amount of income to be earned on
contract cannot reasonably be
determined.



Alternative is completed contract
method.
• Costs incurred are an asset (Contract
Work in Progress) until revenue is
recognized.

11

Production Method



Applies to agricultural and mining.
Criteria:
• Clear market determined price.
• Performance substantially complete.




Minimal remaining costs.

Permitted but not required by GAAP.

12

Installment Method






Customer pays a certain amount per
period.
Installment payment is recognized as
revenue and a proportional part of
cost of sales is recorded.
Under cost recovery method, cost is
recorded equal to installment
payment until total cost of sales is
covered.
13

Real Estate Sales





Developer often finances over many years.
Uncertainty of income due to uncertainty
of receipt of future payments.
Conditions required for revenue
recognition:
• Period allowing cancellation and refund to
buyer has expired.
• Cum payments equal to 10% of purchase
price.
• Seller has completed or is clearly capable of
completing required improvement.

14

Amount of Revenue
Recognized




Net realizable value (amount
reasonably estimated to be
collected).
2 approaches:
• Direct write-off method.
• Allowance method.



% of sales.
% of (analysis of) AR.
15

Direct Write-Off Method




Write-off when specific account that
is uncollectible is identified.
Why is this not acceptable under
GAAP?

16

Allowance Method


Estimate amount of current period
credit sales that will not be collected.
• Historical % tempered by judgment.
• Historical % of aged receivables
(+judgment).




Adjusting entry at end of period.
When an uncollectible account is
identified, it is written off.
17

Example


Amount of revenue recognized:
• Sales for the year were Rs2,000 for
cash and Rs6,000 on credit.
• Historically we don’t collect about 5%
of our credit sales due to customer
bankruptcies or unable to locate
customer.
• A customer, The XYZ Company went
bankrupt. They owed us Rs175.







Entry for revenue?
Entry for bad debts - direct write-off
(not-GAAP)?
Entries for bad debts (allowance
method)?

18

Example






Balances in Accounts
• Accounts receivable dr 3,000.
 Consisting of 2,000 current and 1,000
overdue.
• Allowance for doubtful accounts cr 50.
Estimated amount of accounts that are
uncollectible:
• 2% for current and 10% for non-current
accounts.
What entry do we make at the end of the year
to accrue for bad debts?
19

Allowance Method (continued)




Allowance… is a contra-asset
account.
Collection of a bad debt that was
written-off:


Cash
 Allowance for Doubtful Accounts

20

Sales Discounts


Sales terms are “2/10 net 30”
• Customer gets 2% cash discount if paid
within 10 days.
• Otherwise, total amount is due within
30 days.




What does “1/15 net 45” mean?
What is the effective annual rate of
savings by taking advantage of
terms of “2/10 net 30”?
21

Alternative Methods of
Accounting for Sales Discounts


Record initial sale at gross.
 At collection of net amount record
discount as a reduction from gross
sales.



Record initial sale at gross.
 At collection of net amount record
discount as an expense of the period.



Record initial sale at net.
 Record amounts not taken as discounts
as additional revenue.

22

Example


We sold Rs10,000 of mdse. Sales
terms are 2/10, n/30.
Customers paid us for Rs8,000 of
the merchandise billed within 10
days. The remaining Rs2,000
was paid within 30 days.
• Record at gross.
• Record at net.
23

Credit Card Sales


If cash received by merchant
immediately (Bank plan, MC, Visa):




Cash
Sales discount
Sales revenue

970
30
1000

24

Credit Card Sales (continued)


If cash received by merchant in 30
days (American Express, Discover):




Accounts receivable
Sales discount
Sales revenue

970
30
1000

25

Sales Returns & Allowances


Similar to bad debt expense,
 Estimate percentage of revenues that
will eventually result in returns or
allowances.
 Adjusting entry at end of period.
 Actual return or allowance.

26

Example
 On average 2% of our Rs10,000 of sales
is returned. Adjusting entry at end of
period?
 Entry for return of Rs80 of goods?
 Same for direct write-off method?

27

Sales Returns & Allowances
(Continued)




Provision for Returns and Allowances
is a liability account.
Alternative:
 Not accrue for returns and allowances
but write them off as they occur.
 Is this GAAP?

28

Adjustment vs. Expense





Realization concept suggests
adjustment to revenue.
In practice both methods are found.
Consistency:
 Same handling from year to year.




Allows same company results to be
compared from year to year.
Comparisons between companies may be
distorted.
29

Warranty Costs








Amounts are estimated (usually as a
percentage of sales).
Part of Cost of goods sold.
Record accrual (adjusting entry)
Record the actual expenditures.
Allowance… is a liability account.
Est. warranty exp. Is part of costs of
sales.
30

Warranty Expenses Example




We estimate that warranty expenses
will be 4% of our Rs10,000 of sales.
Entry?
We spent Rs120 on parts and Rs250
on labor for repairs under warranty.
Entry?

31

Interest Revenue




Amount earned by lender during the
period.
2 approaches
• Interest paid at maturity.


Interest is explicit.

• Discounted loan.




Interest is implicit.

Accounted for separately from sale.
32

Example: Interest Revenue


On January 1, 19x1 sold a customer
Rs1,000 of mdse. We received a
promissory note for Rs1,000 plus 8%
interest to be paid in one year.
• Entry for sale?
• Entry for accrual of interest on December 31,
19x1?
• Entry for receipt of payment on note on
January 1, 19x2?



On January 1, 19x1, we sold mdse. and
received a promissory note for Rs5,000
with no interest. The note is due in one
year. The market rate of interest on such
a note is 9%.
• Entry at sale:
• Year end adjusting entry (12/31/19x1)
• Entry when customer pays note (1/1/19x2)

33

Monetary& Non-monetary
Assets







Monetary assets are money or claims to
receive fixed sums of money.
Non-monetary assets are items used in
future production and sales of goods
and services.
Balance sheet distinction
 Current and non-current assets.
 Not monetary and non-monetary.





Non-monetary assets (except
inventory) on BS at unexpired cost.
(Cost less depreciation)
Monetary assets: Cash reported at face.
AR at NRV. Other at fair value.

34

Cash



Funds available for disbursement.
May include liquid short term
investments.
• Highly liquid debt instruments with
original maturities of 90 days or less.

35

Receivables


Trade receivables
• Accounts receivables from usual sales of
products or services for non-financial
institutions.



Other receivables are shown
separately.
 E.g., Due from employees, advances or
loans.
36

Marketable Securities





Must be marketable.
E.g., commercial paper, treasury
bills, publicly traded stocks and
bonds issued by companies.
Also called “Temporary Investments.”

37

Accounting for Marketable
Securities


Three categories
 Held-to-maturity: debt securities,


Valued at cost.

 Trading securities: debt or equity held
for current resale, valued at market.


Realized (i.e., if sold during period) and
unrealized (not yet sold but market price
has changed) gain or loss included in
current year’s income.
38

Accounting for Marketable
Securities (Continued)


Available-for-sale securities:
 Debt or equity securities that do not fit
either of the other 2 categories.
 Reported at market value.
 Realized gains and losses go through
income.
 Unrealized gains and losses directly
credited (or debited) to a stockholders’
equity account.

39

Analysis of Monetary Assets





Current ratio = CA/CL
Acid-test ratio = quick ratio = monetary
CA/CL= (CA - inventories - prepaid
items) /CL.
Days cash = cash/(cash expenses 
365)
 Cash expenses  total expenses depreciation.





Days receivable = average collection
period = Receivables/(Sales  365)
Ratios differ by industry.

40

41


Slide 22

Revenue and Monetary
Assets
JOIN KHALID AZIZ
COACHING CLASSES
ICMAP STAGE 1,2,3,4,5
ICAP MODULE A,B,C,D
PIPFA
BBA & MBA
B.COM & M.COM
ACCOUNTING OF O/A LEVEL
MA-ECONOMICS
0322-3385752
KARACHI, PAKISTAN

Operating Cycle


Cash-to-cash.
• Receive cash from customer
• Purchase materials/services & pay cash
• Convert materials/services to salable
product
• Store product
• Sell product
• Receive cash from customer
2

Revenue Recognition:
When? (Timing) & How much? (Amt.)




At one point in revenue cycle
(objectivity).
Criteria:
• When? Earned (Conservatism)



Normally, goods shipped.
Service performed.

• How much? Realized or realizable
(Realization).





Already collected or collectible.
Amount can be measured reliably.

Next step: matching costs.

3

Basic Revenue Recognition Criteria


Recognize revenue in earliest period
in which:
• Entity has substantially performed what
is required in order to earn income and
• Amount of income can be reliably
measured.

4

Delivery Method




Recognize revenue when goods or
services are delivered.
For goods: when title transfers.
• FOB shipping point (when goods are
given to carrier).



Example 1:
• Order is received for Rs900. Sales
entry?
• Goods are produced. Sales entry?
• Goods are shipped. Sales entry?

5

Consignment Method


Consignor ships goods to
consignee.





Inventory on consignment
Merchandise inventory
1,000

1,000

Consignor retains title until goods
are sold to customer. At sale:





Accounts receivable
Sales revenue
COGS
Inventory on consignment

1,400
1,400
1,000
6

Franchise Revenue


Recognize:
• When earned.
• Not when agreement signed or fee
received.

7

Franchise Revenue First
Example


Tariq & Tariq’s charges a franchise
fee primarily for identifying the site,
designing the store, training
management and staff, and
otherwise helping to get the
franchise started in business.
Assume the initial fee is Rs100,000.
When should this Rs100,000 be
recorded as revenue?

8

Franchise Revenue Second
Example
• Golden, Inc. receives Rs6,000 from a
franchisee for the right to use its
trademark and have access to its
“know-how” for a period of 5 years.
This know-how includes training
sessions, and some one available to
answer questions. When should the
Rs6,000 be recognized as revenue?
9

Percentage-of-Completion Method








Design/development and
construction/production projects that
extends over several years.
Customer pays either fixed price or cost
reimbursement contract.
Reasonable assurance of profit margin and
ultimate realization.
Revenue recognized based on total
percentage of project work performed
during period.
10

Completed Contract Method


Percentage of completion method
required unless:
• Amount of income to be earned on
contract cannot reasonably be
determined.



Alternative is completed contract
method.
• Costs incurred are an asset (Contract
Work in Progress) until revenue is
recognized.

11

Production Method



Applies to agricultural and mining.
Criteria:
• Clear market determined price.
• Performance substantially complete.




Minimal remaining costs.

Permitted but not required by GAAP.

12

Installment Method






Customer pays a certain amount per
period.
Installment payment is recognized as
revenue and a proportional part of
cost of sales is recorded.
Under cost recovery method, cost is
recorded equal to installment
payment until total cost of sales is
covered.
13

Real Estate Sales





Developer often finances over many years.
Uncertainty of income due to uncertainty
of receipt of future payments.
Conditions required for revenue
recognition:
• Period allowing cancellation and refund to
buyer has expired.
• Cum payments equal to 10% of purchase
price.
• Seller has completed or is clearly capable of
completing required improvement.

14

Amount of Revenue
Recognized




Net realizable value (amount
reasonably estimated to be
collected).
2 approaches:
• Direct write-off method.
• Allowance method.



% of sales.
% of (analysis of) AR.
15

Direct Write-Off Method




Write-off when specific account that
is uncollectible is identified.
Why is this not acceptable under
GAAP?

16

Allowance Method


Estimate amount of current period
credit sales that will not be collected.
• Historical % tempered by judgment.
• Historical % of aged receivables
(+judgment).




Adjusting entry at end of period.
When an uncollectible account is
identified, it is written off.
17

Example


Amount of revenue recognized:
• Sales for the year were Rs2,000 for
cash and Rs6,000 on credit.
• Historically we don’t collect about 5%
of our credit sales due to customer
bankruptcies or unable to locate
customer.
• A customer, The XYZ Company went
bankrupt. They owed us Rs175.







Entry for revenue?
Entry for bad debts - direct write-off
(not-GAAP)?
Entries for bad debts (allowance
method)?

18

Example






Balances in Accounts
• Accounts receivable dr 3,000.
 Consisting of 2,000 current and 1,000
overdue.
• Allowance for doubtful accounts cr 50.
Estimated amount of accounts that are
uncollectible:
• 2% for current and 10% for non-current
accounts.
What entry do we make at the end of the year
to accrue for bad debts?
19

Allowance Method (continued)




Allowance… is a contra-asset
account.
Collection of a bad debt that was
written-off:


Cash
 Allowance for Doubtful Accounts

20

Sales Discounts


Sales terms are “2/10 net 30”
• Customer gets 2% cash discount if paid
within 10 days.
• Otherwise, total amount is due within
30 days.




What does “1/15 net 45” mean?
What is the effective annual rate of
savings by taking advantage of
terms of “2/10 net 30”?
21

Alternative Methods of
Accounting for Sales Discounts


Record initial sale at gross.
 At collection of net amount record
discount as a reduction from gross
sales.



Record initial sale at gross.
 At collection of net amount record
discount as an expense of the period.



Record initial sale at net.
 Record amounts not taken as discounts
as additional revenue.

22

Example


We sold Rs10,000 of mdse. Sales
terms are 2/10, n/30.
Customers paid us for Rs8,000 of
the merchandise billed within 10
days. The remaining Rs2,000
was paid within 30 days.
• Record at gross.
• Record at net.
23

Credit Card Sales


If cash received by merchant
immediately (Bank plan, MC, Visa):




Cash
Sales discount
Sales revenue

970
30
1000

24

Credit Card Sales (continued)


If cash received by merchant in 30
days (American Express, Discover):




Accounts receivable
Sales discount
Sales revenue

970
30
1000

25

Sales Returns & Allowances


Similar to bad debt expense,
 Estimate percentage of revenues that
will eventually result in returns or
allowances.
 Adjusting entry at end of period.
 Actual return or allowance.

26

Example
 On average 2% of our Rs10,000 of sales
is returned. Adjusting entry at end of
period?
 Entry for return of Rs80 of goods?
 Same for direct write-off method?

27

Sales Returns & Allowances
(Continued)




Provision for Returns and Allowances
is a liability account.
Alternative:
 Not accrue for returns and allowances
but write them off as they occur.
 Is this GAAP?

28

Adjustment vs. Expense





Realization concept suggests
adjustment to revenue.
In practice both methods are found.
Consistency:
 Same handling from year to year.




Allows same company results to be
compared from year to year.
Comparisons between companies may be
distorted.
29

Warranty Costs








Amounts are estimated (usually as a
percentage of sales).
Part of Cost of goods sold.
Record accrual (adjusting entry)
Record the actual expenditures.
Allowance… is a liability account.
Est. warranty exp. Is part of costs of
sales.
30

Warranty Expenses Example




We estimate that warranty expenses
will be 4% of our Rs10,000 of sales.
Entry?
We spent Rs120 on parts and Rs250
on labor for repairs under warranty.
Entry?

31

Interest Revenue




Amount earned by lender during the
period.
2 approaches
• Interest paid at maturity.


Interest is explicit.

• Discounted loan.




Interest is implicit.

Accounted for separately from sale.
32

Example: Interest Revenue


On January 1, 19x1 sold a customer
Rs1,000 of mdse. We received a
promissory note for Rs1,000 plus 8%
interest to be paid in one year.
• Entry for sale?
• Entry for accrual of interest on December 31,
19x1?
• Entry for receipt of payment on note on
January 1, 19x2?



On January 1, 19x1, we sold mdse. and
received a promissory note for Rs5,000
with no interest. The note is due in one
year. The market rate of interest on such
a note is 9%.
• Entry at sale:
• Year end adjusting entry (12/31/19x1)
• Entry when customer pays note (1/1/19x2)

33

Monetary& Non-monetary
Assets







Monetary assets are money or claims to
receive fixed sums of money.
Non-monetary assets are items used in
future production and sales of goods
and services.
Balance sheet distinction
 Current and non-current assets.
 Not monetary and non-monetary.





Non-monetary assets (except
inventory) on BS at unexpired cost.
(Cost less depreciation)
Monetary assets: Cash reported at face.
AR at NRV. Other at fair value.

34

Cash



Funds available for disbursement.
May include liquid short term
investments.
• Highly liquid debt instruments with
original maturities of 90 days or less.

35

Receivables


Trade receivables
• Accounts receivables from usual sales of
products or services for non-financial
institutions.



Other receivables are shown
separately.
 E.g., Due from employees, advances or
loans.
36

Marketable Securities





Must be marketable.
E.g., commercial paper, treasury
bills, publicly traded stocks and
bonds issued by companies.
Also called “Temporary Investments.”

37

Accounting for Marketable
Securities


Three categories
 Held-to-maturity: debt securities,


Valued at cost.

 Trading securities: debt or equity held
for current resale, valued at market.


Realized (i.e., if sold during period) and
unrealized (not yet sold but market price
has changed) gain or loss included in
current year’s income.
38

Accounting for Marketable
Securities (Continued)


Available-for-sale securities:
 Debt or equity securities that do not fit
either of the other 2 categories.
 Reported at market value.
 Realized gains and losses go through
income.
 Unrealized gains and losses directly
credited (or debited) to a stockholders’
equity account.

39

Analysis of Monetary Assets





Current ratio = CA/CL
Acid-test ratio = quick ratio = monetary
CA/CL= (CA - inventories - prepaid
items) /CL.
Days cash = cash/(cash expenses 
365)
 Cash expenses  total expenses depreciation.





Days receivable = average collection
period = Receivables/(Sales  365)
Ratios differ by industry.

40

41


Slide 23

Revenue and Monetary
Assets
JOIN KHALID AZIZ
COACHING CLASSES
ICMAP STAGE 1,2,3,4,5
ICAP MODULE A,B,C,D
PIPFA
BBA & MBA
B.COM & M.COM
ACCOUNTING OF O/A LEVEL
MA-ECONOMICS
0322-3385752
KARACHI, PAKISTAN

Operating Cycle


Cash-to-cash.
• Receive cash from customer
• Purchase materials/services & pay cash
• Convert materials/services to salable
product
• Store product
• Sell product
• Receive cash from customer
2

Revenue Recognition:
When? (Timing) & How much? (Amt.)




At one point in revenue cycle
(objectivity).
Criteria:
• When? Earned (Conservatism)



Normally, goods shipped.
Service performed.

• How much? Realized or realizable
(Realization).





Already collected or collectible.
Amount can be measured reliably.

Next step: matching costs.

3

Basic Revenue Recognition Criteria


Recognize revenue in earliest period
in which:
• Entity has substantially performed what
is required in order to earn income and
• Amount of income can be reliably
measured.

4

Delivery Method




Recognize revenue when goods or
services are delivered.
For goods: when title transfers.
• FOB shipping point (when goods are
given to carrier).



Example 1:
• Order is received for Rs900. Sales
entry?
• Goods are produced. Sales entry?
• Goods are shipped. Sales entry?

5

Consignment Method


Consignor ships goods to
consignee.





Inventory on consignment
Merchandise inventory
1,000

1,000

Consignor retains title until goods
are sold to customer. At sale:





Accounts receivable
Sales revenue
COGS
Inventory on consignment

1,400
1,400
1,000
6

Franchise Revenue


Recognize:
• When earned.
• Not when agreement signed or fee
received.

7

Franchise Revenue First
Example


Tariq & Tariq’s charges a franchise
fee primarily for identifying the site,
designing the store, training
management and staff, and
otherwise helping to get the
franchise started in business.
Assume the initial fee is Rs100,000.
When should this Rs100,000 be
recorded as revenue?

8

Franchise Revenue Second
Example
• Golden, Inc. receives Rs6,000 from a
franchisee for the right to use its
trademark and have access to its
“know-how” for a period of 5 years.
This know-how includes training
sessions, and some one available to
answer questions. When should the
Rs6,000 be recognized as revenue?
9

Percentage-of-Completion Method








Design/development and
construction/production projects that
extends over several years.
Customer pays either fixed price or cost
reimbursement contract.
Reasonable assurance of profit margin and
ultimate realization.
Revenue recognized based on total
percentage of project work performed
during period.
10

Completed Contract Method


Percentage of completion method
required unless:
• Amount of income to be earned on
contract cannot reasonably be
determined.



Alternative is completed contract
method.
• Costs incurred are an asset (Contract
Work in Progress) until revenue is
recognized.

11

Production Method



Applies to agricultural and mining.
Criteria:
• Clear market determined price.
• Performance substantially complete.




Minimal remaining costs.

Permitted but not required by GAAP.

12

Installment Method






Customer pays a certain amount per
period.
Installment payment is recognized as
revenue and a proportional part of
cost of sales is recorded.
Under cost recovery method, cost is
recorded equal to installment
payment until total cost of sales is
covered.
13

Real Estate Sales





Developer often finances over many years.
Uncertainty of income due to uncertainty
of receipt of future payments.
Conditions required for revenue
recognition:
• Period allowing cancellation and refund to
buyer has expired.
• Cum payments equal to 10% of purchase
price.
• Seller has completed or is clearly capable of
completing required improvement.

14

Amount of Revenue
Recognized




Net realizable value (amount
reasonably estimated to be
collected).
2 approaches:
• Direct write-off method.
• Allowance method.



% of sales.
% of (analysis of) AR.
15

Direct Write-Off Method




Write-off when specific account that
is uncollectible is identified.
Why is this not acceptable under
GAAP?

16

Allowance Method


Estimate amount of current period
credit sales that will not be collected.
• Historical % tempered by judgment.
• Historical % of aged receivables
(+judgment).




Adjusting entry at end of period.
When an uncollectible account is
identified, it is written off.
17

Example


Amount of revenue recognized:
• Sales for the year were Rs2,000 for
cash and Rs6,000 on credit.
• Historically we don’t collect about 5%
of our credit sales due to customer
bankruptcies or unable to locate
customer.
• A customer, The XYZ Company went
bankrupt. They owed us Rs175.







Entry for revenue?
Entry for bad debts - direct write-off
(not-GAAP)?
Entries for bad debts (allowance
method)?

18

Example






Balances in Accounts
• Accounts receivable dr 3,000.
 Consisting of 2,000 current and 1,000
overdue.
• Allowance for doubtful accounts cr 50.
Estimated amount of accounts that are
uncollectible:
• 2% for current and 10% for non-current
accounts.
What entry do we make at the end of the year
to accrue for bad debts?
19

Allowance Method (continued)




Allowance… is a contra-asset
account.
Collection of a bad debt that was
written-off:


Cash
 Allowance for Doubtful Accounts

20

Sales Discounts


Sales terms are “2/10 net 30”
• Customer gets 2% cash discount if paid
within 10 days.
• Otherwise, total amount is due within
30 days.




What does “1/15 net 45” mean?
What is the effective annual rate of
savings by taking advantage of
terms of “2/10 net 30”?
21

Alternative Methods of
Accounting for Sales Discounts


Record initial sale at gross.
 At collection of net amount record
discount as a reduction from gross
sales.



Record initial sale at gross.
 At collection of net amount record
discount as an expense of the period.



Record initial sale at net.
 Record amounts not taken as discounts
as additional revenue.

22

Example


We sold Rs10,000 of mdse. Sales
terms are 2/10, n/30.
Customers paid us for Rs8,000 of
the merchandise billed within 10
days. The remaining Rs2,000
was paid within 30 days.
• Record at gross.
• Record at net.
23

Credit Card Sales


If cash received by merchant
immediately (Bank plan, MC, Visa):




Cash
Sales discount
Sales revenue

970
30
1000

24

Credit Card Sales (continued)


If cash received by merchant in 30
days (American Express, Discover):




Accounts receivable
Sales discount
Sales revenue

970
30
1000

25

Sales Returns & Allowances


Similar to bad debt expense,
 Estimate percentage of revenues that
will eventually result in returns or
allowances.
 Adjusting entry at end of period.
 Actual return or allowance.

26

Example
 On average 2% of our Rs10,000 of sales
is returned. Adjusting entry at end of
period?
 Entry for return of Rs80 of goods?
 Same for direct write-off method?

27

Sales Returns & Allowances
(Continued)




Provision for Returns and Allowances
is a liability account.
Alternative:
 Not accrue for returns and allowances
but write them off as they occur.
 Is this GAAP?

28

Adjustment vs. Expense





Realization concept suggests
adjustment to revenue.
In practice both methods are found.
Consistency:
 Same handling from year to year.




Allows same company results to be
compared from year to year.
Comparisons between companies may be
distorted.
29

Warranty Costs








Amounts are estimated (usually as a
percentage of sales).
Part of Cost of goods sold.
Record accrual (adjusting entry)
Record the actual expenditures.
Allowance… is a liability account.
Est. warranty exp. Is part of costs of
sales.
30

Warranty Expenses Example




We estimate that warranty expenses
will be 4% of our Rs10,000 of sales.
Entry?
We spent Rs120 on parts and Rs250
on labor for repairs under warranty.
Entry?

31

Interest Revenue




Amount earned by lender during the
period.
2 approaches
• Interest paid at maturity.


Interest is explicit.

• Discounted loan.




Interest is implicit.

Accounted for separately from sale.
32

Example: Interest Revenue


On January 1, 19x1 sold a customer
Rs1,000 of mdse. We received a
promissory note for Rs1,000 plus 8%
interest to be paid in one year.
• Entry for sale?
• Entry for accrual of interest on December 31,
19x1?
• Entry for receipt of payment on note on
January 1, 19x2?



On January 1, 19x1, we sold mdse. and
received a promissory note for Rs5,000
with no interest. The note is due in one
year. The market rate of interest on such
a note is 9%.
• Entry at sale:
• Year end adjusting entry (12/31/19x1)
• Entry when customer pays note (1/1/19x2)

33

Monetary& Non-monetary
Assets







Monetary assets are money or claims to
receive fixed sums of money.
Non-monetary assets are items used in
future production and sales of goods
and services.
Balance sheet distinction
 Current and non-current assets.
 Not monetary and non-monetary.





Non-monetary assets (except
inventory) on BS at unexpired cost.
(Cost less depreciation)
Monetary assets: Cash reported at face.
AR at NRV. Other at fair value.

34

Cash



Funds available for disbursement.
May include liquid short term
investments.
• Highly liquid debt instruments with
original maturities of 90 days or less.

35

Receivables


Trade receivables
• Accounts receivables from usual sales of
products or services for non-financial
institutions.



Other receivables are shown
separately.
 E.g., Due from employees, advances or
loans.
36

Marketable Securities





Must be marketable.
E.g., commercial paper, treasury
bills, publicly traded stocks and
bonds issued by companies.
Also called “Temporary Investments.”

37

Accounting for Marketable
Securities


Three categories
 Held-to-maturity: debt securities,


Valued at cost.

 Trading securities: debt or equity held
for current resale, valued at market.


Realized (i.e., if sold during period) and
unrealized (not yet sold but market price
has changed) gain or loss included in
current year’s income.
38

Accounting for Marketable
Securities (Continued)


Available-for-sale securities:
 Debt or equity securities that do not fit
either of the other 2 categories.
 Reported at market value.
 Realized gains and losses go through
income.
 Unrealized gains and losses directly
credited (or debited) to a stockholders’
equity account.

39

Analysis of Monetary Assets





Current ratio = CA/CL
Acid-test ratio = quick ratio = monetary
CA/CL= (CA - inventories - prepaid
items) /CL.
Days cash = cash/(cash expenses 
365)
 Cash expenses  total expenses depreciation.





Days receivable = average collection
period = Receivables/(Sales  365)
Ratios differ by industry.

40

41


Slide 24

Revenue and Monetary
Assets
JOIN KHALID AZIZ
COACHING CLASSES
ICMAP STAGE 1,2,3,4,5
ICAP MODULE A,B,C,D
PIPFA
BBA & MBA
B.COM & M.COM
ACCOUNTING OF O/A LEVEL
MA-ECONOMICS
0322-3385752
KARACHI, PAKISTAN

Operating Cycle


Cash-to-cash.
• Receive cash from customer
• Purchase materials/services & pay cash
• Convert materials/services to salable
product
• Store product
• Sell product
• Receive cash from customer
2

Revenue Recognition:
When? (Timing) & How much? (Amt.)




At one point in revenue cycle
(objectivity).
Criteria:
• When? Earned (Conservatism)



Normally, goods shipped.
Service performed.

• How much? Realized or realizable
(Realization).





Already collected or collectible.
Amount can be measured reliably.

Next step: matching costs.

3

Basic Revenue Recognition Criteria


Recognize revenue in earliest period
in which:
• Entity has substantially performed what
is required in order to earn income and
• Amount of income can be reliably
measured.

4

Delivery Method




Recognize revenue when goods or
services are delivered.
For goods: when title transfers.
• FOB shipping point (when goods are
given to carrier).



Example 1:
• Order is received for Rs900. Sales
entry?
• Goods are produced. Sales entry?
• Goods are shipped. Sales entry?

5

Consignment Method


Consignor ships goods to
consignee.





Inventory on consignment
Merchandise inventory
1,000

1,000

Consignor retains title until goods
are sold to customer. At sale:





Accounts receivable
Sales revenue
COGS
Inventory on consignment

1,400
1,400
1,000
6

Franchise Revenue


Recognize:
• When earned.
• Not when agreement signed or fee
received.

7

Franchise Revenue First
Example


Tariq & Tariq’s charges a franchise
fee primarily for identifying the site,
designing the store, training
management and staff, and
otherwise helping to get the
franchise started in business.
Assume the initial fee is Rs100,000.
When should this Rs100,000 be
recorded as revenue?

8

Franchise Revenue Second
Example
• Golden, Inc. receives Rs6,000 from a
franchisee for the right to use its
trademark and have access to its
“know-how” for a period of 5 years.
This know-how includes training
sessions, and some one available to
answer questions. When should the
Rs6,000 be recognized as revenue?
9

Percentage-of-Completion Method








Design/development and
construction/production projects that
extends over several years.
Customer pays either fixed price or cost
reimbursement contract.
Reasonable assurance of profit margin and
ultimate realization.
Revenue recognized based on total
percentage of project work performed
during period.
10

Completed Contract Method


Percentage of completion method
required unless:
• Amount of income to be earned on
contract cannot reasonably be
determined.



Alternative is completed contract
method.
• Costs incurred are an asset (Contract
Work in Progress) until revenue is
recognized.

11

Production Method



Applies to agricultural and mining.
Criteria:
• Clear market determined price.
• Performance substantially complete.




Minimal remaining costs.

Permitted but not required by GAAP.

12

Installment Method






Customer pays a certain amount per
period.
Installment payment is recognized as
revenue and a proportional part of
cost of sales is recorded.
Under cost recovery method, cost is
recorded equal to installment
payment until total cost of sales is
covered.
13

Real Estate Sales





Developer often finances over many years.
Uncertainty of income due to uncertainty
of receipt of future payments.
Conditions required for revenue
recognition:
• Period allowing cancellation and refund to
buyer has expired.
• Cum payments equal to 10% of purchase
price.
• Seller has completed or is clearly capable of
completing required improvement.

14

Amount of Revenue
Recognized




Net realizable value (amount
reasonably estimated to be
collected).
2 approaches:
• Direct write-off method.
• Allowance method.



% of sales.
% of (analysis of) AR.
15

Direct Write-Off Method




Write-off when specific account that
is uncollectible is identified.
Why is this not acceptable under
GAAP?

16

Allowance Method


Estimate amount of current period
credit sales that will not be collected.
• Historical % tempered by judgment.
• Historical % of aged receivables
(+judgment).




Adjusting entry at end of period.
When an uncollectible account is
identified, it is written off.
17

Example


Amount of revenue recognized:
• Sales for the year were Rs2,000 for
cash and Rs6,000 on credit.
• Historically we don’t collect about 5%
of our credit sales due to customer
bankruptcies or unable to locate
customer.
• A customer, The XYZ Company went
bankrupt. They owed us Rs175.







Entry for revenue?
Entry for bad debts - direct write-off
(not-GAAP)?
Entries for bad debts (allowance
method)?

18

Example






Balances in Accounts
• Accounts receivable dr 3,000.
 Consisting of 2,000 current and 1,000
overdue.
• Allowance for doubtful accounts cr 50.
Estimated amount of accounts that are
uncollectible:
• 2% for current and 10% for non-current
accounts.
What entry do we make at the end of the year
to accrue for bad debts?
19

Allowance Method (continued)




Allowance… is a contra-asset
account.
Collection of a bad debt that was
written-off:


Cash
 Allowance for Doubtful Accounts

20

Sales Discounts


Sales terms are “2/10 net 30”
• Customer gets 2% cash discount if paid
within 10 days.
• Otherwise, total amount is due within
30 days.




What does “1/15 net 45” mean?
What is the effective annual rate of
savings by taking advantage of
terms of “2/10 net 30”?
21

Alternative Methods of
Accounting for Sales Discounts


Record initial sale at gross.
 At collection of net amount record
discount as a reduction from gross
sales.



Record initial sale at gross.
 At collection of net amount record
discount as an expense of the period.



Record initial sale at net.
 Record amounts not taken as discounts
as additional revenue.

22

Example


We sold Rs10,000 of mdse. Sales
terms are 2/10, n/30.
Customers paid us for Rs8,000 of
the merchandise billed within 10
days. The remaining Rs2,000
was paid within 30 days.
• Record at gross.
• Record at net.
23

Credit Card Sales


If cash received by merchant
immediately (Bank plan, MC, Visa):




Cash
Sales discount
Sales revenue

970
30
1000

24

Credit Card Sales (continued)


If cash received by merchant in 30
days (American Express, Discover):




Accounts receivable
Sales discount
Sales revenue

970
30
1000

25

Sales Returns & Allowances


Similar to bad debt expense,
 Estimate percentage of revenues that
will eventually result in returns or
allowances.
 Adjusting entry at end of period.
 Actual return or allowance.

26

Example
 On average 2% of our Rs10,000 of sales
is returned. Adjusting entry at end of
period?
 Entry for return of Rs80 of goods?
 Same for direct write-off method?

27

Sales Returns & Allowances
(Continued)




Provision for Returns and Allowances
is a liability account.
Alternative:
 Not accrue for returns and allowances
but write them off as they occur.
 Is this GAAP?

28

Adjustment vs. Expense





Realization concept suggests
adjustment to revenue.
In practice both methods are found.
Consistency:
 Same handling from year to year.




Allows same company results to be
compared from year to year.
Comparisons between companies may be
distorted.
29

Warranty Costs








Amounts are estimated (usually as a
percentage of sales).
Part of Cost of goods sold.
Record accrual (adjusting entry)
Record the actual expenditures.
Allowance… is a liability account.
Est. warranty exp. Is part of costs of
sales.
30

Warranty Expenses Example




We estimate that warranty expenses
will be 4% of our Rs10,000 of sales.
Entry?
We spent Rs120 on parts and Rs250
on labor for repairs under warranty.
Entry?

31

Interest Revenue




Amount earned by lender during the
period.
2 approaches
• Interest paid at maturity.


Interest is explicit.

• Discounted loan.




Interest is implicit.

Accounted for separately from sale.
32

Example: Interest Revenue


On January 1, 19x1 sold a customer
Rs1,000 of mdse. We received a
promissory note for Rs1,000 plus 8%
interest to be paid in one year.
• Entry for sale?
• Entry for accrual of interest on December 31,
19x1?
• Entry for receipt of payment on note on
January 1, 19x2?



On January 1, 19x1, we sold mdse. and
received a promissory note for Rs5,000
with no interest. The note is due in one
year. The market rate of interest on such
a note is 9%.
• Entry at sale:
• Year end adjusting entry (12/31/19x1)
• Entry when customer pays note (1/1/19x2)

33

Monetary& Non-monetary
Assets







Monetary assets are money or claims to
receive fixed sums of money.
Non-monetary assets are items used in
future production and sales of goods
and services.
Balance sheet distinction
 Current and non-current assets.
 Not monetary and non-monetary.





Non-monetary assets (except
inventory) on BS at unexpired cost.
(Cost less depreciation)
Monetary assets: Cash reported at face.
AR at NRV. Other at fair value.

34

Cash



Funds available for disbursement.
May include liquid short term
investments.
• Highly liquid debt instruments with
original maturities of 90 days or less.

35

Receivables


Trade receivables
• Accounts receivables from usual sales of
products or services for non-financial
institutions.



Other receivables are shown
separately.
 E.g., Due from employees, advances or
loans.
36

Marketable Securities





Must be marketable.
E.g., commercial paper, treasury
bills, publicly traded stocks and
bonds issued by companies.
Also called “Temporary Investments.”

37

Accounting for Marketable
Securities


Three categories
 Held-to-maturity: debt securities,


Valued at cost.

 Trading securities: debt or equity held
for current resale, valued at market.


Realized (i.e., if sold during period) and
unrealized (not yet sold but market price
has changed) gain or loss included in
current year’s income.
38

Accounting for Marketable
Securities (Continued)


Available-for-sale securities:
 Debt or equity securities that do not fit
either of the other 2 categories.
 Reported at market value.
 Realized gains and losses go through
income.
 Unrealized gains and losses directly
credited (or debited) to a stockholders’
equity account.

39

Analysis of Monetary Assets





Current ratio = CA/CL
Acid-test ratio = quick ratio = monetary
CA/CL= (CA - inventories - prepaid
items) /CL.
Days cash = cash/(cash expenses 
365)
 Cash expenses  total expenses depreciation.





Days receivable = average collection
period = Receivables/(Sales  365)
Ratios differ by industry.

40

41


Slide 25

Revenue and Monetary
Assets
JOIN KHALID AZIZ
COACHING CLASSES
ICMAP STAGE 1,2,3,4,5
ICAP MODULE A,B,C,D
PIPFA
BBA & MBA
B.COM & M.COM
ACCOUNTING OF O/A LEVEL
MA-ECONOMICS
0322-3385752
KARACHI, PAKISTAN

Operating Cycle


Cash-to-cash.
• Receive cash from customer
• Purchase materials/services & pay cash
• Convert materials/services to salable
product
• Store product
• Sell product
• Receive cash from customer
2

Revenue Recognition:
When? (Timing) & How much? (Amt.)




At one point in revenue cycle
(objectivity).
Criteria:
• When? Earned (Conservatism)



Normally, goods shipped.
Service performed.

• How much? Realized or realizable
(Realization).





Already collected or collectible.
Amount can be measured reliably.

Next step: matching costs.

3

Basic Revenue Recognition Criteria


Recognize revenue in earliest period
in which:
• Entity has substantially performed what
is required in order to earn income and
• Amount of income can be reliably
measured.

4

Delivery Method




Recognize revenue when goods or
services are delivered.
For goods: when title transfers.
• FOB shipping point (when goods are
given to carrier).



Example 1:
• Order is received for Rs900. Sales
entry?
• Goods are produced. Sales entry?
• Goods are shipped. Sales entry?

5

Consignment Method


Consignor ships goods to
consignee.





Inventory on consignment
Merchandise inventory
1,000

1,000

Consignor retains title until goods
are sold to customer. At sale:





Accounts receivable
Sales revenue
COGS
Inventory on consignment

1,400
1,400
1,000
6

Franchise Revenue


Recognize:
• When earned.
• Not when agreement signed or fee
received.

7

Franchise Revenue First
Example


Tariq & Tariq’s charges a franchise
fee primarily for identifying the site,
designing the store, training
management and staff, and
otherwise helping to get the
franchise started in business.
Assume the initial fee is Rs100,000.
When should this Rs100,000 be
recorded as revenue?

8

Franchise Revenue Second
Example
• Golden, Inc. receives Rs6,000 from a
franchisee for the right to use its
trademark and have access to its
“know-how” for a period of 5 years.
This know-how includes training
sessions, and some one available to
answer questions. When should the
Rs6,000 be recognized as revenue?
9

Percentage-of-Completion Method








Design/development and
construction/production projects that
extends over several years.
Customer pays either fixed price or cost
reimbursement contract.
Reasonable assurance of profit margin and
ultimate realization.
Revenue recognized based on total
percentage of project work performed
during period.
10

Completed Contract Method


Percentage of completion method
required unless:
• Amount of income to be earned on
contract cannot reasonably be
determined.



Alternative is completed contract
method.
• Costs incurred are an asset (Contract
Work in Progress) until revenue is
recognized.

11

Production Method



Applies to agricultural and mining.
Criteria:
• Clear market determined price.
• Performance substantially complete.




Minimal remaining costs.

Permitted but not required by GAAP.

12

Installment Method






Customer pays a certain amount per
period.
Installment payment is recognized as
revenue and a proportional part of
cost of sales is recorded.
Under cost recovery method, cost is
recorded equal to installment
payment until total cost of sales is
covered.
13

Real Estate Sales





Developer often finances over many years.
Uncertainty of income due to uncertainty
of receipt of future payments.
Conditions required for revenue
recognition:
• Period allowing cancellation and refund to
buyer has expired.
• Cum payments equal to 10% of purchase
price.
• Seller has completed or is clearly capable of
completing required improvement.

14

Amount of Revenue
Recognized




Net realizable value (amount
reasonably estimated to be
collected).
2 approaches:
• Direct write-off method.
• Allowance method.



% of sales.
% of (analysis of) AR.
15

Direct Write-Off Method




Write-off when specific account that
is uncollectible is identified.
Why is this not acceptable under
GAAP?

16

Allowance Method


Estimate amount of current period
credit sales that will not be collected.
• Historical % tempered by judgment.
• Historical % of aged receivables
(+judgment).




Adjusting entry at end of period.
When an uncollectible account is
identified, it is written off.
17

Example


Amount of revenue recognized:
• Sales for the year were Rs2,000 for
cash and Rs6,000 on credit.
• Historically we don’t collect about 5%
of our credit sales due to customer
bankruptcies or unable to locate
customer.
• A customer, The XYZ Company went
bankrupt. They owed us Rs175.







Entry for revenue?
Entry for bad debts - direct write-off
(not-GAAP)?
Entries for bad debts (allowance
method)?

18

Example






Balances in Accounts
• Accounts receivable dr 3,000.
 Consisting of 2,000 current and 1,000
overdue.
• Allowance for doubtful accounts cr 50.
Estimated amount of accounts that are
uncollectible:
• 2% for current and 10% for non-current
accounts.
What entry do we make at the end of the year
to accrue for bad debts?
19

Allowance Method (continued)




Allowance… is a contra-asset
account.
Collection of a bad debt that was
written-off:


Cash
 Allowance for Doubtful Accounts

20

Sales Discounts


Sales terms are “2/10 net 30”
• Customer gets 2% cash discount if paid
within 10 days.
• Otherwise, total amount is due within
30 days.




What does “1/15 net 45” mean?
What is the effective annual rate of
savings by taking advantage of
terms of “2/10 net 30”?
21

Alternative Methods of
Accounting for Sales Discounts


Record initial sale at gross.
 At collection of net amount record
discount as a reduction from gross
sales.



Record initial sale at gross.
 At collection of net amount record
discount as an expense of the period.



Record initial sale at net.
 Record amounts not taken as discounts
as additional revenue.

22

Example


We sold Rs10,000 of mdse. Sales
terms are 2/10, n/30.
Customers paid us for Rs8,000 of
the merchandise billed within 10
days. The remaining Rs2,000
was paid within 30 days.
• Record at gross.
• Record at net.
23

Credit Card Sales


If cash received by merchant
immediately (Bank plan, MC, Visa):




Cash
Sales discount
Sales revenue

970
30
1000

24

Credit Card Sales (continued)


If cash received by merchant in 30
days (American Express, Discover):




Accounts receivable
Sales discount
Sales revenue

970
30
1000

25

Sales Returns & Allowances


Similar to bad debt expense,
 Estimate percentage of revenues that
will eventually result in returns or
allowances.
 Adjusting entry at end of period.
 Actual return or allowance.

26

Example
 On average 2% of our Rs10,000 of sales
is returned. Adjusting entry at end of
period?
 Entry for return of Rs80 of goods?
 Same for direct write-off method?

27

Sales Returns & Allowances
(Continued)




Provision for Returns and Allowances
is a liability account.
Alternative:
 Not accrue for returns and allowances
but write them off as they occur.
 Is this GAAP?

28

Adjustment vs. Expense





Realization concept suggests
adjustment to revenue.
In practice both methods are found.
Consistency:
 Same handling from year to year.




Allows same company results to be
compared from year to year.
Comparisons between companies may be
distorted.
29

Warranty Costs








Amounts are estimated (usually as a
percentage of sales).
Part of Cost of goods sold.
Record accrual (adjusting entry)
Record the actual expenditures.
Allowance… is a liability account.
Est. warranty exp. Is part of costs of
sales.
30

Warranty Expenses Example




We estimate that warranty expenses
will be 4% of our Rs10,000 of sales.
Entry?
We spent Rs120 on parts and Rs250
on labor for repairs under warranty.
Entry?

31

Interest Revenue




Amount earned by lender during the
period.
2 approaches
• Interest paid at maturity.


Interest is explicit.

• Discounted loan.




Interest is implicit.

Accounted for separately from sale.
32

Example: Interest Revenue


On January 1, 19x1 sold a customer
Rs1,000 of mdse. We received a
promissory note for Rs1,000 plus 8%
interest to be paid in one year.
• Entry for sale?
• Entry for accrual of interest on December 31,
19x1?
• Entry for receipt of payment on note on
January 1, 19x2?



On January 1, 19x1, we sold mdse. and
received a promissory note for Rs5,000
with no interest. The note is due in one
year. The market rate of interest on such
a note is 9%.
• Entry at sale:
• Year end adjusting entry (12/31/19x1)
• Entry when customer pays note (1/1/19x2)

33

Monetary& Non-monetary
Assets







Monetary assets are money or claims to
receive fixed sums of money.
Non-monetary assets are items used in
future production and sales of goods
and services.
Balance sheet distinction
 Current and non-current assets.
 Not monetary and non-monetary.





Non-monetary assets (except
inventory) on BS at unexpired cost.
(Cost less depreciation)
Monetary assets: Cash reported at face.
AR at NRV. Other at fair value.

34

Cash



Funds available for disbursement.
May include liquid short term
investments.
• Highly liquid debt instruments with
original maturities of 90 days or less.

35

Receivables


Trade receivables
• Accounts receivables from usual sales of
products or services for non-financial
institutions.



Other receivables are shown
separately.
 E.g., Due from employees, advances or
loans.
36

Marketable Securities





Must be marketable.
E.g., commercial paper, treasury
bills, publicly traded stocks and
bonds issued by companies.
Also called “Temporary Investments.”

37

Accounting for Marketable
Securities


Three categories
 Held-to-maturity: debt securities,


Valued at cost.

 Trading securities: debt or equity held
for current resale, valued at market.


Realized (i.e., if sold during period) and
unrealized (not yet sold but market price
has changed) gain or loss included in
current year’s income.
38

Accounting for Marketable
Securities (Continued)


Available-for-sale securities:
 Debt or equity securities that do not fit
either of the other 2 categories.
 Reported at market value.
 Realized gains and losses go through
income.
 Unrealized gains and losses directly
credited (or debited) to a stockholders’
equity account.

39

Analysis of Monetary Assets





Current ratio = CA/CL
Acid-test ratio = quick ratio = monetary
CA/CL= (CA - inventories - prepaid
items) /CL.
Days cash = cash/(cash expenses 
365)
 Cash expenses  total expenses depreciation.





Days receivable = average collection
period = Receivables/(Sales  365)
Ratios differ by industry.

40

41


Slide 26

Revenue and Monetary
Assets
JOIN KHALID AZIZ
COACHING CLASSES
ICMAP STAGE 1,2,3,4,5
ICAP MODULE A,B,C,D
PIPFA
BBA & MBA
B.COM & M.COM
ACCOUNTING OF O/A LEVEL
MA-ECONOMICS
0322-3385752
KARACHI, PAKISTAN

Operating Cycle


Cash-to-cash.
• Receive cash from customer
• Purchase materials/services & pay cash
• Convert materials/services to salable
product
• Store product
• Sell product
• Receive cash from customer
2

Revenue Recognition:
When? (Timing) & How much? (Amt.)




At one point in revenue cycle
(objectivity).
Criteria:
• When? Earned (Conservatism)



Normally, goods shipped.
Service performed.

• How much? Realized or realizable
(Realization).





Already collected or collectible.
Amount can be measured reliably.

Next step: matching costs.

3

Basic Revenue Recognition Criteria


Recognize revenue in earliest period
in which:
• Entity has substantially performed what
is required in order to earn income and
• Amount of income can be reliably
measured.

4

Delivery Method




Recognize revenue when goods or
services are delivered.
For goods: when title transfers.
• FOB shipping point (when goods are
given to carrier).



Example 1:
• Order is received for Rs900. Sales
entry?
• Goods are produced. Sales entry?
• Goods are shipped. Sales entry?

5

Consignment Method


Consignor ships goods to
consignee.





Inventory on consignment
Merchandise inventory
1,000

1,000

Consignor retains title until goods
are sold to customer. At sale:





Accounts receivable
Sales revenue
COGS
Inventory on consignment

1,400
1,400
1,000
6

Franchise Revenue


Recognize:
• When earned.
• Not when agreement signed or fee
received.

7

Franchise Revenue First
Example


Tariq & Tariq’s charges a franchise
fee primarily for identifying the site,
designing the store, training
management and staff, and
otherwise helping to get the
franchise started in business.
Assume the initial fee is Rs100,000.
When should this Rs100,000 be
recorded as revenue?

8

Franchise Revenue Second
Example
• Golden, Inc. receives Rs6,000 from a
franchisee for the right to use its
trademark and have access to its
“know-how” for a period of 5 years.
This know-how includes training
sessions, and some one available to
answer questions. When should the
Rs6,000 be recognized as revenue?
9

Percentage-of-Completion Method








Design/development and
construction/production projects that
extends over several years.
Customer pays either fixed price or cost
reimbursement contract.
Reasonable assurance of profit margin and
ultimate realization.
Revenue recognized based on total
percentage of project work performed
during period.
10

Completed Contract Method


Percentage of completion method
required unless:
• Amount of income to be earned on
contract cannot reasonably be
determined.



Alternative is completed contract
method.
• Costs incurred are an asset (Contract
Work in Progress) until revenue is
recognized.

11

Production Method



Applies to agricultural and mining.
Criteria:
• Clear market determined price.
• Performance substantially complete.




Minimal remaining costs.

Permitted but not required by GAAP.

12

Installment Method






Customer pays a certain amount per
period.
Installment payment is recognized as
revenue and a proportional part of
cost of sales is recorded.
Under cost recovery method, cost is
recorded equal to installment
payment until total cost of sales is
covered.
13

Real Estate Sales





Developer often finances over many years.
Uncertainty of income due to uncertainty
of receipt of future payments.
Conditions required for revenue
recognition:
• Period allowing cancellation and refund to
buyer has expired.
• Cum payments equal to 10% of purchase
price.
• Seller has completed or is clearly capable of
completing required improvement.

14

Amount of Revenue
Recognized




Net realizable value (amount
reasonably estimated to be
collected).
2 approaches:
• Direct write-off method.
• Allowance method.



% of sales.
% of (analysis of) AR.
15

Direct Write-Off Method




Write-off when specific account that
is uncollectible is identified.
Why is this not acceptable under
GAAP?

16

Allowance Method


Estimate amount of current period
credit sales that will not be collected.
• Historical % tempered by judgment.
• Historical % of aged receivables
(+judgment).




Adjusting entry at end of period.
When an uncollectible account is
identified, it is written off.
17

Example


Amount of revenue recognized:
• Sales for the year were Rs2,000 for
cash and Rs6,000 on credit.
• Historically we don’t collect about 5%
of our credit sales due to customer
bankruptcies or unable to locate
customer.
• A customer, The XYZ Company went
bankrupt. They owed us Rs175.







Entry for revenue?
Entry for bad debts - direct write-off
(not-GAAP)?
Entries for bad debts (allowance
method)?

18

Example






Balances in Accounts
• Accounts receivable dr 3,000.
 Consisting of 2,000 current and 1,000
overdue.
• Allowance for doubtful accounts cr 50.
Estimated amount of accounts that are
uncollectible:
• 2% for current and 10% for non-current
accounts.
What entry do we make at the end of the year
to accrue for bad debts?
19

Allowance Method (continued)




Allowance… is a contra-asset
account.
Collection of a bad debt that was
written-off:


Cash
 Allowance for Doubtful Accounts

20

Sales Discounts


Sales terms are “2/10 net 30”
• Customer gets 2% cash discount if paid
within 10 days.
• Otherwise, total amount is due within
30 days.




What does “1/15 net 45” mean?
What is the effective annual rate of
savings by taking advantage of
terms of “2/10 net 30”?
21

Alternative Methods of
Accounting for Sales Discounts


Record initial sale at gross.
 At collection of net amount record
discount as a reduction from gross
sales.



Record initial sale at gross.
 At collection of net amount record
discount as an expense of the period.



Record initial sale at net.
 Record amounts not taken as discounts
as additional revenue.

22

Example


We sold Rs10,000 of mdse. Sales
terms are 2/10, n/30.
Customers paid us for Rs8,000 of
the merchandise billed within 10
days. The remaining Rs2,000
was paid within 30 days.
• Record at gross.
• Record at net.
23

Credit Card Sales


If cash received by merchant
immediately (Bank plan, MC, Visa):




Cash
Sales discount
Sales revenue

970
30
1000

24

Credit Card Sales (continued)


If cash received by merchant in 30
days (American Express, Discover):




Accounts receivable
Sales discount
Sales revenue

970
30
1000

25

Sales Returns & Allowances


Similar to bad debt expense,
 Estimate percentage of revenues that
will eventually result in returns or
allowances.
 Adjusting entry at end of period.
 Actual return or allowance.

26

Example
 On average 2% of our Rs10,000 of sales
is returned. Adjusting entry at end of
period?
 Entry for return of Rs80 of goods?
 Same for direct write-off method?

27

Sales Returns & Allowances
(Continued)




Provision for Returns and Allowances
is a liability account.
Alternative:
 Not accrue for returns and allowances
but write them off as they occur.
 Is this GAAP?

28

Adjustment vs. Expense





Realization concept suggests
adjustment to revenue.
In practice both methods are found.
Consistency:
 Same handling from year to year.




Allows same company results to be
compared from year to year.
Comparisons between companies may be
distorted.
29

Warranty Costs








Amounts are estimated (usually as a
percentage of sales).
Part of Cost of goods sold.
Record accrual (adjusting entry)
Record the actual expenditures.
Allowance… is a liability account.
Est. warranty exp. Is part of costs of
sales.
30

Warranty Expenses Example




We estimate that warranty expenses
will be 4% of our Rs10,000 of sales.
Entry?
We spent Rs120 on parts and Rs250
on labor for repairs under warranty.
Entry?

31

Interest Revenue




Amount earned by lender during the
period.
2 approaches
• Interest paid at maturity.


Interest is explicit.

• Discounted loan.




Interest is implicit.

Accounted for separately from sale.
32

Example: Interest Revenue


On January 1, 19x1 sold a customer
Rs1,000 of mdse. We received a
promissory note for Rs1,000 plus 8%
interest to be paid in one year.
• Entry for sale?
• Entry for accrual of interest on December 31,
19x1?
• Entry for receipt of payment on note on
January 1, 19x2?



On January 1, 19x1, we sold mdse. and
received a promissory note for Rs5,000
with no interest. The note is due in one
year. The market rate of interest on such
a note is 9%.
• Entry at sale:
• Year end adjusting entry (12/31/19x1)
• Entry when customer pays note (1/1/19x2)

33

Monetary& Non-monetary
Assets







Monetary assets are money or claims to
receive fixed sums of money.
Non-monetary assets are items used in
future production and sales of goods
and services.
Balance sheet distinction
 Current and non-current assets.
 Not monetary and non-monetary.





Non-monetary assets (except
inventory) on BS at unexpired cost.
(Cost less depreciation)
Monetary assets: Cash reported at face.
AR at NRV. Other at fair value.

34

Cash



Funds available for disbursement.
May include liquid short term
investments.
• Highly liquid debt instruments with
original maturities of 90 days or less.

35

Receivables


Trade receivables
• Accounts receivables from usual sales of
products or services for non-financial
institutions.



Other receivables are shown
separately.
 E.g., Due from employees, advances or
loans.
36

Marketable Securities





Must be marketable.
E.g., commercial paper, treasury
bills, publicly traded stocks and
bonds issued by companies.
Also called “Temporary Investments.”

37

Accounting for Marketable
Securities


Three categories
 Held-to-maturity: debt securities,


Valued at cost.

 Trading securities: debt or equity held
for current resale, valued at market.


Realized (i.e., if sold during period) and
unrealized (not yet sold but market price
has changed) gain or loss included in
current year’s income.
38

Accounting for Marketable
Securities (Continued)


Available-for-sale securities:
 Debt or equity securities that do not fit
either of the other 2 categories.
 Reported at market value.
 Realized gains and losses go through
income.
 Unrealized gains and losses directly
credited (or debited) to a stockholders’
equity account.

39

Analysis of Monetary Assets





Current ratio = CA/CL
Acid-test ratio = quick ratio = monetary
CA/CL= (CA - inventories - prepaid
items) /CL.
Days cash = cash/(cash expenses 
365)
 Cash expenses  total expenses depreciation.





Days receivable = average collection
period = Receivables/(Sales  365)
Ratios differ by industry.

40

41


Slide 27

Revenue and Monetary
Assets
JOIN KHALID AZIZ
COACHING CLASSES
ICMAP STAGE 1,2,3,4,5
ICAP MODULE A,B,C,D
PIPFA
BBA & MBA
B.COM & M.COM
ACCOUNTING OF O/A LEVEL
MA-ECONOMICS
0322-3385752
KARACHI, PAKISTAN

Operating Cycle


Cash-to-cash.
• Receive cash from customer
• Purchase materials/services & pay cash
• Convert materials/services to salable
product
• Store product
• Sell product
• Receive cash from customer
2

Revenue Recognition:
When? (Timing) & How much? (Amt.)




At one point in revenue cycle
(objectivity).
Criteria:
• When? Earned (Conservatism)



Normally, goods shipped.
Service performed.

• How much? Realized or realizable
(Realization).





Already collected or collectible.
Amount can be measured reliably.

Next step: matching costs.

3

Basic Revenue Recognition Criteria


Recognize revenue in earliest period
in which:
• Entity has substantially performed what
is required in order to earn income and
• Amount of income can be reliably
measured.

4

Delivery Method




Recognize revenue when goods or
services are delivered.
For goods: when title transfers.
• FOB shipping point (when goods are
given to carrier).



Example 1:
• Order is received for Rs900. Sales
entry?
• Goods are produced. Sales entry?
• Goods are shipped. Sales entry?

5

Consignment Method


Consignor ships goods to
consignee.





Inventory on consignment
Merchandise inventory
1,000

1,000

Consignor retains title until goods
are sold to customer. At sale:





Accounts receivable
Sales revenue
COGS
Inventory on consignment

1,400
1,400
1,000
6

Franchise Revenue


Recognize:
• When earned.
• Not when agreement signed or fee
received.

7

Franchise Revenue First
Example


Tariq & Tariq’s charges a franchise
fee primarily for identifying the site,
designing the store, training
management and staff, and
otherwise helping to get the
franchise started in business.
Assume the initial fee is Rs100,000.
When should this Rs100,000 be
recorded as revenue?

8

Franchise Revenue Second
Example
• Golden, Inc. receives Rs6,000 from a
franchisee for the right to use its
trademark and have access to its
“know-how” for a period of 5 years.
This know-how includes training
sessions, and some one available to
answer questions. When should the
Rs6,000 be recognized as revenue?
9

Percentage-of-Completion Method








Design/development and
construction/production projects that
extends over several years.
Customer pays either fixed price or cost
reimbursement contract.
Reasonable assurance of profit margin and
ultimate realization.
Revenue recognized based on total
percentage of project work performed
during period.
10

Completed Contract Method


Percentage of completion method
required unless:
• Amount of income to be earned on
contract cannot reasonably be
determined.



Alternative is completed contract
method.
• Costs incurred are an asset (Contract
Work in Progress) until revenue is
recognized.

11

Production Method



Applies to agricultural and mining.
Criteria:
• Clear market determined price.
• Performance substantially complete.




Minimal remaining costs.

Permitted but not required by GAAP.

12

Installment Method






Customer pays a certain amount per
period.
Installment payment is recognized as
revenue and a proportional part of
cost of sales is recorded.
Under cost recovery method, cost is
recorded equal to installment
payment until total cost of sales is
covered.
13

Real Estate Sales





Developer often finances over many years.
Uncertainty of income due to uncertainty
of receipt of future payments.
Conditions required for revenue
recognition:
• Period allowing cancellation and refund to
buyer has expired.
• Cum payments equal to 10% of purchase
price.
• Seller has completed or is clearly capable of
completing required improvement.

14

Amount of Revenue
Recognized




Net realizable value (amount
reasonably estimated to be
collected).
2 approaches:
• Direct write-off method.
• Allowance method.



% of sales.
% of (analysis of) AR.
15

Direct Write-Off Method




Write-off when specific account that
is uncollectible is identified.
Why is this not acceptable under
GAAP?

16

Allowance Method


Estimate amount of current period
credit sales that will not be collected.
• Historical % tempered by judgment.
• Historical % of aged receivables
(+judgment).




Adjusting entry at end of period.
When an uncollectible account is
identified, it is written off.
17

Example


Amount of revenue recognized:
• Sales for the year were Rs2,000 for
cash and Rs6,000 on credit.
• Historically we don’t collect about 5%
of our credit sales due to customer
bankruptcies or unable to locate
customer.
• A customer, The XYZ Company went
bankrupt. They owed us Rs175.







Entry for revenue?
Entry for bad debts - direct write-off
(not-GAAP)?
Entries for bad debts (allowance
method)?

18

Example






Balances in Accounts
• Accounts receivable dr 3,000.
 Consisting of 2,000 current and 1,000
overdue.
• Allowance for doubtful accounts cr 50.
Estimated amount of accounts that are
uncollectible:
• 2% for current and 10% for non-current
accounts.
What entry do we make at the end of the year
to accrue for bad debts?
19

Allowance Method (continued)




Allowance… is a contra-asset
account.
Collection of a bad debt that was
written-off:


Cash
 Allowance for Doubtful Accounts

20

Sales Discounts


Sales terms are “2/10 net 30”
• Customer gets 2% cash discount if paid
within 10 days.
• Otherwise, total amount is due within
30 days.




What does “1/15 net 45” mean?
What is the effective annual rate of
savings by taking advantage of
terms of “2/10 net 30”?
21

Alternative Methods of
Accounting for Sales Discounts


Record initial sale at gross.
 At collection of net amount record
discount as a reduction from gross
sales.



Record initial sale at gross.
 At collection of net amount record
discount as an expense of the period.



Record initial sale at net.
 Record amounts not taken as discounts
as additional revenue.

22

Example


We sold Rs10,000 of mdse. Sales
terms are 2/10, n/30.
Customers paid us for Rs8,000 of
the merchandise billed within 10
days. The remaining Rs2,000
was paid within 30 days.
• Record at gross.
• Record at net.
23

Credit Card Sales


If cash received by merchant
immediately (Bank plan, MC, Visa):




Cash
Sales discount
Sales revenue

970
30
1000

24

Credit Card Sales (continued)


If cash received by merchant in 30
days (American Express, Discover):




Accounts receivable
Sales discount
Sales revenue

970
30
1000

25

Sales Returns & Allowances


Similar to bad debt expense,
 Estimate percentage of revenues that
will eventually result in returns or
allowances.
 Adjusting entry at end of period.
 Actual return or allowance.

26

Example
 On average 2% of our Rs10,000 of sales
is returned. Adjusting entry at end of
period?
 Entry for return of Rs80 of goods?
 Same for direct write-off method?

27

Sales Returns & Allowances
(Continued)




Provision for Returns and Allowances
is a liability account.
Alternative:
 Not accrue for returns and allowances
but write them off as they occur.
 Is this GAAP?

28

Adjustment vs. Expense





Realization concept suggests
adjustment to revenue.
In practice both methods are found.
Consistency:
 Same handling from year to year.




Allows same company results to be
compared from year to year.
Comparisons between companies may be
distorted.
29

Warranty Costs








Amounts are estimated (usually as a
percentage of sales).
Part of Cost of goods sold.
Record accrual (adjusting entry)
Record the actual expenditures.
Allowance… is a liability account.
Est. warranty exp. Is part of costs of
sales.
30

Warranty Expenses Example




We estimate that warranty expenses
will be 4% of our Rs10,000 of sales.
Entry?
We spent Rs120 on parts and Rs250
on labor for repairs under warranty.
Entry?

31

Interest Revenue




Amount earned by lender during the
period.
2 approaches
• Interest paid at maturity.


Interest is explicit.

• Discounted loan.




Interest is implicit.

Accounted for separately from sale.
32

Example: Interest Revenue


On January 1, 19x1 sold a customer
Rs1,000 of mdse. We received a
promissory note for Rs1,000 plus 8%
interest to be paid in one year.
• Entry for sale?
• Entry for accrual of interest on December 31,
19x1?
• Entry for receipt of payment on note on
January 1, 19x2?



On January 1, 19x1, we sold mdse. and
received a promissory note for Rs5,000
with no interest. The note is due in one
year. The market rate of interest on such
a note is 9%.
• Entry at sale:
• Year end adjusting entry (12/31/19x1)
• Entry when customer pays note (1/1/19x2)

33

Monetary& Non-monetary
Assets







Monetary assets are money or claims to
receive fixed sums of money.
Non-monetary assets are items used in
future production and sales of goods
and services.
Balance sheet distinction
 Current and non-current assets.
 Not monetary and non-monetary.





Non-monetary assets (except
inventory) on BS at unexpired cost.
(Cost less depreciation)
Monetary assets: Cash reported at face.
AR at NRV. Other at fair value.

34

Cash



Funds available for disbursement.
May include liquid short term
investments.
• Highly liquid debt instruments with
original maturities of 90 days or less.

35

Receivables


Trade receivables
• Accounts receivables from usual sales of
products or services for non-financial
institutions.



Other receivables are shown
separately.
 E.g., Due from employees, advances or
loans.
36

Marketable Securities





Must be marketable.
E.g., commercial paper, treasury
bills, publicly traded stocks and
bonds issued by companies.
Also called “Temporary Investments.”

37

Accounting for Marketable
Securities


Three categories
 Held-to-maturity: debt securities,


Valued at cost.

 Trading securities: debt or equity held
for current resale, valued at market.


Realized (i.e., if sold during period) and
unrealized (not yet sold but market price
has changed) gain or loss included in
current year’s income.
38

Accounting for Marketable
Securities (Continued)


Available-for-sale securities:
 Debt or equity securities that do not fit
either of the other 2 categories.
 Reported at market value.
 Realized gains and losses go through
income.
 Unrealized gains and losses directly
credited (or debited) to a stockholders’
equity account.

39

Analysis of Monetary Assets





Current ratio = CA/CL
Acid-test ratio = quick ratio = monetary
CA/CL= (CA - inventories - prepaid
items) /CL.
Days cash = cash/(cash expenses 
365)
 Cash expenses  total expenses depreciation.





Days receivable = average collection
period = Receivables/(Sales  365)
Ratios differ by industry.

40

41


Slide 28

Revenue and Monetary
Assets
JOIN KHALID AZIZ
COACHING CLASSES
ICMAP STAGE 1,2,3,4,5
ICAP MODULE A,B,C,D
PIPFA
BBA & MBA
B.COM & M.COM
ACCOUNTING OF O/A LEVEL
MA-ECONOMICS
0322-3385752
KARACHI, PAKISTAN

Operating Cycle


Cash-to-cash.
• Receive cash from customer
• Purchase materials/services & pay cash
• Convert materials/services to salable
product
• Store product
• Sell product
• Receive cash from customer
2

Revenue Recognition:
When? (Timing) & How much? (Amt.)




At one point in revenue cycle
(objectivity).
Criteria:
• When? Earned (Conservatism)



Normally, goods shipped.
Service performed.

• How much? Realized or realizable
(Realization).





Already collected or collectible.
Amount can be measured reliably.

Next step: matching costs.

3

Basic Revenue Recognition Criteria


Recognize revenue in earliest period
in which:
• Entity has substantially performed what
is required in order to earn income and
• Amount of income can be reliably
measured.

4

Delivery Method




Recognize revenue when goods or
services are delivered.
For goods: when title transfers.
• FOB shipping point (when goods are
given to carrier).



Example 1:
• Order is received for Rs900. Sales
entry?
• Goods are produced. Sales entry?
• Goods are shipped. Sales entry?

5

Consignment Method


Consignor ships goods to
consignee.





Inventory on consignment
Merchandise inventory
1,000

1,000

Consignor retains title until goods
are sold to customer. At sale:





Accounts receivable
Sales revenue
COGS
Inventory on consignment

1,400
1,400
1,000
6

Franchise Revenue


Recognize:
• When earned.
• Not when agreement signed or fee
received.

7

Franchise Revenue First
Example


Tariq & Tariq’s charges a franchise
fee primarily for identifying the site,
designing the store, training
management and staff, and
otherwise helping to get the
franchise started in business.
Assume the initial fee is Rs100,000.
When should this Rs100,000 be
recorded as revenue?

8

Franchise Revenue Second
Example
• Golden, Inc. receives Rs6,000 from a
franchisee for the right to use its
trademark and have access to its
“know-how” for a period of 5 years.
This know-how includes training
sessions, and some one available to
answer questions. When should the
Rs6,000 be recognized as revenue?
9

Percentage-of-Completion Method








Design/development and
construction/production projects that
extends over several years.
Customer pays either fixed price or cost
reimbursement contract.
Reasonable assurance of profit margin and
ultimate realization.
Revenue recognized based on total
percentage of project work performed
during period.
10

Completed Contract Method


Percentage of completion method
required unless:
• Amount of income to be earned on
contract cannot reasonably be
determined.



Alternative is completed contract
method.
• Costs incurred are an asset (Contract
Work in Progress) until revenue is
recognized.

11

Production Method



Applies to agricultural and mining.
Criteria:
• Clear market determined price.
• Performance substantially complete.




Minimal remaining costs.

Permitted but not required by GAAP.

12

Installment Method






Customer pays a certain amount per
period.
Installment payment is recognized as
revenue and a proportional part of
cost of sales is recorded.
Under cost recovery method, cost is
recorded equal to installment
payment until total cost of sales is
covered.
13

Real Estate Sales





Developer often finances over many years.
Uncertainty of income due to uncertainty
of receipt of future payments.
Conditions required for revenue
recognition:
• Period allowing cancellation and refund to
buyer has expired.
• Cum payments equal to 10% of purchase
price.
• Seller has completed or is clearly capable of
completing required improvement.

14

Amount of Revenue
Recognized




Net realizable value (amount
reasonably estimated to be
collected).
2 approaches:
• Direct write-off method.
• Allowance method.



% of sales.
% of (analysis of) AR.
15

Direct Write-Off Method




Write-off when specific account that
is uncollectible is identified.
Why is this not acceptable under
GAAP?

16

Allowance Method


Estimate amount of current period
credit sales that will not be collected.
• Historical % tempered by judgment.
• Historical % of aged receivables
(+judgment).




Adjusting entry at end of period.
When an uncollectible account is
identified, it is written off.
17

Example


Amount of revenue recognized:
• Sales for the year were Rs2,000 for
cash and Rs6,000 on credit.
• Historically we don’t collect about 5%
of our credit sales due to customer
bankruptcies or unable to locate
customer.
• A customer, The XYZ Company went
bankrupt. They owed us Rs175.







Entry for revenue?
Entry for bad debts - direct write-off
(not-GAAP)?
Entries for bad debts (allowance
method)?

18

Example






Balances in Accounts
• Accounts receivable dr 3,000.
 Consisting of 2,000 current and 1,000
overdue.
• Allowance for doubtful accounts cr 50.
Estimated amount of accounts that are
uncollectible:
• 2% for current and 10% for non-current
accounts.
What entry do we make at the end of the year
to accrue for bad debts?
19

Allowance Method (continued)




Allowance… is a contra-asset
account.
Collection of a bad debt that was
written-off:


Cash
 Allowance for Doubtful Accounts

20

Sales Discounts


Sales terms are “2/10 net 30”
• Customer gets 2% cash discount if paid
within 10 days.
• Otherwise, total amount is due within
30 days.




What does “1/15 net 45” mean?
What is the effective annual rate of
savings by taking advantage of
terms of “2/10 net 30”?
21

Alternative Methods of
Accounting for Sales Discounts


Record initial sale at gross.
 At collection of net amount record
discount as a reduction from gross
sales.



Record initial sale at gross.
 At collection of net amount record
discount as an expense of the period.



Record initial sale at net.
 Record amounts not taken as discounts
as additional revenue.

22

Example


We sold Rs10,000 of mdse. Sales
terms are 2/10, n/30.
Customers paid us for Rs8,000 of
the merchandise billed within 10
days. The remaining Rs2,000
was paid within 30 days.
• Record at gross.
• Record at net.
23

Credit Card Sales


If cash received by merchant
immediately (Bank plan, MC, Visa):




Cash
Sales discount
Sales revenue

970
30
1000

24

Credit Card Sales (continued)


If cash received by merchant in 30
days (American Express, Discover):




Accounts receivable
Sales discount
Sales revenue

970
30
1000

25

Sales Returns & Allowances


Similar to bad debt expense,
 Estimate percentage of revenues that
will eventually result in returns or
allowances.
 Adjusting entry at end of period.
 Actual return or allowance.

26

Example
 On average 2% of our Rs10,000 of sales
is returned. Adjusting entry at end of
period?
 Entry for return of Rs80 of goods?
 Same for direct write-off method?

27

Sales Returns & Allowances
(Continued)




Provision for Returns and Allowances
is a liability account.
Alternative:
 Not accrue for returns and allowances
but write them off as they occur.
 Is this GAAP?

28

Adjustment vs. Expense





Realization concept suggests
adjustment to revenue.
In practice both methods are found.
Consistency:
 Same handling from year to year.




Allows same company results to be
compared from year to year.
Comparisons between companies may be
distorted.
29

Warranty Costs








Amounts are estimated (usually as a
percentage of sales).
Part of Cost of goods sold.
Record accrual (adjusting entry)
Record the actual expenditures.
Allowance… is a liability account.
Est. warranty exp. Is part of costs of
sales.
30

Warranty Expenses Example




We estimate that warranty expenses
will be 4% of our Rs10,000 of sales.
Entry?
We spent Rs120 on parts and Rs250
on labor for repairs under warranty.
Entry?

31

Interest Revenue




Amount earned by lender during the
period.
2 approaches
• Interest paid at maturity.


Interest is explicit.

• Discounted loan.




Interest is implicit.

Accounted for separately from sale.
32

Example: Interest Revenue


On January 1, 19x1 sold a customer
Rs1,000 of mdse. We received a
promissory note for Rs1,000 plus 8%
interest to be paid in one year.
• Entry for sale?
• Entry for accrual of interest on December 31,
19x1?
• Entry for receipt of payment on note on
January 1, 19x2?



On January 1, 19x1, we sold mdse. and
received a promissory note for Rs5,000
with no interest. The note is due in one
year. The market rate of interest on such
a note is 9%.
• Entry at sale:
• Year end adjusting entry (12/31/19x1)
• Entry when customer pays note (1/1/19x2)

33

Monetary& Non-monetary
Assets







Monetary assets are money or claims to
receive fixed sums of money.
Non-monetary assets are items used in
future production and sales of goods
and services.
Balance sheet distinction
 Current and non-current assets.
 Not monetary and non-monetary.





Non-monetary assets (except
inventory) on BS at unexpired cost.
(Cost less depreciation)
Monetary assets: Cash reported at face.
AR at NRV. Other at fair value.

34

Cash



Funds available for disbursement.
May include liquid short term
investments.
• Highly liquid debt instruments with
original maturities of 90 days or less.

35

Receivables


Trade receivables
• Accounts receivables from usual sales of
products or services for non-financial
institutions.



Other receivables are shown
separately.
 E.g., Due from employees, advances or
loans.
36

Marketable Securities





Must be marketable.
E.g., commercial paper, treasury
bills, publicly traded stocks and
bonds issued by companies.
Also called “Temporary Investments.”

37

Accounting for Marketable
Securities


Three categories
 Held-to-maturity: debt securities,


Valued at cost.

 Trading securities: debt or equity held
for current resale, valued at market.


Realized (i.e., if sold during period) and
unrealized (not yet sold but market price
has changed) gain or loss included in
current year’s income.
38

Accounting for Marketable
Securities (Continued)


Available-for-sale securities:
 Debt or equity securities that do not fit
either of the other 2 categories.
 Reported at market value.
 Realized gains and losses go through
income.
 Unrealized gains and losses directly
credited (or debited) to a stockholders’
equity account.

39

Analysis of Monetary Assets





Current ratio = CA/CL
Acid-test ratio = quick ratio = monetary
CA/CL= (CA - inventories - prepaid
items) /CL.
Days cash = cash/(cash expenses 
365)
 Cash expenses  total expenses depreciation.





Days receivable = average collection
period = Receivables/(Sales  365)
Ratios differ by industry.

40

41


Slide 29

Revenue and Monetary
Assets
JOIN KHALID AZIZ
COACHING CLASSES
ICMAP STAGE 1,2,3,4,5
ICAP MODULE A,B,C,D
PIPFA
BBA & MBA
B.COM & M.COM
ACCOUNTING OF O/A LEVEL
MA-ECONOMICS
0322-3385752
KARACHI, PAKISTAN

Operating Cycle


Cash-to-cash.
• Receive cash from customer
• Purchase materials/services & pay cash
• Convert materials/services to salable
product
• Store product
• Sell product
• Receive cash from customer
2

Revenue Recognition:
When? (Timing) & How much? (Amt.)




At one point in revenue cycle
(objectivity).
Criteria:
• When? Earned (Conservatism)



Normally, goods shipped.
Service performed.

• How much? Realized or realizable
(Realization).





Already collected or collectible.
Amount can be measured reliably.

Next step: matching costs.

3

Basic Revenue Recognition Criteria


Recognize revenue in earliest period
in which:
• Entity has substantially performed what
is required in order to earn income and
• Amount of income can be reliably
measured.

4

Delivery Method




Recognize revenue when goods or
services are delivered.
For goods: when title transfers.
• FOB shipping point (when goods are
given to carrier).



Example 1:
• Order is received for Rs900. Sales
entry?
• Goods are produced. Sales entry?
• Goods are shipped. Sales entry?

5

Consignment Method


Consignor ships goods to
consignee.





Inventory on consignment
Merchandise inventory
1,000

1,000

Consignor retains title until goods
are sold to customer. At sale:





Accounts receivable
Sales revenue
COGS
Inventory on consignment

1,400
1,400
1,000
6

Franchise Revenue


Recognize:
• When earned.
• Not when agreement signed or fee
received.

7

Franchise Revenue First
Example


Tariq & Tariq’s charges a franchise
fee primarily for identifying the site,
designing the store, training
management and staff, and
otherwise helping to get the
franchise started in business.
Assume the initial fee is Rs100,000.
When should this Rs100,000 be
recorded as revenue?

8

Franchise Revenue Second
Example
• Golden, Inc. receives Rs6,000 from a
franchisee for the right to use its
trademark and have access to its
“know-how” for a period of 5 years.
This know-how includes training
sessions, and some one available to
answer questions. When should the
Rs6,000 be recognized as revenue?
9

Percentage-of-Completion Method








Design/development and
construction/production projects that
extends over several years.
Customer pays either fixed price or cost
reimbursement contract.
Reasonable assurance of profit margin and
ultimate realization.
Revenue recognized based on total
percentage of project work performed
during period.
10

Completed Contract Method


Percentage of completion method
required unless:
• Amount of income to be earned on
contract cannot reasonably be
determined.



Alternative is completed contract
method.
• Costs incurred are an asset (Contract
Work in Progress) until revenue is
recognized.

11

Production Method



Applies to agricultural and mining.
Criteria:
• Clear market determined price.
• Performance substantially complete.




Minimal remaining costs.

Permitted but not required by GAAP.

12

Installment Method






Customer pays a certain amount per
period.
Installment payment is recognized as
revenue and a proportional part of
cost of sales is recorded.
Under cost recovery method, cost is
recorded equal to installment
payment until total cost of sales is
covered.
13

Real Estate Sales





Developer often finances over many years.
Uncertainty of income due to uncertainty
of receipt of future payments.
Conditions required for revenue
recognition:
• Period allowing cancellation and refund to
buyer has expired.
• Cum payments equal to 10% of purchase
price.
• Seller has completed or is clearly capable of
completing required improvement.

14

Amount of Revenue
Recognized




Net realizable value (amount
reasonably estimated to be
collected).
2 approaches:
• Direct write-off method.
• Allowance method.



% of sales.
% of (analysis of) AR.
15

Direct Write-Off Method




Write-off when specific account that
is uncollectible is identified.
Why is this not acceptable under
GAAP?

16

Allowance Method


Estimate amount of current period
credit sales that will not be collected.
• Historical % tempered by judgment.
• Historical % of aged receivables
(+judgment).




Adjusting entry at end of period.
When an uncollectible account is
identified, it is written off.
17

Example


Amount of revenue recognized:
• Sales for the year were Rs2,000 for
cash and Rs6,000 on credit.
• Historically we don’t collect about 5%
of our credit sales due to customer
bankruptcies or unable to locate
customer.
• A customer, The XYZ Company went
bankrupt. They owed us Rs175.







Entry for revenue?
Entry for bad debts - direct write-off
(not-GAAP)?
Entries for bad debts (allowance
method)?

18

Example






Balances in Accounts
• Accounts receivable dr 3,000.
 Consisting of 2,000 current and 1,000
overdue.
• Allowance for doubtful accounts cr 50.
Estimated amount of accounts that are
uncollectible:
• 2% for current and 10% for non-current
accounts.
What entry do we make at the end of the year
to accrue for bad debts?
19

Allowance Method (continued)




Allowance… is a contra-asset
account.
Collection of a bad debt that was
written-off:


Cash
 Allowance for Doubtful Accounts

20

Sales Discounts


Sales terms are “2/10 net 30”
• Customer gets 2% cash discount if paid
within 10 days.
• Otherwise, total amount is due within
30 days.




What does “1/15 net 45” mean?
What is the effective annual rate of
savings by taking advantage of
terms of “2/10 net 30”?
21

Alternative Methods of
Accounting for Sales Discounts


Record initial sale at gross.
 At collection of net amount record
discount as a reduction from gross
sales.



Record initial sale at gross.
 At collection of net amount record
discount as an expense of the period.



Record initial sale at net.
 Record amounts not taken as discounts
as additional revenue.

22

Example


We sold Rs10,000 of mdse. Sales
terms are 2/10, n/30.
Customers paid us for Rs8,000 of
the merchandise billed within 10
days. The remaining Rs2,000
was paid within 30 days.
• Record at gross.
• Record at net.
23

Credit Card Sales


If cash received by merchant
immediately (Bank plan, MC, Visa):




Cash
Sales discount
Sales revenue

970
30
1000

24

Credit Card Sales (continued)


If cash received by merchant in 30
days (American Express, Discover):




Accounts receivable
Sales discount
Sales revenue

970
30
1000

25

Sales Returns & Allowances


Similar to bad debt expense,
 Estimate percentage of revenues that
will eventually result in returns or
allowances.
 Adjusting entry at end of period.
 Actual return or allowance.

26

Example
 On average 2% of our Rs10,000 of sales
is returned. Adjusting entry at end of
period?
 Entry for return of Rs80 of goods?
 Same for direct write-off method?

27

Sales Returns & Allowances
(Continued)




Provision for Returns and Allowances
is a liability account.
Alternative:
 Not accrue for returns and allowances
but write them off as they occur.
 Is this GAAP?

28

Adjustment vs. Expense





Realization concept suggests
adjustment to revenue.
In practice both methods are found.
Consistency:
 Same handling from year to year.




Allows same company results to be
compared from year to year.
Comparisons between companies may be
distorted.
29

Warranty Costs








Amounts are estimated (usually as a
percentage of sales).
Part of Cost of goods sold.
Record accrual (adjusting entry)
Record the actual expenditures.
Allowance… is a liability account.
Est. warranty exp. Is part of costs of
sales.
30

Warranty Expenses Example




We estimate that warranty expenses
will be 4% of our Rs10,000 of sales.
Entry?
We spent Rs120 on parts and Rs250
on labor for repairs under warranty.
Entry?

31

Interest Revenue




Amount earned by lender during the
period.
2 approaches
• Interest paid at maturity.


Interest is explicit.

• Discounted loan.




Interest is implicit.

Accounted for separately from sale.
32

Example: Interest Revenue


On January 1, 19x1 sold a customer
Rs1,000 of mdse. We received a
promissory note for Rs1,000 plus 8%
interest to be paid in one year.
• Entry for sale?
• Entry for accrual of interest on December 31,
19x1?
• Entry for receipt of payment on note on
January 1, 19x2?



On January 1, 19x1, we sold mdse. and
received a promissory note for Rs5,000
with no interest. The note is due in one
year. The market rate of interest on such
a note is 9%.
• Entry at sale:
• Year end adjusting entry (12/31/19x1)
• Entry when customer pays note (1/1/19x2)

33

Monetary& Non-monetary
Assets







Monetary assets are money or claims to
receive fixed sums of money.
Non-monetary assets are items used in
future production and sales of goods
and services.
Balance sheet distinction
 Current and non-current assets.
 Not monetary and non-monetary.





Non-monetary assets (except
inventory) on BS at unexpired cost.
(Cost less depreciation)
Monetary assets: Cash reported at face.
AR at NRV. Other at fair value.

34

Cash



Funds available for disbursement.
May include liquid short term
investments.
• Highly liquid debt instruments with
original maturities of 90 days or less.

35

Receivables


Trade receivables
• Accounts receivables from usual sales of
products or services for non-financial
institutions.



Other receivables are shown
separately.
 E.g., Due from employees, advances or
loans.
36

Marketable Securities





Must be marketable.
E.g., commercial paper, treasury
bills, publicly traded stocks and
bonds issued by companies.
Also called “Temporary Investments.”

37

Accounting for Marketable
Securities


Three categories
 Held-to-maturity: debt securities,


Valued at cost.

 Trading securities: debt or equity held
for current resale, valued at market.


Realized (i.e., if sold during period) and
unrealized (not yet sold but market price
has changed) gain or loss included in
current year’s income.
38

Accounting for Marketable
Securities (Continued)


Available-for-sale securities:
 Debt or equity securities that do not fit
either of the other 2 categories.
 Reported at market value.
 Realized gains and losses go through
income.
 Unrealized gains and losses directly
credited (or debited) to a stockholders’
equity account.

39

Analysis of Monetary Assets





Current ratio = CA/CL
Acid-test ratio = quick ratio = monetary
CA/CL= (CA - inventories - prepaid
items) /CL.
Days cash = cash/(cash expenses 
365)
 Cash expenses  total expenses depreciation.





Days receivable = average collection
period = Receivables/(Sales  365)
Ratios differ by industry.

40

41


Slide 30

Revenue and Monetary
Assets
JOIN KHALID AZIZ
COACHING CLASSES
ICMAP STAGE 1,2,3,4,5
ICAP MODULE A,B,C,D
PIPFA
BBA & MBA
B.COM & M.COM
ACCOUNTING OF O/A LEVEL
MA-ECONOMICS
0322-3385752
KARACHI, PAKISTAN

Operating Cycle


Cash-to-cash.
• Receive cash from customer
• Purchase materials/services & pay cash
• Convert materials/services to salable
product
• Store product
• Sell product
• Receive cash from customer
2

Revenue Recognition:
When? (Timing) & How much? (Amt.)




At one point in revenue cycle
(objectivity).
Criteria:
• When? Earned (Conservatism)



Normally, goods shipped.
Service performed.

• How much? Realized or realizable
(Realization).





Already collected or collectible.
Amount can be measured reliably.

Next step: matching costs.

3

Basic Revenue Recognition Criteria


Recognize revenue in earliest period
in which:
• Entity has substantially performed what
is required in order to earn income and
• Amount of income can be reliably
measured.

4

Delivery Method




Recognize revenue when goods or
services are delivered.
For goods: when title transfers.
• FOB shipping point (when goods are
given to carrier).



Example 1:
• Order is received for Rs900. Sales
entry?
• Goods are produced. Sales entry?
• Goods are shipped. Sales entry?

5

Consignment Method


Consignor ships goods to
consignee.





Inventory on consignment
Merchandise inventory
1,000

1,000

Consignor retains title until goods
are sold to customer. At sale:





Accounts receivable
Sales revenue
COGS
Inventory on consignment

1,400
1,400
1,000
6

Franchise Revenue


Recognize:
• When earned.
• Not when agreement signed or fee
received.

7

Franchise Revenue First
Example


Tariq & Tariq’s charges a franchise
fee primarily for identifying the site,
designing the store, training
management and staff, and
otherwise helping to get the
franchise started in business.
Assume the initial fee is Rs100,000.
When should this Rs100,000 be
recorded as revenue?

8

Franchise Revenue Second
Example
• Golden, Inc. receives Rs6,000 from a
franchisee for the right to use its
trademark and have access to its
“know-how” for a period of 5 years.
This know-how includes training
sessions, and some one available to
answer questions. When should the
Rs6,000 be recognized as revenue?
9

Percentage-of-Completion Method








Design/development and
construction/production projects that
extends over several years.
Customer pays either fixed price or cost
reimbursement contract.
Reasonable assurance of profit margin and
ultimate realization.
Revenue recognized based on total
percentage of project work performed
during period.
10

Completed Contract Method


Percentage of completion method
required unless:
• Amount of income to be earned on
contract cannot reasonably be
determined.



Alternative is completed contract
method.
• Costs incurred are an asset (Contract
Work in Progress) until revenue is
recognized.

11

Production Method



Applies to agricultural and mining.
Criteria:
• Clear market determined price.
• Performance substantially complete.




Minimal remaining costs.

Permitted but not required by GAAP.

12

Installment Method






Customer pays a certain amount per
period.
Installment payment is recognized as
revenue and a proportional part of
cost of sales is recorded.
Under cost recovery method, cost is
recorded equal to installment
payment until total cost of sales is
covered.
13

Real Estate Sales





Developer often finances over many years.
Uncertainty of income due to uncertainty
of receipt of future payments.
Conditions required for revenue
recognition:
• Period allowing cancellation and refund to
buyer has expired.
• Cum payments equal to 10% of purchase
price.
• Seller has completed or is clearly capable of
completing required improvement.

14

Amount of Revenue
Recognized




Net realizable value (amount
reasonably estimated to be
collected).
2 approaches:
• Direct write-off method.
• Allowance method.



% of sales.
% of (analysis of) AR.
15

Direct Write-Off Method




Write-off when specific account that
is uncollectible is identified.
Why is this not acceptable under
GAAP?

16

Allowance Method


Estimate amount of current period
credit sales that will not be collected.
• Historical % tempered by judgment.
• Historical % of aged receivables
(+judgment).




Adjusting entry at end of period.
When an uncollectible account is
identified, it is written off.
17

Example


Amount of revenue recognized:
• Sales for the year were Rs2,000 for
cash and Rs6,000 on credit.
• Historically we don’t collect about 5%
of our credit sales due to customer
bankruptcies or unable to locate
customer.
• A customer, The XYZ Company went
bankrupt. They owed us Rs175.







Entry for revenue?
Entry for bad debts - direct write-off
(not-GAAP)?
Entries for bad debts (allowance
method)?

18

Example






Balances in Accounts
• Accounts receivable dr 3,000.
 Consisting of 2,000 current and 1,000
overdue.
• Allowance for doubtful accounts cr 50.
Estimated amount of accounts that are
uncollectible:
• 2% for current and 10% for non-current
accounts.
What entry do we make at the end of the year
to accrue for bad debts?
19

Allowance Method (continued)




Allowance… is a contra-asset
account.
Collection of a bad debt that was
written-off:


Cash
 Allowance for Doubtful Accounts

20

Sales Discounts


Sales terms are “2/10 net 30”
• Customer gets 2% cash discount if paid
within 10 days.
• Otherwise, total amount is due within
30 days.




What does “1/15 net 45” mean?
What is the effective annual rate of
savings by taking advantage of
terms of “2/10 net 30”?
21

Alternative Methods of
Accounting for Sales Discounts


Record initial sale at gross.
 At collection of net amount record
discount as a reduction from gross
sales.



Record initial sale at gross.
 At collection of net amount record
discount as an expense of the period.



Record initial sale at net.
 Record amounts not taken as discounts
as additional revenue.

22

Example


We sold Rs10,000 of mdse. Sales
terms are 2/10, n/30.
Customers paid us for Rs8,000 of
the merchandise billed within 10
days. The remaining Rs2,000
was paid within 30 days.
• Record at gross.
• Record at net.
23

Credit Card Sales


If cash received by merchant
immediately (Bank plan, MC, Visa):




Cash
Sales discount
Sales revenue

970
30
1000

24

Credit Card Sales (continued)


If cash received by merchant in 30
days (American Express, Discover):




Accounts receivable
Sales discount
Sales revenue

970
30
1000

25

Sales Returns & Allowances


Similar to bad debt expense,
 Estimate percentage of revenues that
will eventually result in returns or
allowances.
 Adjusting entry at end of period.
 Actual return or allowance.

26

Example
 On average 2% of our Rs10,000 of sales
is returned. Adjusting entry at end of
period?
 Entry for return of Rs80 of goods?
 Same for direct write-off method?

27

Sales Returns & Allowances
(Continued)




Provision for Returns and Allowances
is a liability account.
Alternative:
 Not accrue for returns and allowances
but write them off as they occur.
 Is this GAAP?

28

Adjustment vs. Expense





Realization concept suggests
adjustment to revenue.
In practice both methods are found.
Consistency:
 Same handling from year to year.




Allows same company results to be
compared from year to year.
Comparisons between companies may be
distorted.
29

Warranty Costs








Amounts are estimated (usually as a
percentage of sales).
Part of Cost of goods sold.
Record accrual (adjusting entry)
Record the actual expenditures.
Allowance… is a liability account.
Est. warranty exp. Is part of costs of
sales.
30

Warranty Expenses Example




We estimate that warranty expenses
will be 4% of our Rs10,000 of sales.
Entry?
We spent Rs120 on parts and Rs250
on labor for repairs under warranty.
Entry?

31

Interest Revenue




Amount earned by lender during the
period.
2 approaches
• Interest paid at maturity.


Interest is explicit.

• Discounted loan.




Interest is implicit.

Accounted for separately from sale.
32

Example: Interest Revenue


On January 1, 19x1 sold a customer
Rs1,000 of mdse. We received a
promissory note for Rs1,000 plus 8%
interest to be paid in one year.
• Entry for sale?
• Entry for accrual of interest on December 31,
19x1?
• Entry for receipt of payment on note on
January 1, 19x2?



On January 1, 19x1, we sold mdse. and
received a promissory note for Rs5,000
with no interest. The note is due in one
year. The market rate of interest on such
a note is 9%.
• Entry at sale:
• Year end adjusting entry (12/31/19x1)
• Entry when customer pays note (1/1/19x2)

33

Monetary& Non-monetary
Assets







Monetary assets are money or claims to
receive fixed sums of money.
Non-monetary assets are items used in
future production and sales of goods
and services.
Balance sheet distinction
 Current and non-current assets.
 Not monetary and non-monetary.





Non-monetary assets (except
inventory) on BS at unexpired cost.
(Cost less depreciation)
Monetary assets: Cash reported at face.
AR at NRV. Other at fair value.

34

Cash



Funds available for disbursement.
May include liquid short term
investments.
• Highly liquid debt instruments with
original maturities of 90 days or less.

35

Receivables


Trade receivables
• Accounts receivables from usual sales of
products or services for non-financial
institutions.



Other receivables are shown
separately.
 E.g., Due from employees, advances or
loans.
36

Marketable Securities





Must be marketable.
E.g., commercial paper, treasury
bills, publicly traded stocks and
bonds issued by companies.
Also called “Temporary Investments.”

37

Accounting for Marketable
Securities


Three categories
 Held-to-maturity: debt securities,


Valued at cost.

 Trading securities: debt or equity held
for current resale, valued at market.


Realized (i.e., if sold during period) and
unrealized (not yet sold but market price
has changed) gain or loss included in
current year’s income.
38

Accounting for Marketable
Securities (Continued)


Available-for-sale securities:
 Debt or equity securities that do not fit
either of the other 2 categories.
 Reported at market value.
 Realized gains and losses go through
income.
 Unrealized gains and losses directly
credited (or debited) to a stockholders’
equity account.

39

Analysis of Monetary Assets





Current ratio = CA/CL
Acid-test ratio = quick ratio = monetary
CA/CL= (CA - inventories - prepaid
items) /CL.
Days cash = cash/(cash expenses 
365)
 Cash expenses  total expenses depreciation.





Days receivable = average collection
period = Receivables/(Sales  365)
Ratios differ by industry.

40

41


Slide 31

Revenue and Monetary
Assets
JOIN KHALID AZIZ
COACHING CLASSES
ICMAP STAGE 1,2,3,4,5
ICAP MODULE A,B,C,D
PIPFA
BBA & MBA
B.COM & M.COM
ACCOUNTING OF O/A LEVEL
MA-ECONOMICS
0322-3385752
KARACHI, PAKISTAN

Operating Cycle


Cash-to-cash.
• Receive cash from customer
• Purchase materials/services & pay cash
• Convert materials/services to salable
product
• Store product
• Sell product
• Receive cash from customer
2

Revenue Recognition:
When? (Timing) & How much? (Amt.)




At one point in revenue cycle
(objectivity).
Criteria:
• When? Earned (Conservatism)



Normally, goods shipped.
Service performed.

• How much? Realized or realizable
(Realization).





Already collected or collectible.
Amount can be measured reliably.

Next step: matching costs.

3

Basic Revenue Recognition Criteria


Recognize revenue in earliest period
in which:
• Entity has substantially performed what
is required in order to earn income and
• Amount of income can be reliably
measured.

4

Delivery Method




Recognize revenue when goods or
services are delivered.
For goods: when title transfers.
• FOB shipping point (when goods are
given to carrier).



Example 1:
• Order is received for Rs900. Sales
entry?
• Goods are produced. Sales entry?
• Goods are shipped. Sales entry?

5

Consignment Method


Consignor ships goods to
consignee.





Inventory on consignment
Merchandise inventory
1,000

1,000

Consignor retains title until goods
are sold to customer. At sale:





Accounts receivable
Sales revenue
COGS
Inventory on consignment

1,400
1,400
1,000
6

Franchise Revenue


Recognize:
• When earned.
• Not when agreement signed or fee
received.

7

Franchise Revenue First
Example


Tariq & Tariq’s charges a franchise
fee primarily for identifying the site,
designing the store, training
management and staff, and
otherwise helping to get the
franchise started in business.
Assume the initial fee is Rs100,000.
When should this Rs100,000 be
recorded as revenue?

8

Franchise Revenue Second
Example
• Golden, Inc. receives Rs6,000 from a
franchisee for the right to use its
trademark and have access to its
“know-how” for a period of 5 years.
This know-how includes training
sessions, and some one available to
answer questions. When should the
Rs6,000 be recognized as revenue?
9

Percentage-of-Completion Method








Design/development and
construction/production projects that
extends over several years.
Customer pays either fixed price or cost
reimbursement contract.
Reasonable assurance of profit margin and
ultimate realization.
Revenue recognized based on total
percentage of project work performed
during period.
10

Completed Contract Method


Percentage of completion method
required unless:
• Amount of income to be earned on
contract cannot reasonably be
determined.



Alternative is completed contract
method.
• Costs incurred are an asset (Contract
Work in Progress) until revenue is
recognized.

11

Production Method



Applies to agricultural and mining.
Criteria:
• Clear market determined price.
• Performance substantially complete.




Minimal remaining costs.

Permitted but not required by GAAP.

12

Installment Method






Customer pays a certain amount per
period.
Installment payment is recognized as
revenue and a proportional part of
cost of sales is recorded.
Under cost recovery method, cost is
recorded equal to installment
payment until total cost of sales is
covered.
13

Real Estate Sales





Developer often finances over many years.
Uncertainty of income due to uncertainty
of receipt of future payments.
Conditions required for revenue
recognition:
• Period allowing cancellation and refund to
buyer has expired.
• Cum payments equal to 10% of purchase
price.
• Seller has completed or is clearly capable of
completing required improvement.

14

Amount of Revenue
Recognized




Net realizable value (amount
reasonably estimated to be
collected).
2 approaches:
• Direct write-off method.
• Allowance method.



% of sales.
% of (analysis of) AR.
15

Direct Write-Off Method




Write-off when specific account that
is uncollectible is identified.
Why is this not acceptable under
GAAP?

16

Allowance Method


Estimate amount of current period
credit sales that will not be collected.
• Historical % tempered by judgment.
• Historical % of aged receivables
(+judgment).




Adjusting entry at end of period.
When an uncollectible account is
identified, it is written off.
17

Example


Amount of revenue recognized:
• Sales for the year were Rs2,000 for
cash and Rs6,000 on credit.
• Historically we don’t collect about 5%
of our credit sales due to customer
bankruptcies or unable to locate
customer.
• A customer, The XYZ Company went
bankrupt. They owed us Rs175.







Entry for revenue?
Entry for bad debts - direct write-off
(not-GAAP)?
Entries for bad debts (allowance
method)?

18

Example






Balances in Accounts
• Accounts receivable dr 3,000.
 Consisting of 2,000 current and 1,000
overdue.
• Allowance for doubtful accounts cr 50.
Estimated amount of accounts that are
uncollectible:
• 2% for current and 10% for non-current
accounts.
What entry do we make at the end of the year
to accrue for bad debts?
19

Allowance Method (continued)




Allowance… is a contra-asset
account.
Collection of a bad debt that was
written-off:


Cash
 Allowance for Doubtful Accounts

20

Sales Discounts


Sales terms are “2/10 net 30”
• Customer gets 2% cash discount if paid
within 10 days.
• Otherwise, total amount is due within
30 days.




What does “1/15 net 45” mean?
What is the effective annual rate of
savings by taking advantage of
terms of “2/10 net 30”?
21

Alternative Methods of
Accounting for Sales Discounts


Record initial sale at gross.
 At collection of net amount record
discount as a reduction from gross
sales.



Record initial sale at gross.
 At collection of net amount record
discount as an expense of the period.



Record initial sale at net.
 Record amounts not taken as discounts
as additional revenue.

22

Example


We sold Rs10,000 of mdse. Sales
terms are 2/10, n/30.
Customers paid us for Rs8,000 of
the merchandise billed within 10
days. The remaining Rs2,000
was paid within 30 days.
• Record at gross.
• Record at net.
23

Credit Card Sales


If cash received by merchant
immediately (Bank plan, MC, Visa):




Cash
Sales discount
Sales revenue

970
30
1000

24

Credit Card Sales (continued)


If cash received by merchant in 30
days (American Express, Discover):




Accounts receivable
Sales discount
Sales revenue

970
30
1000

25

Sales Returns & Allowances


Similar to bad debt expense,
 Estimate percentage of revenues that
will eventually result in returns or
allowances.
 Adjusting entry at end of period.
 Actual return or allowance.

26

Example
 On average 2% of our Rs10,000 of sales
is returned. Adjusting entry at end of
period?
 Entry for return of Rs80 of goods?
 Same for direct write-off method?

27

Sales Returns & Allowances
(Continued)




Provision for Returns and Allowances
is a liability account.
Alternative:
 Not accrue for returns and allowances
but write them off as they occur.
 Is this GAAP?

28

Adjustment vs. Expense





Realization concept suggests
adjustment to revenue.
In practice both methods are found.
Consistency:
 Same handling from year to year.




Allows same company results to be
compared from year to year.
Comparisons between companies may be
distorted.
29

Warranty Costs








Amounts are estimated (usually as a
percentage of sales).
Part of Cost of goods sold.
Record accrual (adjusting entry)
Record the actual expenditures.
Allowance… is a liability account.
Est. warranty exp. Is part of costs of
sales.
30

Warranty Expenses Example




We estimate that warranty expenses
will be 4% of our Rs10,000 of sales.
Entry?
We spent Rs120 on parts and Rs250
on labor for repairs under warranty.
Entry?

31

Interest Revenue




Amount earned by lender during the
period.
2 approaches
• Interest paid at maturity.


Interest is explicit.

• Discounted loan.




Interest is implicit.

Accounted for separately from sale.
32

Example: Interest Revenue


On January 1, 19x1 sold a customer
Rs1,000 of mdse. We received a
promissory note for Rs1,000 plus 8%
interest to be paid in one year.
• Entry for sale?
• Entry for accrual of interest on December 31,
19x1?
• Entry for receipt of payment on note on
January 1, 19x2?



On January 1, 19x1, we sold mdse. and
received a promissory note for Rs5,000
with no interest. The note is due in one
year. The market rate of interest on such
a note is 9%.
• Entry at sale:
• Year end adjusting entry (12/31/19x1)
• Entry when customer pays note (1/1/19x2)

33

Monetary& Non-monetary
Assets







Monetary assets are money or claims to
receive fixed sums of money.
Non-monetary assets are items used in
future production and sales of goods
and services.
Balance sheet distinction
 Current and non-current assets.
 Not monetary and non-monetary.





Non-monetary assets (except
inventory) on BS at unexpired cost.
(Cost less depreciation)
Monetary assets: Cash reported at face.
AR at NRV. Other at fair value.

34

Cash



Funds available for disbursement.
May include liquid short term
investments.
• Highly liquid debt instruments with
original maturities of 90 days or less.

35

Receivables


Trade receivables
• Accounts receivables from usual sales of
products or services for non-financial
institutions.



Other receivables are shown
separately.
 E.g., Due from employees, advances or
loans.
36

Marketable Securities





Must be marketable.
E.g., commercial paper, treasury
bills, publicly traded stocks and
bonds issued by companies.
Also called “Temporary Investments.”

37

Accounting for Marketable
Securities


Three categories
 Held-to-maturity: debt securities,


Valued at cost.

 Trading securities: debt or equity held
for current resale, valued at market.


Realized (i.e., if sold during period) and
unrealized (not yet sold but market price
has changed) gain or loss included in
current year’s income.
38

Accounting for Marketable
Securities (Continued)


Available-for-sale securities:
 Debt or equity securities that do not fit
either of the other 2 categories.
 Reported at market value.
 Realized gains and losses go through
income.
 Unrealized gains and losses directly
credited (or debited) to a stockholders’
equity account.

39

Analysis of Monetary Assets





Current ratio = CA/CL
Acid-test ratio = quick ratio = monetary
CA/CL= (CA - inventories - prepaid
items) /CL.
Days cash = cash/(cash expenses 
365)
 Cash expenses  total expenses depreciation.





Days receivable = average collection
period = Receivables/(Sales  365)
Ratios differ by industry.

40

41


Slide 32

Revenue and Monetary
Assets
JOIN KHALID AZIZ
COACHING CLASSES
ICMAP STAGE 1,2,3,4,5
ICAP MODULE A,B,C,D
PIPFA
BBA & MBA
B.COM & M.COM
ACCOUNTING OF O/A LEVEL
MA-ECONOMICS
0322-3385752
KARACHI, PAKISTAN

Operating Cycle


Cash-to-cash.
• Receive cash from customer
• Purchase materials/services & pay cash
• Convert materials/services to salable
product
• Store product
• Sell product
• Receive cash from customer
2

Revenue Recognition:
When? (Timing) & How much? (Amt.)




At one point in revenue cycle
(objectivity).
Criteria:
• When? Earned (Conservatism)



Normally, goods shipped.
Service performed.

• How much? Realized or realizable
(Realization).





Already collected or collectible.
Amount can be measured reliably.

Next step: matching costs.

3

Basic Revenue Recognition Criteria


Recognize revenue in earliest period
in which:
• Entity has substantially performed what
is required in order to earn income and
• Amount of income can be reliably
measured.

4

Delivery Method




Recognize revenue when goods or
services are delivered.
For goods: when title transfers.
• FOB shipping point (when goods are
given to carrier).



Example 1:
• Order is received for Rs900. Sales
entry?
• Goods are produced. Sales entry?
• Goods are shipped. Sales entry?

5

Consignment Method


Consignor ships goods to
consignee.





Inventory on consignment
Merchandise inventory
1,000

1,000

Consignor retains title until goods
are sold to customer. At sale:





Accounts receivable
Sales revenue
COGS
Inventory on consignment

1,400
1,400
1,000
6

Franchise Revenue


Recognize:
• When earned.
• Not when agreement signed or fee
received.

7

Franchise Revenue First
Example


Tariq & Tariq’s charges a franchise
fee primarily for identifying the site,
designing the store, training
management and staff, and
otherwise helping to get the
franchise started in business.
Assume the initial fee is Rs100,000.
When should this Rs100,000 be
recorded as revenue?

8

Franchise Revenue Second
Example
• Golden, Inc. receives Rs6,000 from a
franchisee for the right to use its
trademark and have access to its
“know-how” for a period of 5 years.
This know-how includes training
sessions, and some one available to
answer questions. When should the
Rs6,000 be recognized as revenue?
9

Percentage-of-Completion Method








Design/development and
construction/production projects that
extends over several years.
Customer pays either fixed price or cost
reimbursement contract.
Reasonable assurance of profit margin and
ultimate realization.
Revenue recognized based on total
percentage of project work performed
during period.
10

Completed Contract Method


Percentage of completion method
required unless:
• Amount of income to be earned on
contract cannot reasonably be
determined.



Alternative is completed contract
method.
• Costs incurred are an asset (Contract
Work in Progress) until revenue is
recognized.

11

Production Method



Applies to agricultural and mining.
Criteria:
• Clear market determined price.
• Performance substantially complete.




Minimal remaining costs.

Permitted but not required by GAAP.

12

Installment Method






Customer pays a certain amount per
period.
Installment payment is recognized as
revenue and a proportional part of
cost of sales is recorded.
Under cost recovery method, cost is
recorded equal to installment
payment until total cost of sales is
covered.
13

Real Estate Sales





Developer often finances over many years.
Uncertainty of income due to uncertainty
of receipt of future payments.
Conditions required for revenue
recognition:
• Period allowing cancellation and refund to
buyer has expired.
• Cum payments equal to 10% of purchase
price.
• Seller has completed or is clearly capable of
completing required improvement.

14

Amount of Revenue
Recognized




Net realizable value (amount
reasonably estimated to be
collected).
2 approaches:
• Direct write-off method.
• Allowance method.



% of sales.
% of (analysis of) AR.
15

Direct Write-Off Method




Write-off when specific account that
is uncollectible is identified.
Why is this not acceptable under
GAAP?

16

Allowance Method


Estimate amount of current period
credit sales that will not be collected.
• Historical % tempered by judgment.
• Historical % of aged receivables
(+judgment).




Adjusting entry at end of period.
When an uncollectible account is
identified, it is written off.
17

Example


Amount of revenue recognized:
• Sales for the year were Rs2,000 for
cash and Rs6,000 on credit.
• Historically we don’t collect about 5%
of our credit sales due to customer
bankruptcies or unable to locate
customer.
• A customer, The XYZ Company went
bankrupt. They owed us Rs175.







Entry for revenue?
Entry for bad debts - direct write-off
(not-GAAP)?
Entries for bad debts (allowance
method)?

18

Example






Balances in Accounts
• Accounts receivable dr 3,000.
 Consisting of 2,000 current and 1,000
overdue.
• Allowance for doubtful accounts cr 50.
Estimated amount of accounts that are
uncollectible:
• 2% for current and 10% for non-current
accounts.
What entry do we make at the end of the year
to accrue for bad debts?
19

Allowance Method (continued)




Allowance… is a contra-asset
account.
Collection of a bad debt that was
written-off:


Cash
 Allowance for Doubtful Accounts

20

Sales Discounts


Sales terms are “2/10 net 30”
• Customer gets 2% cash discount if paid
within 10 days.
• Otherwise, total amount is due within
30 days.




What does “1/15 net 45” mean?
What is the effective annual rate of
savings by taking advantage of
terms of “2/10 net 30”?
21

Alternative Methods of
Accounting for Sales Discounts


Record initial sale at gross.
 At collection of net amount record
discount as a reduction from gross
sales.



Record initial sale at gross.
 At collection of net amount record
discount as an expense of the period.



Record initial sale at net.
 Record amounts not taken as discounts
as additional revenue.

22

Example


We sold Rs10,000 of mdse. Sales
terms are 2/10, n/30.
Customers paid us for Rs8,000 of
the merchandise billed within 10
days. The remaining Rs2,000
was paid within 30 days.
• Record at gross.
• Record at net.
23

Credit Card Sales


If cash received by merchant
immediately (Bank plan, MC, Visa):




Cash
Sales discount
Sales revenue

970
30
1000

24

Credit Card Sales (continued)


If cash received by merchant in 30
days (American Express, Discover):




Accounts receivable
Sales discount
Sales revenue

970
30
1000

25

Sales Returns & Allowances


Similar to bad debt expense,
 Estimate percentage of revenues that
will eventually result in returns or
allowances.
 Adjusting entry at end of period.
 Actual return or allowance.

26

Example
 On average 2% of our Rs10,000 of sales
is returned. Adjusting entry at end of
period?
 Entry for return of Rs80 of goods?
 Same for direct write-off method?

27

Sales Returns & Allowances
(Continued)




Provision for Returns and Allowances
is a liability account.
Alternative:
 Not accrue for returns and allowances
but write them off as they occur.
 Is this GAAP?

28

Adjustment vs. Expense





Realization concept suggests
adjustment to revenue.
In practice both methods are found.
Consistency:
 Same handling from year to year.




Allows same company results to be
compared from year to year.
Comparisons between companies may be
distorted.
29

Warranty Costs








Amounts are estimated (usually as a
percentage of sales).
Part of Cost of goods sold.
Record accrual (adjusting entry)
Record the actual expenditures.
Allowance… is a liability account.
Est. warranty exp. Is part of costs of
sales.
30

Warranty Expenses Example




We estimate that warranty expenses
will be 4% of our Rs10,000 of sales.
Entry?
We spent Rs120 on parts and Rs250
on labor for repairs under warranty.
Entry?

31

Interest Revenue




Amount earned by lender during the
period.
2 approaches
• Interest paid at maturity.


Interest is explicit.

• Discounted loan.




Interest is implicit.

Accounted for separately from sale.
32

Example: Interest Revenue


On January 1, 19x1 sold a customer
Rs1,000 of mdse. We received a
promissory note for Rs1,000 plus 8%
interest to be paid in one year.
• Entry for sale?
• Entry for accrual of interest on December 31,
19x1?
• Entry for receipt of payment on note on
January 1, 19x2?



On January 1, 19x1, we sold mdse. and
received a promissory note for Rs5,000
with no interest. The note is due in one
year. The market rate of interest on such
a note is 9%.
• Entry at sale:
• Year end adjusting entry (12/31/19x1)
• Entry when customer pays note (1/1/19x2)

33

Monetary& Non-monetary
Assets







Monetary assets are money or claims to
receive fixed sums of money.
Non-monetary assets are items used in
future production and sales of goods
and services.
Balance sheet distinction
 Current and non-current assets.
 Not monetary and non-monetary.





Non-monetary assets (except
inventory) on BS at unexpired cost.
(Cost less depreciation)
Monetary assets: Cash reported at face.
AR at NRV. Other at fair value.

34

Cash



Funds available for disbursement.
May include liquid short term
investments.
• Highly liquid debt instruments with
original maturities of 90 days or less.

35

Receivables


Trade receivables
• Accounts receivables from usual sales of
products or services for non-financial
institutions.



Other receivables are shown
separately.
 E.g., Due from employees, advances or
loans.
36

Marketable Securities





Must be marketable.
E.g., commercial paper, treasury
bills, publicly traded stocks and
bonds issued by companies.
Also called “Temporary Investments.”

37

Accounting for Marketable
Securities


Three categories
 Held-to-maturity: debt securities,


Valued at cost.

 Trading securities: debt or equity held
for current resale, valued at market.


Realized (i.e., if sold during period) and
unrealized (not yet sold but market price
has changed) gain or loss included in
current year’s income.
38

Accounting for Marketable
Securities (Continued)


Available-for-sale securities:
 Debt or equity securities that do not fit
either of the other 2 categories.
 Reported at market value.
 Realized gains and losses go through
income.
 Unrealized gains and losses directly
credited (or debited) to a stockholders’
equity account.

39

Analysis of Monetary Assets





Current ratio = CA/CL
Acid-test ratio = quick ratio = monetary
CA/CL= (CA - inventories - prepaid
items) /CL.
Days cash = cash/(cash expenses 
365)
 Cash expenses  total expenses depreciation.





Days receivable = average collection
period = Receivables/(Sales  365)
Ratios differ by industry.

40

41


Slide 33

Revenue and Monetary
Assets
JOIN KHALID AZIZ
COACHING CLASSES
ICMAP STAGE 1,2,3,4,5
ICAP MODULE A,B,C,D
PIPFA
BBA & MBA
B.COM & M.COM
ACCOUNTING OF O/A LEVEL
MA-ECONOMICS
0322-3385752
KARACHI, PAKISTAN

Operating Cycle


Cash-to-cash.
• Receive cash from customer
• Purchase materials/services & pay cash
• Convert materials/services to salable
product
• Store product
• Sell product
• Receive cash from customer
2

Revenue Recognition:
When? (Timing) & How much? (Amt.)




At one point in revenue cycle
(objectivity).
Criteria:
• When? Earned (Conservatism)



Normally, goods shipped.
Service performed.

• How much? Realized or realizable
(Realization).





Already collected or collectible.
Amount can be measured reliably.

Next step: matching costs.

3

Basic Revenue Recognition Criteria


Recognize revenue in earliest period
in which:
• Entity has substantially performed what
is required in order to earn income and
• Amount of income can be reliably
measured.

4

Delivery Method




Recognize revenue when goods or
services are delivered.
For goods: when title transfers.
• FOB shipping point (when goods are
given to carrier).



Example 1:
• Order is received for Rs900. Sales
entry?
• Goods are produced. Sales entry?
• Goods are shipped. Sales entry?

5

Consignment Method


Consignor ships goods to
consignee.





Inventory on consignment
Merchandise inventory
1,000

1,000

Consignor retains title until goods
are sold to customer. At sale:





Accounts receivable
Sales revenue
COGS
Inventory on consignment

1,400
1,400
1,000
6

Franchise Revenue


Recognize:
• When earned.
• Not when agreement signed or fee
received.

7

Franchise Revenue First
Example


Tariq & Tariq’s charges a franchise
fee primarily for identifying the site,
designing the store, training
management and staff, and
otherwise helping to get the
franchise started in business.
Assume the initial fee is Rs100,000.
When should this Rs100,000 be
recorded as revenue?

8

Franchise Revenue Second
Example
• Golden, Inc. receives Rs6,000 from a
franchisee for the right to use its
trademark and have access to its
“know-how” for a period of 5 years.
This know-how includes training
sessions, and some one available to
answer questions. When should the
Rs6,000 be recognized as revenue?
9

Percentage-of-Completion Method








Design/development and
construction/production projects that
extends over several years.
Customer pays either fixed price or cost
reimbursement contract.
Reasonable assurance of profit margin and
ultimate realization.
Revenue recognized based on total
percentage of project work performed
during period.
10

Completed Contract Method


Percentage of completion method
required unless:
• Amount of income to be earned on
contract cannot reasonably be
determined.



Alternative is completed contract
method.
• Costs incurred are an asset (Contract
Work in Progress) until revenue is
recognized.

11

Production Method



Applies to agricultural and mining.
Criteria:
• Clear market determined price.
• Performance substantially complete.




Minimal remaining costs.

Permitted but not required by GAAP.

12

Installment Method






Customer pays a certain amount per
period.
Installment payment is recognized as
revenue and a proportional part of
cost of sales is recorded.
Under cost recovery method, cost is
recorded equal to installment
payment until total cost of sales is
covered.
13

Real Estate Sales





Developer often finances over many years.
Uncertainty of income due to uncertainty
of receipt of future payments.
Conditions required for revenue
recognition:
• Period allowing cancellation and refund to
buyer has expired.
• Cum payments equal to 10% of purchase
price.
• Seller has completed or is clearly capable of
completing required improvement.

14

Amount of Revenue
Recognized




Net realizable value (amount
reasonably estimated to be
collected).
2 approaches:
• Direct write-off method.
• Allowance method.



% of sales.
% of (analysis of) AR.
15

Direct Write-Off Method




Write-off when specific account that
is uncollectible is identified.
Why is this not acceptable under
GAAP?

16

Allowance Method


Estimate amount of current period
credit sales that will not be collected.
• Historical % tempered by judgment.
• Historical % of aged receivables
(+judgment).




Adjusting entry at end of period.
When an uncollectible account is
identified, it is written off.
17

Example


Amount of revenue recognized:
• Sales for the year were Rs2,000 for
cash and Rs6,000 on credit.
• Historically we don’t collect about 5%
of our credit sales due to customer
bankruptcies or unable to locate
customer.
• A customer, The XYZ Company went
bankrupt. They owed us Rs175.







Entry for revenue?
Entry for bad debts - direct write-off
(not-GAAP)?
Entries for bad debts (allowance
method)?

18

Example






Balances in Accounts
• Accounts receivable dr 3,000.
 Consisting of 2,000 current and 1,000
overdue.
• Allowance for doubtful accounts cr 50.
Estimated amount of accounts that are
uncollectible:
• 2% for current and 10% for non-current
accounts.
What entry do we make at the end of the year
to accrue for bad debts?
19

Allowance Method (continued)




Allowance… is a contra-asset
account.
Collection of a bad debt that was
written-off:


Cash
 Allowance for Doubtful Accounts

20

Sales Discounts


Sales terms are “2/10 net 30”
• Customer gets 2% cash discount if paid
within 10 days.
• Otherwise, total amount is due within
30 days.




What does “1/15 net 45” mean?
What is the effective annual rate of
savings by taking advantage of
terms of “2/10 net 30”?
21

Alternative Methods of
Accounting for Sales Discounts


Record initial sale at gross.
 At collection of net amount record
discount as a reduction from gross
sales.



Record initial sale at gross.
 At collection of net amount record
discount as an expense of the period.



Record initial sale at net.
 Record amounts not taken as discounts
as additional revenue.

22

Example


We sold Rs10,000 of mdse. Sales
terms are 2/10, n/30.
Customers paid us for Rs8,000 of
the merchandise billed within 10
days. The remaining Rs2,000
was paid within 30 days.
• Record at gross.
• Record at net.
23

Credit Card Sales


If cash received by merchant
immediately (Bank plan, MC, Visa):




Cash
Sales discount
Sales revenue

970
30
1000

24

Credit Card Sales (continued)


If cash received by merchant in 30
days (American Express, Discover):




Accounts receivable
Sales discount
Sales revenue

970
30
1000

25

Sales Returns & Allowances


Similar to bad debt expense,
 Estimate percentage of revenues that
will eventually result in returns or
allowances.
 Adjusting entry at end of period.
 Actual return or allowance.

26

Example
 On average 2% of our Rs10,000 of sales
is returned. Adjusting entry at end of
period?
 Entry for return of Rs80 of goods?
 Same for direct write-off method?

27

Sales Returns & Allowances
(Continued)




Provision for Returns and Allowances
is a liability account.
Alternative:
 Not accrue for returns and allowances
but write them off as they occur.
 Is this GAAP?

28

Adjustment vs. Expense





Realization concept suggests
adjustment to revenue.
In practice both methods are found.
Consistency:
 Same handling from year to year.




Allows same company results to be
compared from year to year.
Comparisons between companies may be
distorted.
29

Warranty Costs








Amounts are estimated (usually as a
percentage of sales).
Part of Cost of goods sold.
Record accrual (adjusting entry)
Record the actual expenditures.
Allowance… is a liability account.
Est. warranty exp. Is part of costs of
sales.
30

Warranty Expenses Example




We estimate that warranty expenses
will be 4% of our Rs10,000 of sales.
Entry?
We spent Rs120 on parts and Rs250
on labor for repairs under warranty.
Entry?

31

Interest Revenue




Amount earned by lender during the
period.
2 approaches
• Interest paid at maturity.


Interest is explicit.

• Discounted loan.




Interest is implicit.

Accounted for separately from sale.
32

Example: Interest Revenue


On January 1, 19x1 sold a customer
Rs1,000 of mdse. We received a
promissory note for Rs1,000 plus 8%
interest to be paid in one year.
• Entry for sale?
• Entry for accrual of interest on December 31,
19x1?
• Entry for receipt of payment on note on
January 1, 19x2?



On January 1, 19x1, we sold mdse. and
received a promissory note for Rs5,000
with no interest. The note is due in one
year. The market rate of interest on such
a note is 9%.
• Entry at sale:
• Year end adjusting entry (12/31/19x1)
• Entry when customer pays note (1/1/19x2)

33

Monetary& Non-monetary
Assets







Monetary assets are money or claims to
receive fixed sums of money.
Non-monetary assets are items used in
future production and sales of goods
and services.
Balance sheet distinction
 Current and non-current assets.
 Not monetary and non-monetary.





Non-monetary assets (except
inventory) on BS at unexpired cost.
(Cost less depreciation)
Monetary assets: Cash reported at face.
AR at NRV. Other at fair value.

34

Cash



Funds available for disbursement.
May include liquid short term
investments.
• Highly liquid debt instruments with
original maturities of 90 days or less.

35

Receivables


Trade receivables
• Accounts receivables from usual sales of
products or services for non-financial
institutions.



Other receivables are shown
separately.
 E.g., Due from employees, advances or
loans.
36

Marketable Securities





Must be marketable.
E.g., commercial paper, treasury
bills, publicly traded stocks and
bonds issued by companies.
Also called “Temporary Investments.”

37

Accounting for Marketable
Securities


Three categories
 Held-to-maturity: debt securities,


Valued at cost.

 Trading securities: debt or equity held
for current resale, valued at market.


Realized (i.e., if sold during period) and
unrealized (not yet sold but market price
has changed) gain or loss included in
current year’s income.
38

Accounting for Marketable
Securities (Continued)


Available-for-sale securities:
 Debt or equity securities that do not fit
either of the other 2 categories.
 Reported at market value.
 Realized gains and losses go through
income.
 Unrealized gains and losses directly
credited (or debited) to a stockholders’
equity account.

39

Analysis of Monetary Assets





Current ratio = CA/CL
Acid-test ratio = quick ratio = monetary
CA/CL= (CA - inventories - prepaid
items) /CL.
Days cash = cash/(cash expenses 
365)
 Cash expenses  total expenses depreciation.





Days receivable = average collection
period = Receivables/(Sales  365)
Ratios differ by industry.

40

41


Slide 34

Revenue and Monetary
Assets
JOIN KHALID AZIZ
COACHING CLASSES
ICMAP STAGE 1,2,3,4,5
ICAP MODULE A,B,C,D
PIPFA
BBA & MBA
B.COM & M.COM
ACCOUNTING OF O/A LEVEL
MA-ECONOMICS
0322-3385752
KARACHI, PAKISTAN

Operating Cycle


Cash-to-cash.
• Receive cash from customer
• Purchase materials/services & pay cash
• Convert materials/services to salable
product
• Store product
• Sell product
• Receive cash from customer
2

Revenue Recognition:
When? (Timing) & How much? (Amt.)




At one point in revenue cycle
(objectivity).
Criteria:
• When? Earned (Conservatism)



Normally, goods shipped.
Service performed.

• How much? Realized or realizable
(Realization).





Already collected or collectible.
Amount can be measured reliably.

Next step: matching costs.

3

Basic Revenue Recognition Criteria


Recognize revenue in earliest period
in which:
• Entity has substantially performed what
is required in order to earn income and
• Amount of income can be reliably
measured.

4

Delivery Method




Recognize revenue when goods or
services are delivered.
For goods: when title transfers.
• FOB shipping point (when goods are
given to carrier).



Example 1:
• Order is received for Rs900. Sales
entry?
• Goods are produced. Sales entry?
• Goods are shipped. Sales entry?

5

Consignment Method


Consignor ships goods to
consignee.





Inventory on consignment
Merchandise inventory
1,000

1,000

Consignor retains title until goods
are sold to customer. At sale:





Accounts receivable
Sales revenue
COGS
Inventory on consignment

1,400
1,400
1,000
6

Franchise Revenue


Recognize:
• When earned.
• Not when agreement signed or fee
received.

7

Franchise Revenue First
Example


Tariq & Tariq’s charges a franchise
fee primarily for identifying the site,
designing the store, training
management and staff, and
otherwise helping to get the
franchise started in business.
Assume the initial fee is Rs100,000.
When should this Rs100,000 be
recorded as revenue?

8

Franchise Revenue Second
Example
• Golden, Inc. receives Rs6,000 from a
franchisee for the right to use its
trademark and have access to its
“know-how” for a period of 5 years.
This know-how includes training
sessions, and some one available to
answer questions. When should the
Rs6,000 be recognized as revenue?
9

Percentage-of-Completion Method








Design/development and
construction/production projects that
extends over several years.
Customer pays either fixed price or cost
reimbursement contract.
Reasonable assurance of profit margin and
ultimate realization.
Revenue recognized based on total
percentage of project work performed
during period.
10

Completed Contract Method


Percentage of completion method
required unless:
• Amount of income to be earned on
contract cannot reasonably be
determined.



Alternative is completed contract
method.
• Costs incurred are an asset (Contract
Work in Progress) until revenue is
recognized.

11

Production Method



Applies to agricultural and mining.
Criteria:
• Clear market determined price.
• Performance substantially complete.




Minimal remaining costs.

Permitted but not required by GAAP.

12

Installment Method






Customer pays a certain amount per
period.
Installment payment is recognized as
revenue and a proportional part of
cost of sales is recorded.
Under cost recovery method, cost is
recorded equal to installment
payment until total cost of sales is
covered.
13

Real Estate Sales





Developer often finances over many years.
Uncertainty of income due to uncertainty
of receipt of future payments.
Conditions required for revenue
recognition:
• Period allowing cancellation and refund to
buyer has expired.
• Cum payments equal to 10% of purchase
price.
• Seller has completed or is clearly capable of
completing required improvement.

14

Amount of Revenue
Recognized




Net realizable value (amount
reasonably estimated to be
collected).
2 approaches:
• Direct write-off method.
• Allowance method.



% of sales.
% of (analysis of) AR.
15

Direct Write-Off Method




Write-off when specific account that
is uncollectible is identified.
Why is this not acceptable under
GAAP?

16

Allowance Method


Estimate amount of current period
credit sales that will not be collected.
• Historical % tempered by judgment.
• Historical % of aged receivables
(+judgment).




Adjusting entry at end of period.
When an uncollectible account is
identified, it is written off.
17

Example


Amount of revenue recognized:
• Sales for the year were Rs2,000 for
cash and Rs6,000 on credit.
• Historically we don’t collect about 5%
of our credit sales due to customer
bankruptcies or unable to locate
customer.
• A customer, The XYZ Company went
bankrupt. They owed us Rs175.







Entry for revenue?
Entry for bad debts - direct write-off
(not-GAAP)?
Entries for bad debts (allowance
method)?

18

Example






Balances in Accounts
• Accounts receivable dr 3,000.
 Consisting of 2,000 current and 1,000
overdue.
• Allowance for doubtful accounts cr 50.
Estimated amount of accounts that are
uncollectible:
• 2% for current and 10% for non-current
accounts.
What entry do we make at the end of the year
to accrue for bad debts?
19

Allowance Method (continued)




Allowance… is a contra-asset
account.
Collection of a bad debt that was
written-off:


Cash
 Allowance for Doubtful Accounts

20

Sales Discounts


Sales terms are “2/10 net 30”
• Customer gets 2% cash discount if paid
within 10 days.
• Otherwise, total amount is due within
30 days.




What does “1/15 net 45” mean?
What is the effective annual rate of
savings by taking advantage of
terms of “2/10 net 30”?
21

Alternative Methods of
Accounting for Sales Discounts


Record initial sale at gross.
 At collection of net amount record
discount as a reduction from gross
sales.



Record initial sale at gross.
 At collection of net amount record
discount as an expense of the period.



Record initial sale at net.
 Record amounts not taken as discounts
as additional revenue.

22

Example


We sold Rs10,000 of mdse. Sales
terms are 2/10, n/30.
Customers paid us for Rs8,000 of
the merchandise billed within 10
days. The remaining Rs2,000
was paid within 30 days.
• Record at gross.
• Record at net.
23

Credit Card Sales


If cash received by merchant
immediately (Bank plan, MC, Visa):




Cash
Sales discount
Sales revenue

970
30
1000

24

Credit Card Sales (continued)


If cash received by merchant in 30
days (American Express, Discover):




Accounts receivable
Sales discount
Sales revenue

970
30
1000

25

Sales Returns & Allowances


Similar to bad debt expense,
 Estimate percentage of revenues that
will eventually result in returns or
allowances.
 Adjusting entry at end of period.
 Actual return or allowance.

26

Example
 On average 2% of our Rs10,000 of sales
is returned. Adjusting entry at end of
period?
 Entry for return of Rs80 of goods?
 Same for direct write-off method?

27

Sales Returns & Allowances
(Continued)




Provision for Returns and Allowances
is a liability account.
Alternative:
 Not accrue for returns and allowances
but write them off as they occur.
 Is this GAAP?

28

Adjustment vs. Expense





Realization concept suggests
adjustment to revenue.
In practice both methods are found.
Consistency:
 Same handling from year to year.




Allows same company results to be
compared from year to year.
Comparisons between companies may be
distorted.
29

Warranty Costs








Amounts are estimated (usually as a
percentage of sales).
Part of Cost of goods sold.
Record accrual (adjusting entry)
Record the actual expenditures.
Allowance… is a liability account.
Est. warranty exp. Is part of costs of
sales.
30

Warranty Expenses Example




We estimate that warranty expenses
will be 4% of our Rs10,000 of sales.
Entry?
We spent Rs120 on parts and Rs250
on labor for repairs under warranty.
Entry?

31

Interest Revenue




Amount earned by lender during the
period.
2 approaches
• Interest paid at maturity.


Interest is explicit.

• Discounted loan.




Interest is implicit.

Accounted for separately from sale.
32

Example: Interest Revenue


On January 1, 19x1 sold a customer
Rs1,000 of mdse. We received a
promissory note for Rs1,000 plus 8%
interest to be paid in one year.
• Entry for sale?
• Entry for accrual of interest on December 31,
19x1?
• Entry for receipt of payment on note on
January 1, 19x2?



On January 1, 19x1, we sold mdse. and
received a promissory note for Rs5,000
with no interest. The note is due in one
year. The market rate of interest on such
a note is 9%.
• Entry at sale:
• Year end adjusting entry (12/31/19x1)
• Entry when customer pays note (1/1/19x2)

33

Monetary& Non-monetary
Assets







Monetary assets are money or claims to
receive fixed sums of money.
Non-monetary assets are items used in
future production and sales of goods
and services.
Balance sheet distinction
 Current and non-current assets.
 Not monetary and non-monetary.





Non-monetary assets (except
inventory) on BS at unexpired cost.
(Cost less depreciation)
Monetary assets: Cash reported at face.
AR at NRV. Other at fair value.

34

Cash



Funds available for disbursement.
May include liquid short term
investments.
• Highly liquid debt instruments with
original maturities of 90 days or less.

35

Receivables


Trade receivables
• Accounts receivables from usual sales of
products or services for non-financial
institutions.



Other receivables are shown
separately.
 E.g., Due from employees, advances or
loans.
36

Marketable Securities





Must be marketable.
E.g., commercial paper, treasury
bills, publicly traded stocks and
bonds issued by companies.
Also called “Temporary Investments.”

37

Accounting for Marketable
Securities


Three categories
 Held-to-maturity: debt securities,


Valued at cost.

 Trading securities: debt or equity held
for current resale, valued at market.


Realized (i.e., if sold during period) and
unrealized (not yet sold but market price
has changed) gain or loss included in
current year’s income.
38

Accounting for Marketable
Securities (Continued)


Available-for-sale securities:
 Debt or equity securities that do not fit
either of the other 2 categories.
 Reported at market value.
 Realized gains and losses go through
income.
 Unrealized gains and losses directly
credited (or debited) to a stockholders’
equity account.

39

Analysis of Monetary Assets





Current ratio = CA/CL
Acid-test ratio = quick ratio = monetary
CA/CL= (CA - inventories - prepaid
items) /CL.
Days cash = cash/(cash expenses 
365)
 Cash expenses  total expenses depreciation.





Days receivable = average collection
period = Receivables/(Sales  365)
Ratios differ by industry.

40

41


Slide 35

Revenue and Monetary
Assets
JOIN KHALID AZIZ
COACHING CLASSES
ICMAP STAGE 1,2,3,4,5
ICAP MODULE A,B,C,D
PIPFA
BBA & MBA
B.COM & M.COM
ACCOUNTING OF O/A LEVEL
MA-ECONOMICS
0322-3385752
KARACHI, PAKISTAN

Operating Cycle


Cash-to-cash.
• Receive cash from customer
• Purchase materials/services & pay cash
• Convert materials/services to salable
product
• Store product
• Sell product
• Receive cash from customer
2

Revenue Recognition:
When? (Timing) & How much? (Amt.)




At one point in revenue cycle
(objectivity).
Criteria:
• When? Earned (Conservatism)



Normally, goods shipped.
Service performed.

• How much? Realized or realizable
(Realization).





Already collected or collectible.
Amount can be measured reliably.

Next step: matching costs.

3

Basic Revenue Recognition Criteria


Recognize revenue in earliest period
in which:
• Entity has substantially performed what
is required in order to earn income and
• Amount of income can be reliably
measured.

4

Delivery Method




Recognize revenue when goods or
services are delivered.
For goods: when title transfers.
• FOB shipping point (when goods are
given to carrier).



Example 1:
• Order is received for Rs900. Sales
entry?
• Goods are produced. Sales entry?
• Goods are shipped. Sales entry?

5

Consignment Method


Consignor ships goods to
consignee.





Inventory on consignment
Merchandise inventory
1,000

1,000

Consignor retains title until goods
are sold to customer. At sale:





Accounts receivable
Sales revenue
COGS
Inventory on consignment

1,400
1,400
1,000
6

Franchise Revenue


Recognize:
• When earned.
• Not when agreement signed or fee
received.

7

Franchise Revenue First
Example


Tariq & Tariq’s charges a franchise
fee primarily for identifying the site,
designing the store, training
management and staff, and
otherwise helping to get the
franchise started in business.
Assume the initial fee is Rs100,000.
When should this Rs100,000 be
recorded as revenue?

8

Franchise Revenue Second
Example
• Golden, Inc. receives Rs6,000 from a
franchisee for the right to use its
trademark and have access to its
“know-how” for a period of 5 years.
This know-how includes training
sessions, and some one available to
answer questions. When should the
Rs6,000 be recognized as revenue?
9

Percentage-of-Completion Method








Design/development and
construction/production projects that
extends over several years.
Customer pays either fixed price or cost
reimbursement contract.
Reasonable assurance of profit margin and
ultimate realization.
Revenue recognized based on total
percentage of project work performed
during period.
10

Completed Contract Method


Percentage of completion method
required unless:
• Amount of income to be earned on
contract cannot reasonably be
determined.



Alternative is completed contract
method.
• Costs incurred are an asset (Contract
Work in Progress) until revenue is
recognized.

11

Production Method



Applies to agricultural and mining.
Criteria:
• Clear market determined price.
• Performance substantially complete.




Minimal remaining costs.

Permitted but not required by GAAP.

12

Installment Method






Customer pays a certain amount per
period.
Installment payment is recognized as
revenue and a proportional part of
cost of sales is recorded.
Under cost recovery method, cost is
recorded equal to installment
payment until total cost of sales is
covered.
13

Real Estate Sales





Developer often finances over many years.
Uncertainty of income due to uncertainty
of receipt of future payments.
Conditions required for revenue
recognition:
• Period allowing cancellation and refund to
buyer has expired.
• Cum payments equal to 10% of purchase
price.
• Seller has completed or is clearly capable of
completing required improvement.

14

Amount of Revenue
Recognized




Net realizable value (amount
reasonably estimated to be
collected).
2 approaches:
• Direct write-off method.
• Allowance method.



% of sales.
% of (analysis of) AR.
15

Direct Write-Off Method




Write-off when specific account that
is uncollectible is identified.
Why is this not acceptable under
GAAP?

16

Allowance Method


Estimate amount of current period
credit sales that will not be collected.
• Historical % tempered by judgment.
• Historical % of aged receivables
(+judgment).




Adjusting entry at end of period.
When an uncollectible account is
identified, it is written off.
17

Example


Amount of revenue recognized:
• Sales for the year were Rs2,000 for
cash and Rs6,000 on credit.
• Historically we don’t collect about 5%
of our credit sales due to customer
bankruptcies or unable to locate
customer.
• A customer, The XYZ Company went
bankrupt. They owed us Rs175.







Entry for revenue?
Entry for bad debts - direct write-off
(not-GAAP)?
Entries for bad debts (allowance
method)?

18

Example






Balances in Accounts
• Accounts receivable dr 3,000.
 Consisting of 2,000 current and 1,000
overdue.
• Allowance for doubtful accounts cr 50.
Estimated amount of accounts that are
uncollectible:
• 2% for current and 10% for non-current
accounts.
What entry do we make at the end of the year
to accrue for bad debts?
19

Allowance Method (continued)




Allowance… is a contra-asset
account.
Collection of a bad debt that was
written-off:


Cash
 Allowance for Doubtful Accounts

20

Sales Discounts


Sales terms are “2/10 net 30”
• Customer gets 2% cash discount if paid
within 10 days.
• Otherwise, total amount is due within
30 days.




What does “1/15 net 45” mean?
What is the effective annual rate of
savings by taking advantage of
terms of “2/10 net 30”?
21

Alternative Methods of
Accounting for Sales Discounts


Record initial sale at gross.
 At collection of net amount record
discount as a reduction from gross
sales.



Record initial sale at gross.
 At collection of net amount record
discount as an expense of the period.



Record initial sale at net.
 Record amounts not taken as discounts
as additional revenue.

22

Example


We sold Rs10,000 of mdse. Sales
terms are 2/10, n/30.
Customers paid us for Rs8,000 of
the merchandise billed within 10
days. The remaining Rs2,000
was paid within 30 days.
• Record at gross.
• Record at net.
23

Credit Card Sales


If cash received by merchant
immediately (Bank plan, MC, Visa):




Cash
Sales discount
Sales revenue

970
30
1000

24

Credit Card Sales (continued)


If cash received by merchant in 30
days (American Express, Discover):




Accounts receivable
Sales discount
Sales revenue

970
30
1000

25

Sales Returns & Allowances


Similar to bad debt expense,
 Estimate percentage of revenues that
will eventually result in returns or
allowances.
 Adjusting entry at end of period.
 Actual return or allowance.

26

Example
 On average 2% of our Rs10,000 of sales
is returned. Adjusting entry at end of
period?
 Entry for return of Rs80 of goods?
 Same for direct write-off method?

27

Sales Returns & Allowances
(Continued)




Provision for Returns and Allowances
is a liability account.
Alternative:
 Not accrue for returns and allowances
but write them off as they occur.
 Is this GAAP?

28

Adjustment vs. Expense





Realization concept suggests
adjustment to revenue.
In practice both methods are found.
Consistency:
 Same handling from year to year.




Allows same company results to be
compared from year to year.
Comparisons between companies may be
distorted.
29

Warranty Costs








Amounts are estimated (usually as a
percentage of sales).
Part of Cost of goods sold.
Record accrual (adjusting entry)
Record the actual expenditures.
Allowance… is a liability account.
Est. warranty exp. Is part of costs of
sales.
30

Warranty Expenses Example




We estimate that warranty expenses
will be 4% of our Rs10,000 of sales.
Entry?
We spent Rs120 on parts and Rs250
on labor for repairs under warranty.
Entry?

31

Interest Revenue




Amount earned by lender during the
period.
2 approaches
• Interest paid at maturity.


Interest is explicit.

• Discounted loan.




Interest is implicit.

Accounted for separately from sale.
32

Example: Interest Revenue


On January 1, 19x1 sold a customer
Rs1,000 of mdse. We received a
promissory note for Rs1,000 plus 8%
interest to be paid in one year.
• Entry for sale?
• Entry for accrual of interest on December 31,
19x1?
• Entry for receipt of payment on note on
January 1, 19x2?



On January 1, 19x1, we sold mdse. and
received a promissory note for Rs5,000
with no interest. The note is due in one
year. The market rate of interest on such
a note is 9%.
• Entry at sale:
• Year end adjusting entry (12/31/19x1)
• Entry when customer pays note (1/1/19x2)

33

Monetary& Non-monetary
Assets







Monetary assets are money or claims to
receive fixed sums of money.
Non-monetary assets are items used in
future production and sales of goods
and services.
Balance sheet distinction
 Current and non-current assets.
 Not monetary and non-monetary.





Non-monetary assets (except
inventory) on BS at unexpired cost.
(Cost less depreciation)
Monetary assets: Cash reported at face.
AR at NRV. Other at fair value.

34

Cash



Funds available for disbursement.
May include liquid short term
investments.
• Highly liquid debt instruments with
original maturities of 90 days or less.

35

Receivables


Trade receivables
• Accounts receivables from usual sales of
products or services for non-financial
institutions.



Other receivables are shown
separately.
 E.g., Due from employees, advances or
loans.
36

Marketable Securities





Must be marketable.
E.g., commercial paper, treasury
bills, publicly traded stocks and
bonds issued by companies.
Also called “Temporary Investments.”

37

Accounting for Marketable
Securities


Three categories
 Held-to-maturity: debt securities,


Valued at cost.

 Trading securities: debt or equity held
for current resale, valued at market.


Realized (i.e., if sold during period) and
unrealized (not yet sold but market price
has changed) gain or loss included in
current year’s income.
38

Accounting for Marketable
Securities (Continued)


Available-for-sale securities:
 Debt or equity securities that do not fit
either of the other 2 categories.
 Reported at market value.
 Realized gains and losses go through
income.
 Unrealized gains and losses directly
credited (or debited) to a stockholders’
equity account.

39

Analysis of Monetary Assets





Current ratio = CA/CL
Acid-test ratio = quick ratio = monetary
CA/CL= (CA - inventories - prepaid
items) /CL.
Days cash = cash/(cash expenses 
365)
 Cash expenses  total expenses depreciation.





Days receivable = average collection
period = Receivables/(Sales  365)
Ratios differ by industry.

40

41


Slide 36

Revenue and Monetary
Assets
JOIN KHALID AZIZ
COACHING CLASSES
ICMAP STAGE 1,2,3,4,5
ICAP MODULE A,B,C,D
PIPFA
BBA & MBA
B.COM & M.COM
ACCOUNTING OF O/A LEVEL
MA-ECONOMICS
0322-3385752
KARACHI, PAKISTAN

Operating Cycle


Cash-to-cash.
• Receive cash from customer
• Purchase materials/services & pay cash
• Convert materials/services to salable
product
• Store product
• Sell product
• Receive cash from customer
2

Revenue Recognition:
When? (Timing) & How much? (Amt.)




At one point in revenue cycle
(objectivity).
Criteria:
• When? Earned (Conservatism)



Normally, goods shipped.
Service performed.

• How much? Realized or realizable
(Realization).





Already collected or collectible.
Amount can be measured reliably.

Next step: matching costs.

3

Basic Revenue Recognition Criteria


Recognize revenue in earliest period
in which:
• Entity has substantially performed what
is required in order to earn income and
• Amount of income can be reliably
measured.

4

Delivery Method




Recognize revenue when goods or
services are delivered.
For goods: when title transfers.
• FOB shipping point (when goods are
given to carrier).



Example 1:
• Order is received for Rs900. Sales
entry?
• Goods are produced. Sales entry?
• Goods are shipped. Sales entry?

5

Consignment Method


Consignor ships goods to
consignee.





Inventory on consignment
Merchandise inventory
1,000

1,000

Consignor retains title until goods
are sold to customer. At sale:





Accounts receivable
Sales revenue
COGS
Inventory on consignment

1,400
1,400
1,000
6

Franchise Revenue


Recognize:
• When earned.
• Not when agreement signed or fee
received.

7

Franchise Revenue First
Example


Tariq & Tariq’s charges a franchise
fee primarily for identifying the site,
designing the store, training
management and staff, and
otherwise helping to get the
franchise started in business.
Assume the initial fee is Rs100,000.
When should this Rs100,000 be
recorded as revenue?

8

Franchise Revenue Second
Example
• Golden, Inc. receives Rs6,000 from a
franchisee for the right to use its
trademark and have access to its
“know-how” for a period of 5 years.
This know-how includes training
sessions, and some one available to
answer questions. When should the
Rs6,000 be recognized as revenue?
9

Percentage-of-Completion Method








Design/development and
construction/production projects that
extends over several years.
Customer pays either fixed price or cost
reimbursement contract.
Reasonable assurance of profit margin and
ultimate realization.
Revenue recognized based on total
percentage of project work performed
during period.
10

Completed Contract Method


Percentage of completion method
required unless:
• Amount of income to be earned on
contract cannot reasonably be
determined.



Alternative is completed contract
method.
• Costs incurred are an asset (Contract
Work in Progress) until revenue is
recognized.

11

Production Method



Applies to agricultural and mining.
Criteria:
• Clear market determined price.
• Performance substantially complete.




Minimal remaining costs.

Permitted but not required by GAAP.

12

Installment Method






Customer pays a certain amount per
period.
Installment payment is recognized as
revenue and a proportional part of
cost of sales is recorded.
Under cost recovery method, cost is
recorded equal to installment
payment until total cost of sales is
covered.
13

Real Estate Sales





Developer often finances over many years.
Uncertainty of income due to uncertainty
of receipt of future payments.
Conditions required for revenue
recognition:
• Period allowing cancellation and refund to
buyer has expired.
• Cum payments equal to 10% of purchase
price.
• Seller has completed or is clearly capable of
completing required improvement.

14

Amount of Revenue
Recognized




Net realizable value (amount
reasonably estimated to be
collected).
2 approaches:
• Direct write-off method.
• Allowance method.



% of sales.
% of (analysis of) AR.
15

Direct Write-Off Method




Write-off when specific account that
is uncollectible is identified.
Why is this not acceptable under
GAAP?

16

Allowance Method


Estimate amount of current period
credit sales that will not be collected.
• Historical % tempered by judgment.
• Historical % of aged receivables
(+judgment).




Adjusting entry at end of period.
When an uncollectible account is
identified, it is written off.
17

Example


Amount of revenue recognized:
• Sales for the year were Rs2,000 for
cash and Rs6,000 on credit.
• Historically we don’t collect about 5%
of our credit sales due to customer
bankruptcies or unable to locate
customer.
• A customer, The XYZ Company went
bankrupt. They owed us Rs175.







Entry for revenue?
Entry for bad debts - direct write-off
(not-GAAP)?
Entries for bad debts (allowance
method)?

18

Example






Balances in Accounts
• Accounts receivable dr 3,000.
 Consisting of 2,000 current and 1,000
overdue.
• Allowance for doubtful accounts cr 50.
Estimated amount of accounts that are
uncollectible:
• 2% for current and 10% for non-current
accounts.
What entry do we make at the end of the year
to accrue for bad debts?
19

Allowance Method (continued)




Allowance… is a contra-asset
account.
Collection of a bad debt that was
written-off:


Cash
 Allowance for Doubtful Accounts

20

Sales Discounts


Sales terms are “2/10 net 30”
• Customer gets 2% cash discount if paid
within 10 days.
• Otherwise, total amount is due within
30 days.




What does “1/15 net 45” mean?
What is the effective annual rate of
savings by taking advantage of
terms of “2/10 net 30”?
21

Alternative Methods of
Accounting for Sales Discounts


Record initial sale at gross.
 At collection of net amount record
discount as a reduction from gross
sales.



Record initial sale at gross.
 At collection of net amount record
discount as an expense of the period.



Record initial sale at net.
 Record amounts not taken as discounts
as additional revenue.

22

Example


We sold Rs10,000 of mdse. Sales
terms are 2/10, n/30.
Customers paid us for Rs8,000 of
the merchandise billed within 10
days. The remaining Rs2,000
was paid within 30 days.
• Record at gross.
• Record at net.
23

Credit Card Sales


If cash received by merchant
immediately (Bank plan, MC, Visa):




Cash
Sales discount
Sales revenue

970
30
1000

24

Credit Card Sales (continued)


If cash received by merchant in 30
days (American Express, Discover):




Accounts receivable
Sales discount
Sales revenue

970
30
1000

25

Sales Returns & Allowances


Similar to bad debt expense,
 Estimate percentage of revenues that
will eventually result in returns or
allowances.
 Adjusting entry at end of period.
 Actual return or allowance.

26

Example
 On average 2% of our Rs10,000 of sales
is returned. Adjusting entry at end of
period?
 Entry for return of Rs80 of goods?
 Same for direct write-off method?

27

Sales Returns & Allowances
(Continued)




Provision for Returns and Allowances
is a liability account.
Alternative:
 Not accrue for returns and allowances
but write them off as they occur.
 Is this GAAP?

28

Adjustment vs. Expense





Realization concept suggests
adjustment to revenue.
In practice both methods are found.
Consistency:
 Same handling from year to year.




Allows same company results to be
compared from year to year.
Comparisons between companies may be
distorted.
29

Warranty Costs








Amounts are estimated (usually as a
percentage of sales).
Part of Cost of goods sold.
Record accrual (adjusting entry)
Record the actual expenditures.
Allowance… is a liability account.
Est. warranty exp. Is part of costs of
sales.
30

Warranty Expenses Example




We estimate that warranty expenses
will be 4% of our Rs10,000 of sales.
Entry?
We spent Rs120 on parts and Rs250
on labor for repairs under warranty.
Entry?

31

Interest Revenue




Amount earned by lender during the
period.
2 approaches
• Interest paid at maturity.


Interest is explicit.

• Discounted loan.




Interest is implicit.

Accounted for separately from sale.
32

Example: Interest Revenue


On January 1, 19x1 sold a customer
Rs1,000 of mdse. We received a
promissory note for Rs1,000 plus 8%
interest to be paid in one year.
• Entry for sale?
• Entry for accrual of interest on December 31,
19x1?
• Entry for receipt of payment on note on
January 1, 19x2?



On January 1, 19x1, we sold mdse. and
received a promissory note for Rs5,000
with no interest. The note is due in one
year. The market rate of interest on such
a note is 9%.
• Entry at sale:
• Year end adjusting entry (12/31/19x1)
• Entry when customer pays note (1/1/19x2)

33

Monetary& Non-monetary
Assets







Monetary assets are money or claims to
receive fixed sums of money.
Non-monetary assets are items used in
future production and sales of goods
and services.
Balance sheet distinction
 Current and non-current assets.
 Not monetary and non-monetary.





Non-monetary assets (except
inventory) on BS at unexpired cost.
(Cost less depreciation)
Monetary assets: Cash reported at face.
AR at NRV. Other at fair value.

34

Cash



Funds available for disbursement.
May include liquid short term
investments.
• Highly liquid debt instruments with
original maturities of 90 days or less.

35

Receivables


Trade receivables
• Accounts receivables from usual sales of
products or services for non-financial
institutions.



Other receivables are shown
separately.
 E.g., Due from employees, advances or
loans.
36

Marketable Securities





Must be marketable.
E.g., commercial paper, treasury
bills, publicly traded stocks and
bonds issued by companies.
Also called “Temporary Investments.”

37

Accounting for Marketable
Securities


Three categories
 Held-to-maturity: debt securities,


Valued at cost.

 Trading securities: debt or equity held
for current resale, valued at market.


Realized (i.e., if sold during period) and
unrealized (not yet sold but market price
has changed) gain or loss included in
current year’s income.
38

Accounting for Marketable
Securities (Continued)


Available-for-sale securities:
 Debt or equity securities that do not fit
either of the other 2 categories.
 Reported at market value.
 Realized gains and losses go through
income.
 Unrealized gains and losses directly
credited (or debited) to a stockholders’
equity account.

39

Analysis of Monetary Assets





Current ratio = CA/CL
Acid-test ratio = quick ratio = monetary
CA/CL= (CA - inventories - prepaid
items) /CL.
Days cash = cash/(cash expenses 
365)
 Cash expenses  total expenses depreciation.





Days receivable = average collection
period = Receivables/(Sales  365)
Ratios differ by industry.

40

41


Slide 37

Revenue and Monetary
Assets
JOIN KHALID AZIZ
COACHING CLASSES
ICMAP STAGE 1,2,3,4,5
ICAP MODULE A,B,C,D
PIPFA
BBA & MBA
B.COM & M.COM
ACCOUNTING OF O/A LEVEL
MA-ECONOMICS
0322-3385752
KARACHI, PAKISTAN

Operating Cycle


Cash-to-cash.
• Receive cash from customer
• Purchase materials/services & pay cash
• Convert materials/services to salable
product
• Store product
• Sell product
• Receive cash from customer
2

Revenue Recognition:
When? (Timing) & How much? (Amt.)




At one point in revenue cycle
(objectivity).
Criteria:
• When? Earned (Conservatism)



Normally, goods shipped.
Service performed.

• How much? Realized or realizable
(Realization).





Already collected or collectible.
Amount can be measured reliably.

Next step: matching costs.

3

Basic Revenue Recognition Criteria


Recognize revenue in earliest period
in which:
• Entity has substantially performed what
is required in order to earn income and
• Amount of income can be reliably
measured.

4

Delivery Method




Recognize revenue when goods or
services are delivered.
For goods: when title transfers.
• FOB shipping point (when goods are
given to carrier).



Example 1:
• Order is received for Rs900. Sales
entry?
• Goods are produced. Sales entry?
• Goods are shipped. Sales entry?

5

Consignment Method


Consignor ships goods to
consignee.





Inventory on consignment
Merchandise inventory
1,000

1,000

Consignor retains title until goods
are sold to customer. At sale:





Accounts receivable
Sales revenue
COGS
Inventory on consignment

1,400
1,400
1,000
6

Franchise Revenue


Recognize:
• When earned.
• Not when agreement signed or fee
received.

7

Franchise Revenue First
Example


Tariq & Tariq’s charges a franchise
fee primarily for identifying the site,
designing the store, training
management and staff, and
otherwise helping to get the
franchise started in business.
Assume the initial fee is Rs100,000.
When should this Rs100,000 be
recorded as revenue?

8

Franchise Revenue Second
Example
• Golden, Inc. receives Rs6,000 from a
franchisee for the right to use its
trademark and have access to its
“know-how” for a period of 5 years.
This know-how includes training
sessions, and some one available to
answer questions. When should the
Rs6,000 be recognized as revenue?
9

Percentage-of-Completion Method








Design/development and
construction/production projects that
extends over several years.
Customer pays either fixed price or cost
reimbursement contract.
Reasonable assurance of profit margin and
ultimate realization.
Revenue recognized based on total
percentage of project work performed
during period.
10

Completed Contract Method


Percentage of completion method
required unless:
• Amount of income to be earned on
contract cannot reasonably be
determined.



Alternative is completed contract
method.
• Costs incurred are an asset (Contract
Work in Progress) until revenue is
recognized.

11

Production Method



Applies to agricultural and mining.
Criteria:
• Clear market determined price.
• Performance substantially complete.




Minimal remaining costs.

Permitted but not required by GAAP.

12

Installment Method






Customer pays a certain amount per
period.
Installment payment is recognized as
revenue and a proportional part of
cost of sales is recorded.
Under cost recovery method, cost is
recorded equal to installment
payment until total cost of sales is
covered.
13

Real Estate Sales





Developer often finances over many years.
Uncertainty of income due to uncertainty
of receipt of future payments.
Conditions required for revenue
recognition:
• Period allowing cancellation and refund to
buyer has expired.
• Cum payments equal to 10% of purchase
price.
• Seller has completed or is clearly capable of
completing required improvement.

14

Amount of Revenue
Recognized




Net realizable value (amount
reasonably estimated to be
collected).
2 approaches:
• Direct write-off method.
• Allowance method.



% of sales.
% of (analysis of) AR.
15

Direct Write-Off Method




Write-off when specific account that
is uncollectible is identified.
Why is this not acceptable under
GAAP?

16

Allowance Method


Estimate amount of current period
credit sales that will not be collected.
• Historical % tempered by judgment.
• Historical % of aged receivables
(+judgment).




Adjusting entry at end of period.
When an uncollectible account is
identified, it is written off.
17

Example


Amount of revenue recognized:
• Sales for the year were Rs2,000 for
cash and Rs6,000 on credit.
• Historically we don’t collect about 5%
of our credit sales due to customer
bankruptcies or unable to locate
customer.
• A customer, The XYZ Company went
bankrupt. They owed us Rs175.







Entry for revenue?
Entry for bad debts - direct write-off
(not-GAAP)?
Entries for bad debts (allowance
method)?

18

Example






Balances in Accounts
• Accounts receivable dr 3,000.
 Consisting of 2,000 current and 1,000
overdue.
• Allowance for doubtful accounts cr 50.
Estimated amount of accounts that are
uncollectible:
• 2% for current and 10% for non-current
accounts.
What entry do we make at the end of the year
to accrue for bad debts?
19

Allowance Method (continued)




Allowance… is a contra-asset
account.
Collection of a bad debt that was
written-off:


Cash
 Allowance for Doubtful Accounts

20

Sales Discounts


Sales terms are “2/10 net 30”
• Customer gets 2% cash discount if paid
within 10 days.
• Otherwise, total amount is due within
30 days.




What does “1/15 net 45” mean?
What is the effective annual rate of
savings by taking advantage of
terms of “2/10 net 30”?
21

Alternative Methods of
Accounting for Sales Discounts


Record initial sale at gross.
 At collection of net amount record
discount as a reduction from gross
sales.



Record initial sale at gross.
 At collection of net amount record
discount as an expense of the period.



Record initial sale at net.
 Record amounts not taken as discounts
as additional revenue.

22

Example


We sold Rs10,000 of mdse. Sales
terms are 2/10, n/30.
Customers paid us for Rs8,000 of
the merchandise billed within 10
days. The remaining Rs2,000
was paid within 30 days.
• Record at gross.
• Record at net.
23

Credit Card Sales


If cash received by merchant
immediately (Bank plan, MC, Visa):




Cash
Sales discount
Sales revenue

970
30
1000

24

Credit Card Sales (continued)


If cash received by merchant in 30
days (American Express, Discover):




Accounts receivable
Sales discount
Sales revenue

970
30
1000

25

Sales Returns & Allowances


Similar to bad debt expense,
 Estimate percentage of revenues that
will eventually result in returns or
allowances.
 Adjusting entry at end of period.
 Actual return or allowance.

26

Example
 On average 2% of our Rs10,000 of sales
is returned. Adjusting entry at end of
period?
 Entry for return of Rs80 of goods?
 Same for direct write-off method?

27

Sales Returns & Allowances
(Continued)




Provision for Returns and Allowances
is a liability account.
Alternative:
 Not accrue for returns and allowances
but write them off as they occur.
 Is this GAAP?

28

Adjustment vs. Expense





Realization concept suggests
adjustment to revenue.
In practice both methods are found.
Consistency:
 Same handling from year to year.




Allows same company results to be
compared from year to year.
Comparisons between companies may be
distorted.
29

Warranty Costs








Amounts are estimated (usually as a
percentage of sales).
Part of Cost of goods sold.
Record accrual (adjusting entry)
Record the actual expenditures.
Allowance… is a liability account.
Est. warranty exp. Is part of costs of
sales.
30

Warranty Expenses Example




We estimate that warranty expenses
will be 4% of our Rs10,000 of sales.
Entry?
We spent Rs120 on parts and Rs250
on labor for repairs under warranty.
Entry?

31

Interest Revenue




Amount earned by lender during the
period.
2 approaches
• Interest paid at maturity.


Interest is explicit.

• Discounted loan.




Interest is implicit.

Accounted for separately from sale.
32

Example: Interest Revenue


On January 1, 19x1 sold a customer
Rs1,000 of mdse. We received a
promissory note for Rs1,000 plus 8%
interest to be paid in one year.
• Entry for sale?
• Entry for accrual of interest on December 31,
19x1?
• Entry for receipt of payment on note on
January 1, 19x2?



On January 1, 19x1, we sold mdse. and
received a promissory note for Rs5,000
with no interest. The note is due in one
year. The market rate of interest on such
a note is 9%.
• Entry at sale:
• Year end adjusting entry (12/31/19x1)
• Entry when customer pays note (1/1/19x2)

33

Monetary& Non-monetary
Assets







Monetary assets are money or claims to
receive fixed sums of money.
Non-monetary assets are items used in
future production and sales of goods
and services.
Balance sheet distinction
 Current and non-current assets.
 Not monetary and non-monetary.





Non-monetary assets (except
inventory) on BS at unexpired cost.
(Cost less depreciation)
Monetary assets: Cash reported at face.
AR at NRV. Other at fair value.

34

Cash



Funds available for disbursement.
May include liquid short term
investments.
• Highly liquid debt instruments with
original maturities of 90 days or less.

35

Receivables


Trade receivables
• Accounts receivables from usual sales of
products or services for non-financial
institutions.



Other receivables are shown
separately.
 E.g., Due from employees, advances or
loans.
36

Marketable Securities





Must be marketable.
E.g., commercial paper, treasury
bills, publicly traded stocks and
bonds issued by companies.
Also called “Temporary Investments.”

37

Accounting for Marketable
Securities


Three categories
 Held-to-maturity: debt securities,


Valued at cost.

 Trading securities: debt or equity held
for current resale, valued at market.


Realized (i.e., if sold during period) and
unrealized (not yet sold but market price
has changed) gain or loss included in
current year’s income.
38

Accounting for Marketable
Securities (Continued)


Available-for-sale securities:
 Debt or equity securities that do not fit
either of the other 2 categories.
 Reported at market value.
 Realized gains and losses go through
income.
 Unrealized gains and losses directly
credited (or debited) to a stockholders’
equity account.

39

Analysis of Monetary Assets





Current ratio = CA/CL
Acid-test ratio = quick ratio = monetary
CA/CL= (CA - inventories - prepaid
items) /CL.
Days cash = cash/(cash expenses 
365)
 Cash expenses  total expenses depreciation.





Days receivable = average collection
period = Receivables/(Sales  365)
Ratios differ by industry.

40

41


Slide 38

Revenue and Monetary
Assets
JOIN KHALID AZIZ
COACHING CLASSES
ICMAP STAGE 1,2,3,4,5
ICAP MODULE A,B,C,D
PIPFA
BBA & MBA
B.COM & M.COM
ACCOUNTING OF O/A LEVEL
MA-ECONOMICS
0322-3385752
KARACHI, PAKISTAN

Operating Cycle


Cash-to-cash.
• Receive cash from customer
• Purchase materials/services & pay cash
• Convert materials/services to salable
product
• Store product
• Sell product
• Receive cash from customer
2

Revenue Recognition:
When? (Timing) & How much? (Amt.)




At one point in revenue cycle
(objectivity).
Criteria:
• When? Earned (Conservatism)



Normally, goods shipped.
Service performed.

• How much? Realized or realizable
(Realization).





Already collected or collectible.
Amount can be measured reliably.

Next step: matching costs.

3

Basic Revenue Recognition Criteria


Recognize revenue in earliest period
in which:
• Entity has substantially performed what
is required in order to earn income and
• Amount of income can be reliably
measured.

4

Delivery Method




Recognize revenue when goods or
services are delivered.
For goods: when title transfers.
• FOB shipping point (when goods are
given to carrier).



Example 1:
• Order is received for Rs900. Sales
entry?
• Goods are produced. Sales entry?
• Goods are shipped. Sales entry?

5

Consignment Method


Consignor ships goods to
consignee.





Inventory on consignment
Merchandise inventory
1,000

1,000

Consignor retains title until goods
are sold to customer. At sale:





Accounts receivable
Sales revenue
COGS
Inventory on consignment

1,400
1,400
1,000
6

Franchise Revenue


Recognize:
• When earned.
• Not when agreement signed or fee
received.

7

Franchise Revenue First
Example


Tariq & Tariq’s charges a franchise
fee primarily for identifying the site,
designing the store, training
management and staff, and
otherwise helping to get the
franchise started in business.
Assume the initial fee is Rs100,000.
When should this Rs100,000 be
recorded as revenue?

8

Franchise Revenue Second
Example
• Golden, Inc. receives Rs6,000 from a
franchisee for the right to use its
trademark and have access to its
“know-how” for a period of 5 years.
This know-how includes training
sessions, and some one available to
answer questions. When should the
Rs6,000 be recognized as revenue?
9

Percentage-of-Completion Method








Design/development and
construction/production projects that
extends over several years.
Customer pays either fixed price or cost
reimbursement contract.
Reasonable assurance of profit margin and
ultimate realization.
Revenue recognized based on total
percentage of project work performed
during period.
10

Completed Contract Method


Percentage of completion method
required unless:
• Amount of income to be earned on
contract cannot reasonably be
determined.



Alternative is completed contract
method.
• Costs incurred are an asset (Contract
Work in Progress) until revenue is
recognized.

11

Production Method



Applies to agricultural and mining.
Criteria:
• Clear market determined price.
• Performance substantially complete.




Minimal remaining costs.

Permitted but not required by GAAP.

12

Installment Method






Customer pays a certain amount per
period.
Installment payment is recognized as
revenue and a proportional part of
cost of sales is recorded.
Under cost recovery method, cost is
recorded equal to installment
payment until total cost of sales is
covered.
13

Real Estate Sales





Developer often finances over many years.
Uncertainty of income due to uncertainty
of receipt of future payments.
Conditions required for revenue
recognition:
• Period allowing cancellation and refund to
buyer has expired.
• Cum payments equal to 10% of purchase
price.
• Seller has completed or is clearly capable of
completing required improvement.

14

Amount of Revenue
Recognized




Net realizable value (amount
reasonably estimated to be
collected).
2 approaches:
• Direct write-off method.
• Allowance method.



% of sales.
% of (analysis of) AR.
15

Direct Write-Off Method




Write-off when specific account that
is uncollectible is identified.
Why is this not acceptable under
GAAP?

16

Allowance Method


Estimate amount of current period
credit sales that will not be collected.
• Historical % tempered by judgment.
• Historical % of aged receivables
(+judgment).




Adjusting entry at end of period.
When an uncollectible account is
identified, it is written off.
17

Example


Amount of revenue recognized:
• Sales for the year were Rs2,000 for
cash and Rs6,000 on credit.
• Historically we don’t collect about 5%
of our credit sales due to customer
bankruptcies or unable to locate
customer.
• A customer, The XYZ Company went
bankrupt. They owed us Rs175.







Entry for revenue?
Entry for bad debts - direct write-off
(not-GAAP)?
Entries for bad debts (allowance
method)?

18

Example






Balances in Accounts
• Accounts receivable dr 3,000.
 Consisting of 2,000 current and 1,000
overdue.
• Allowance for doubtful accounts cr 50.
Estimated amount of accounts that are
uncollectible:
• 2% for current and 10% for non-current
accounts.
What entry do we make at the end of the year
to accrue for bad debts?
19

Allowance Method (continued)




Allowance… is a contra-asset
account.
Collection of a bad debt that was
written-off:


Cash
 Allowance for Doubtful Accounts

20

Sales Discounts


Sales terms are “2/10 net 30”
• Customer gets 2% cash discount if paid
within 10 days.
• Otherwise, total amount is due within
30 days.




What does “1/15 net 45” mean?
What is the effective annual rate of
savings by taking advantage of
terms of “2/10 net 30”?
21

Alternative Methods of
Accounting for Sales Discounts


Record initial sale at gross.
 At collection of net amount record
discount as a reduction from gross
sales.



Record initial sale at gross.
 At collection of net amount record
discount as an expense of the period.



Record initial sale at net.
 Record amounts not taken as discounts
as additional revenue.

22

Example


We sold Rs10,000 of mdse. Sales
terms are 2/10, n/30.
Customers paid us for Rs8,000 of
the merchandise billed within 10
days. The remaining Rs2,000
was paid within 30 days.
• Record at gross.
• Record at net.
23

Credit Card Sales


If cash received by merchant
immediately (Bank plan, MC, Visa):




Cash
Sales discount
Sales revenue

970
30
1000

24

Credit Card Sales (continued)


If cash received by merchant in 30
days (American Express, Discover):




Accounts receivable
Sales discount
Sales revenue

970
30
1000

25

Sales Returns & Allowances


Similar to bad debt expense,
 Estimate percentage of revenues that
will eventually result in returns or
allowances.
 Adjusting entry at end of period.
 Actual return or allowance.

26

Example
 On average 2% of our Rs10,000 of sales
is returned. Adjusting entry at end of
period?
 Entry for return of Rs80 of goods?
 Same for direct write-off method?

27

Sales Returns & Allowances
(Continued)




Provision for Returns and Allowances
is a liability account.
Alternative:
 Not accrue for returns and allowances
but write them off as they occur.
 Is this GAAP?

28

Adjustment vs. Expense





Realization concept suggests
adjustment to revenue.
In practice both methods are found.
Consistency:
 Same handling from year to year.




Allows same company results to be
compared from year to year.
Comparisons between companies may be
distorted.
29

Warranty Costs








Amounts are estimated (usually as a
percentage of sales).
Part of Cost of goods sold.
Record accrual (adjusting entry)
Record the actual expenditures.
Allowance… is a liability account.
Est. warranty exp. Is part of costs of
sales.
30

Warranty Expenses Example




We estimate that warranty expenses
will be 4% of our Rs10,000 of sales.
Entry?
We spent Rs120 on parts and Rs250
on labor for repairs under warranty.
Entry?

31

Interest Revenue




Amount earned by lender during the
period.
2 approaches
• Interest paid at maturity.


Interest is explicit.

• Discounted loan.




Interest is implicit.

Accounted for separately from sale.
32

Example: Interest Revenue


On January 1, 19x1 sold a customer
Rs1,000 of mdse. We received a
promissory note for Rs1,000 plus 8%
interest to be paid in one year.
• Entry for sale?
• Entry for accrual of interest on December 31,
19x1?
• Entry for receipt of payment on note on
January 1, 19x2?



On January 1, 19x1, we sold mdse. and
received a promissory note for Rs5,000
with no interest. The note is due in one
year. The market rate of interest on such
a note is 9%.
• Entry at sale:
• Year end adjusting entry (12/31/19x1)
• Entry when customer pays note (1/1/19x2)

33

Monetary& Non-monetary
Assets







Monetary assets are money or claims to
receive fixed sums of money.
Non-monetary assets are items used in
future production and sales of goods
and services.
Balance sheet distinction
 Current and non-current assets.
 Not monetary and non-monetary.





Non-monetary assets (except
inventory) on BS at unexpired cost.
(Cost less depreciation)
Monetary assets: Cash reported at face.
AR at NRV. Other at fair value.

34

Cash



Funds available for disbursement.
May include liquid short term
investments.
• Highly liquid debt instruments with
original maturities of 90 days or less.

35

Receivables


Trade receivables
• Accounts receivables from usual sales of
products or services for non-financial
institutions.



Other receivables are shown
separately.
 E.g., Due from employees, advances or
loans.
36

Marketable Securities





Must be marketable.
E.g., commercial paper, treasury
bills, publicly traded stocks and
bonds issued by companies.
Also called “Temporary Investments.”

37

Accounting for Marketable
Securities


Three categories
 Held-to-maturity: debt securities,


Valued at cost.

 Trading securities: debt or equity held
for current resale, valued at market.


Realized (i.e., if sold during period) and
unrealized (not yet sold but market price
has changed) gain or loss included in
current year’s income.
38

Accounting for Marketable
Securities (Continued)


Available-for-sale securities:
 Debt or equity securities that do not fit
either of the other 2 categories.
 Reported at market value.
 Realized gains and losses go through
income.
 Unrealized gains and losses directly
credited (or debited) to a stockholders’
equity account.

39

Analysis of Monetary Assets





Current ratio = CA/CL
Acid-test ratio = quick ratio = monetary
CA/CL= (CA - inventories - prepaid
items) /CL.
Days cash = cash/(cash expenses 
365)
 Cash expenses  total expenses depreciation.





Days receivable = average collection
period = Receivables/(Sales  365)
Ratios differ by industry.

40

41


Slide 39

Revenue and Monetary
Assets
JOIN KHALID AZIZ
COACHING CLASSES
ICMAP STAGE 1,2,3,4,5
ICAP MODULE A,B,C,D
PIPFA
BBA & MBA
B.COM & M.COM
ACCOUNTING OF O/A LEVEL
MA-ECONOMICS
0322-3385752
KARACHI, PAKISTAN

Operating Cycle


Cash-to-cash.
• Receive cash from customer
• Purchase materials/services & pay cash
• Convert materials/services to salable
product
• Store product
• Sell product
• Receive cash from customer
2

Revenue Recognition:
When? (Timing) & How much? (Amt.)




At one point in revenue cycle
(objectivity).
Criteria:
• When? Earned (Conservatism)



Normally, goods shipped.
Service performed.

• How much? Realized or realizable
(Realization).





Already collected or collectible.
Amount can be measured reliably.

Next step: matching costs.

3

Basic Revenue Recognition Criteria


Recognize revenue in earliest period
in which:
• Entity has substantially performed what
is required in order to earn income and
• Amount of income can be reliably
measured.

4

Delivery Method




Recognize revenue when goods or
services are delivered.
For goods: when title transfers.
• FOB shipping point (when goods are
given to carrier).



Example 1:
• Order is received for Rs900. Sales
entry?
• Goods are produced. Sales entry?
• Goods are shipped. Sales entry?

5

Consignment Method


Consignor ships goods to
consignee.





Inventory on consignment
Merchandise inventory
1,000

1,000

Consignor retains title until goods
are sold to customer. At sale:





Accounts receivable
Sales revenue
COGS
Inventory on consignment

1,400
1,400
1,000
6

Franchise Revenue


Recognize:
• When earned.
• Not when agreement signed or fee
received.

7

Franchise Revenue First
Example


Tariq & Tariq’s charges a franchise
fee primarily for identifying the site,
designing the store, training
management and staff, and
otherwise helping to get the
franchise started in business.
Assume the initial fee is Rs100,000.
When should this Rs100,000 be
recorded as revenue?

8

Franchise Revenue Second
Example
• Golden, Inc. receives Rs6,000 from a
franchisee for the right to use its
trademark and have access to its
“know-how” for a period of 5 years.
This know-how includes training
sessions, and some one available to
answer questions. When should the
Rs6,000 be recognized as revenue?
9

Percentage-of-Completion Method








Design/development and
construction/production projects that
extends over several years.
Customer pays either fixed price or cost
reimbursement contract.
Reasonable assurance of profit margin and
ultimate realization.
Revenue recognized based on total
percentage of project work performed
during period.
10

Completed Contract Method


Percentage of completion method
required unless:
• Amount of income to be earned on
contract cannot reasonably be
determined.



Alternative is completed contract
method.
• Costs incurred are an asset (Contract
Work in Progress) until revenue is
recognized.

11

Production Method



Applies to agricultural and mining.
Criteria:
• Clear market determined price.
• Performance substantially complete.




Minimal remaining costs.

Permitted but not required by GAAP.

12

Installment Method






Customer pays a certain amount per
period.
Installment payment is recognized as
revenue and a proportional part of
cost of sales is recorded.
Under cost recovery method, cost is
recorded equal to installment
payment until total cost of sales is
covered.
13

Real Estate Sales





Developer often finances over many years.
Uncertainty of income due to uncertainty
of receipt of future payments.
Conditions required for revenue
recognition:
• Period allowing cancellation and refund to
buyer has expired.
• Cum payments equal to 10% of purchase
price.
• Seller has completed or is clearly capable of
completing required improvement.

14

Amount of Revenue
Recognized




Net realizable value (amount
reasonably estimated to be
collected).
2 approaches:
• Direct write-off method.
• Allowance method.



% of sales.
% of (analysis of) AR.
15

Direct Write-Off Method




Write-off when specific account that
is uncollectible is identified.
Why is this not acceptable under
GAAP?

16

Allowance Method


Estimate amount of current period
credit sales that will not be collected.
• Historical % tempered by judgment.
• Historical % of aged receivables
(+judgment).




Adjusting entry at end of period.
When an uncollectible account is
identified, it is written off.
17

Example


Amount of revenue recognized:
• Sales for the year were Rs2,000 for
cash and Rs6,000 on credit.
• Historically we don’t collect about 5%
of our credit sales due to customer
bankruptcies or unable to locate
customer.
• A customer, The XYZ Company went
bankrupt. They owed us Rs175.







Entry for revenue?
Entry for bad debts - direct write-off
(not-GAAP)?
Entries for bad debts (allowance
method)?

18

Example






Balances in Accounts
• Accounts receivable dr 3,000.
 Consisting of 2,000 current and 1,000
overdue.
• Allowance for doubtful accounts cr 50.
Estimated amount of accounts that are
uncollectible:
• 2% for current and 10% for non-current
accounts.
What entry do we make at the end of the year
to accrue for bad debts?
19

Allowance Method (continued)




Allowance… is a contra-asset
account.
Collection of a bad debt that was
written-off:


Cash
 Allowance for Doubtful Accounts

20

Sales Discounts


Sales terms are “2/10 net 30”
• Customer gets 2% cash discount if paid
within 10 days.
• Otherwise, total amount is due within
30 days.




What does “1/15 net 45” mean?
What is the effective annual rate of
savings by taking advantage of
terms of “2/10 net 30”?
21

Alternative Methods of
Accounting for Sales Discounts


Record initial sale at gross.
 At collection of net amount record
discount as a reduction from gross
sales.



Record initial sale at gross.
 At collection of net amount record
discount as an expense of the period.



Record initial sale at net.
 Record amounts not taken as discounts
as additional revenue.

22

Example


We sold Rs10,000 of mdse. Sales
terms are 2/10, n/30.
Customers paid us for Rs8,000 of
the merchandise billed within 10
days. The remaining Rs2,000
was paid within 30 days.
• Record at gross.
• Record at net.
23

Credit Card Sales


If cash received by merchant
immediately (Bank plan, MC, Visa):




Cash
Sales discount
Sales revenue

970
30
1000

24

Credit Card Sales (continued)


If cash received by merchant in 30
days (American Express, Discover):




Accounts receivable
Sales discount
Sales revenue

970
30
1000

25

Sales Returns & Allowances


Similar to bad debt expense,
 Estimate percentage of revenues that
will eventually result in returns or
allowances.
 Adjusting entry at end of period.
 Actual return or allowance.

26

Example
 On average 2% of our Rs10,000 of sales
is returned. Adjusting entry at end of
period?
 Entry for return of Rs80 of goods?
 Same for direct write-off method?

27

Sales Returns & Allowances
(Continued)




Provision for Returns and Allowances
is a liability account.
Alternative:
 Not accrue for returns and allowances
but write them off as they occur.
 Is this GAAP?

28

Adjustment vs. Expense





Realization concept suggests
adjustment to revenue.
In practice both methods are found.
Consistency:
 Same handling from year to year.




Allows same company results to be
compared from year to year.
Comparisons between companies may be
distorted.
29

Warranty Costs








Amounts are estimated (usually as a
percentage of sales).
Part of Cost of goods sold.
Record accrual (adjusting entry)
Record the actual expenditures.
Allowance… is a liability account.
Est. warranty exp. Is part of costs of
sales.
30

Warranty Expenses Example




We estimate that warranty expenses
will be 4% of our Rs10,000 of sales.
Entry?
We spent Rs120 on parts and Rs250
on labor for repairs under warranty.
Entry?

31

Interest Revenue




Amount earned by lender during the
period.
2 approaches
• Interest paid at maturity.


Interest is explicit.

• Discounted loan.




Interest is implicit.

Accounted for separately from sale.
32

Example: Interest Revenue


On January 1, 19x1 sold a customer
Rs1,000 of mdse. We received a
promissory note for Rs1,000 plus 8%
interest to be paid in one year.
• Entry for sale?
• Entry for accrual of interest on December 31,
19x1?
• Entry for receipt of payment on note on
January 1, 19x2?



On January 1, 19x1, we sold mdse. and
received a promissory note for Rs5,000
with no interest. The note is due in one
year. The market rate of interest on such
a note is 9%.
• Entry at sale:
• Year end adjusting entry (12/31/19x1)
• Entry when customer pays note (1/1/19x2)

33

Monetary& Non-monetary
Assets







Monetary assets are money or claims to
receive fixed sums of money.
Non-monetary assets are items used in
future production and sales of goods
and services.
Balance sheet distinction
 Current and non-current assets.
 Not monetary and non-monetary.





Non-monetary assets (except
inventory) on BS at unexpired cost.
(Cost less depreciation)
Monetary assets: Cash reported at face.
AR at NRV. Other at fair value.

34

Cash



Funds available for disbursement.
May include liquid short term
investments.
• Highly liquid debt instruments with
original maturities of 90 days or less.

35

Receivables


Trade receivables
• Accounts receivables from usual sales of
products or services for non-financial
institutions.



Other receivables are shown
separately.
 E.g., Due from employees, advances or
loans.
36

Marketable Securities





Must be marketable.
E.g., commercial paper, treasury
bills, publicly traded stocks and
bonds issued by companies.
Also called “Temporary Investments.”

37

Accounting for Marketable
Securities


Three categories
 Held-to-maturity: debt securities,


Valued at cost.

 Trading securities: debt or equity held
for current resale, valued at market.


Realized (i.e., if sold during period) and
unrealized (not yet sold but market price
has changed) gain or loss included in
current year’s income.
38

Accounting for Marketable
Securities (Continued)


Available-for-sale securities:
 Debt or equity securities that do not fit
either of the other 2 categories.
 Reported at market value.
 Realized gains and losses go through
income.
 Unrealized gains and losses directly
credited (or debited) to a stockholders’
equity account.

39

Analysis of Monetary Assets





Current ratio = CA/CL
Acid-test ratio = quick ratio = monetary
CA/CL= (CA - inventories - prepaid
items) /CL.
Days cash = cash/(cash expenses 
365)
 Cash expenses  total expenses depreciation.





Days receivable = average collection
period = Receivables/(Sales  365)
Ratios differ by industry.

40

41


Slide 40

Revenue and Monetary
Assets
JOIN KHALID AZIZ
COACHING CLASSES
ICMAP STAGE 1,2,3,4,5
ICAP MODULE A,B,C,D
PIPFA
BBA & MBA
B.COM & M.COM
ACCOUNTING OF O/A LEVEL
MA-ECONOMICS
0322-3385752
KARACHI, PAKISTAN

Operating Cycle


Cash-to-cash.
• Receive cash from customer
• Purchase materials/services & pay cash
• Convert materials/services to salable
product
• Store product
• Sell product
• Receive cash from customer
2

Revenue Recognition:
When? (Timing) & How much? (Amt.)




At one point in revenue cycle
(objectivity).
Criteria:
• When? Earned (Conservatism)



Normally, goods shipped.
Service performed.

• How much? Realized or realizable
(Realization).





Already collected or collectible.
Amount can be measured reliably.

Next step: matching costs.

3

Basic Revenue Recognition Criteria


Recognize revenue in earliest period
in which:
• Entity has substantially performed what
is required in order to earn income and
• Amount of income can be reliably
measured.

4

Delivery Method




Recognize revenue when goods or
services are delivered.
For goods: when title transfers.
• FOB shipping point (when goods are
given to carrier).



Example 1:
• Order is received for Rs900. Sales
entry?
• Goods are produced. Sales entry?
• Goods are shipped. Sales entry?

5

Consignment Method


Consignor ships goods to
consignee.





Inventory on consignment
Merchandise inventory
1,000

1,000

Consignor retains title until goods
are sold to customer. At sale:





Accounts receivable
Sales revenue
COGS
Inventory on consignment

1,400
1,400
1,000
6

Franchise Revenue


Recognize:
• When earned.
• Not when agreement signed or fee
received.

7

Franchise Revenue First
Example


Tariq & Tariq’s charges a franchise
fee primarily for identifying the site,
designing the store, training
management and staff, and
otherwise helping to get the
franchise started in business.
Assume the initial fee is Rs100,000.
When should this Rs100,000 be
recorded as revenue?

8

Franchise Revenue Second
Example
• Golden, Inc. receives Rs6,000 from a
franchisee for the right to use its
trademark and have access to its
“know-how” for a period of 5 years.
This know-how includes training
sessions, and some one available to
answer questions. When should the
Rs6,000 be recognized as revenue?
9

Percentage-of-Completion Method








Design/development and
construction/production projects that
extends over several years.
Customer pays either fixed price or cost
reimbursement contract.
Reasonable assurance of profit margin and
ultimate realization.
Revenue recognized based on total
percentage of project work performed
during period.
10

Completed Contract Method


Percentage of completion method
required unless:
• Amount of income to be earned on
contract cannot reasonably be
determined.



Alternative is completed contract
method.
• Costs incurred are an asset (Contract
Work in Progress) until revenue is
recognized.

11

Production Method



Applies to agricultural and mining.
Criteria:
• Clear market determined price.
• Performance substantially complete.




Minimal remaining costs.

Permitted but not required by GAAP.

12

Installment Method






Customer pays a certain amount per
period.
Installment payment is recognized as
revenue and a proportional part of
cost of sales is recorded.
Under cost recovery method, cost is
recorded equal to installment
payment until total cost of sales is
covered.
13

Real Estate Sales





Developer often finances over many years.
Uncertainty of income due to uncertainty
of receipt of future payments.
Conditions required for revenue
recognition:
• Period allowing cancellation and refund to
buyer has expired.
• Cum payments equal to 10% of purchase
price.
• Seller has completed or is clearly capable of
completing required improvement.

14

Amount of Revenue
Recognized




Net realizable value (amount
reasonably estimated to be
collected).
2 approaches:
• Direct write-off method.
• Allowance method.



% of sales.
% of (analysis of) AR.
15

Direct Write-Off Method




Write-off when specific account that
is uncollectible is identified.
Why is this not acceptable under
GAAP?

16

Allowance Method


Estimate amount of current period
credit sales that will not be collected.
• Historical % tempered by judgment.
• Historical % of aged receivables
(+judgment).




Adjusting entry at end of period.
When an uncollectible account is
identified, it is written off.
17

Example


Amount of revenue recognized:
• Sales for the year were Rs2,000 for
cash and Rs6,000 on credit.
• Historically we don’t collect about 5%
of our credit sales due to customer
bankruptcies or unable to locate
customer.
• A customer, The XYZ Company went
bankrupt. They owed us Rs175.







Entry for revenue?
Entry for bad debts - direct write-off
(not-GAAP)?
Entries for bad debts (allowance
method)?

18

Example






Balances in Accounts
• Accounts receivable dr 3,000.
 Consisting of 2,000 current and 1,000
overdue.
• Allowance for doubtful accounts cr 50.
Estimated amount of accounts that are
uncollectible:
• 2% for current and 10% for non-current
accounts.
What entry do we make at the end of the year
to accrue for bad debts?
19

Allowance Method (continued)




Allowance… is a contra-asset
account.
Collection of a bad debt that was
written-off:


Cash
 Allowance for Doubtful Accounts

20

Sales Discounts


Sales terms are “2/10 net 30”
• Customer gets 2% cash discount if paid
within 10 days.
• Otherwise, total amount is due within
30 days.




What does “1/15 net 45” mean?
What is the effective annual rate of
savings by taking advantage of
terms of “2/10 net 30”?
21

Alternative Methods of
Accounting for Sales Discounts


Record initial sale at gross.
 At collection of net amount record
discount as a reduction from gross
sales.



Record initial sale at gross.
 At collection of net amount record
discount as an expense of the period.



Record initial sale at net.
 Record amounts not taken as discounts
as additional revenue.

22

Example


We sold Rs10,000 of mdse. Sales
terms are 2/10, n/30.
Customers paid us for Rs8,000 of
the merchandise billed within 10
days. The remaining Rs2,000
was paid within 30 days.
• Record at gross.
• Record at net.
23

Credit Card Sales


If cash received by merchant
immediately (Bank plan, MC, Visa):




Cash
Sales discount
Sales revenue

970
30
1000

24

Credit Card Sales (continued)


If cash received by merchant in 30
days (American Express, Discover):




Accounts receivable
Sales discount
Sales revenue

970
30
1000

25

Sales Returns & Allowances


Similar to bad debt expense,
 Estimate percentage of revenues that
will eventually result in returns or
allowances.
 Adjusting entry at end of period.
 Actual return or allowance.

26

Example
 On average 2% of our Rs10,000 of sales
is returned. Adjusting entry at end of
period?
 Entry for return of Rs80 of goods?
 Same for direct write-off method?

27

Sales Returns & Allowances
(Continued)




Provision for Returns and Allowances
is a liability account.
Alternative:
 Not accrue for returns and allowances
but write them off as they occur.
 Is this GAAP?

28

Adjustment vs. Expense





Realization concept suggests
adjustment to revenue.
In practice both methods are found.
Consistency:
 Same handling from year to year.




Allows same company results to be
compared from year to year.
Comparisons between companies may be
distorted.
29

Warranty Costs








Amounts are estimated (usually as a
percentage of sales).
Part of Cost of goods sold.
Record accrual (adjusting entry)
Record the actual expenditures.
Allowance… is a liability account.
Est. warranty exp. Is part of costs of
sales.
30

Warranty Expenses Example




We estimate that warranty expenses
will be 4% of our Rs10,000 of sales.
Entry?
We spent Rs120 on parts and Rs250
on labor for repairs under warranty.
Entry?

31

Interest Revenue




Amount earned by lender during the
period.
2 approaches
• Interest paid at maturity.


Interest is explicit.

• Discounted loan.




Interest is implicit.

Accounted for separately from sale.
32

Example: Interest Revenue


On January 1, 19x1 sold a customer
Rs1,000 of mdse. We received a
promissory note for Rs1,000 plus 8%
interest to be paid in one year.
• Entry for sale?
• Entry for accrual of interest on December 31,
19x1?
• Entry for receipt of payment on note on
January 1, 19x2?



On January 1, 19x1, we sold mdse. and
received a promissory note for Rs5,000
with no interest. The note is due in one
year. The market rate of interest on such
a note is 9%.
• Entry at sale:
• Year end adjusting entry (12/31/19x1)
• Entry when customer pays note (1/1/19x2)

33

Monetary& Non-monetary
Assets







Monetary assets are money or claims to
receive fixed sums of money.
Non-monetary assets are items used in
future production and sales of goods
and services.
Balance sheet distinction
 Current and non-current assets.
 Not monetary and non-monetary.





Non-monetary assets (except
inventory) on BS at unexpired cost.
(Cost less depreciation)
Monetary assets: Cash reported at face.
AR at NRV. Other at fair value.

34

Cash



Funds available for disbursement.
May include liquid short term
investments.
• Highly liquid debt instruments with
original maturities of 90 days or less.

35

Receivables


Trade receivables
• Accounts receivables from usual sales of
products or services for non-financial
institutions.



Other receivables are shown
separately.
 E.g., Due from employees, advances or
loans.
36

Marketable Securities





Must be marketable.
E.g., commercial paper, treasury
bills, publicly traded stocks and
bonds issued by companies.
Also called “Temporary Investments.”

37

Accounting for Marketable
Securities


Three categories
 Held-to-maturity: debt securities,


Valued at cost.

 Trading securities: debt or equity held
for current resale, valued at market.


Realized (i.e., if sold during period) and
unrealized (not yet sold but market price
has changed) gain or loss included in
current year’s income.
38

Accounting for Marketable
Securities (Continued)


Available-for-sale securities:
 Debt or equity securities that do not fit
either of the other 2 categories.
 Reported at market value.
 Realized gains and losses go through
income.
 Unrealized gains and losses directly
credited (or debited) to a stockholders’
equity account.

39

Analysis of Monetary Assets





Current ratio = CA/CL
Acid-test ratio = quick ratio = monetary
CA/CL= (CA - inventories - prepaid
items) /CL.
Days cash = cash/(cash expenses 
365)
 Cash expenses  total expenses depreciation.





Days receivable = average collection
period = Receivables/(Sales  365)
Ratios differ by industry.

40

41


Slide 41

Revenue and Monetary
Assets
JOIN KHALID AZIZ
COACHING CLASSES
ICMAP STAGE 1,2,3,4,5
ICAP MODULE A,B,C,D
PIPFA
BBA & MBA
B.COM & M.COM
ACCOUNTING OF O/A LEVEL
MA-ECONOMICS
0322-3385752
KARACHI, PAKISTAN

Operating Cycle


Cash-to-cash.
• Receive cash from customer
• Purchase materials/services & pay cash
• Convert materials/services to salable
product
• Store product
• Sell product
• Receive cash from customer
2

Revenue Recognition:
When? (Timing) & How much? (Amt.)




At one point in revenue cycle
(objectivity).
Criteria:
• When? Earned (Conservatism)



Normally, goods shipped.
Service performed.

• How much? Realized or realizable
(Realization).





Already collected or collectible.
Amount can be measured reliably.

Next step: matching costs.

3

Basic Revenue Recognition Criteria


Recognize revenue in earliest period
in which:
• Entity has substantially performed what
is required in order to earn income and
• Amount of income can be reliably
measured.

4

Delivery Method




Recognize revenue when goods or
services are delivered.
For goods: when title transfers.
• FOB shipping point (when goods are
given to carrier).



Example 1:
• Order is received for Rs900. Sales
entry?
• Goods are produced. Sales entry?
• Goods are shipped. Sales entry?

5

Consignment Method


Consignor ships goods to
consignee.





Inventory on consignment
Merchandise inventory
1,000

1,000

Consignor retains title until goods
are sold to customer. At sale:





Accounts receivable
Sales revenue
COGS
Inventory on consignment

1,400
1,400
1,000
6

Franchise Revenue


Recognize:
• When earned.
• Not when agreement signed or fee
received.

7

Franchise Revenue First
Example


Tariq & Tariq’s charges a franchise
fee primarily for identifying the site,
designing the store, training
management and staff, and
otherwise helping to get the
franchise started in business.
Assume the initial fee is Rs100,000.
When should this Rs100,000 be
recorded as revenue?

8

Franchise Revenue Second
Example
• Golden, Inc. receives Rs6,000 from a
franchisee for the right to use its
trademark and have access to its
“know-how” for a period of 5 years.
This know-how includes training
sessions, and some one available to
answer questions. When should the
Rs6,000 be recognized as revenue?
9

Percentage-of-Completion Method








Design/development and
construction/production projects that
extends over several years.
Customer pays either fixed price or cost
reimbursement contract.
Reasonable assurance of profit margin and
ultimate realization.
Revenue recognized based on total
percentage of project work performed
during period.
10

Completed Contract Method


Percentage of completion method
required unless:
• Amount of income to be earned on
contract cannot reasonably be
determined.



Alternative is completed contract
method.
• Costs incurred are an asset (Contract
Work in Progress) until revenue is
recognized.

11

Production Method



Applies to agricultural and mining.
Criteria:
• Clear market determined price.
• Performance substantially complete.




Minimal remaining costs.

Permitted but not required by GAAP.

12

Installment Method






Customer pays a certain amount per
period.
Installment payment is recognized as
revenue and a proportional part of
cost of sales is recorded.
Under cost recovery method, cost is
recorded equal to installment
payment until total cost of sales is
covered.
13

Real Estate Sales





Developer often finances over many years.
Uncertainty of income due to uncertainty
of receipt of future payments.
Conditions required for revenue
recognition:
• Period allowing cancellation and refund to
buyer has expired.
• Cum payments equal to 10% of purchase
price.
• Seller has completed or is clearly capable of
completing required improvement.

14

Amount of Revenue
Recognized




Net realizable value (amount
reasonably estimated to be
collected).
2 approaches:
• Direct write-off method.
• Allowance method.



% of sales.
% of (analysis of) AR.
15

Direct Write-Off Method




Write-off when specific account that
is uncollectible is identified.
Why is this not acceptable under
GAAP?

16

Allowance Method


Estimate amount of current period
credit sales that will not be collected.
• Historical % tempered by judgment.
• Historical % of aged receivables
(+judgment).




Adjusting entry at end of period.
When an uncollectible account is
identified, it is written off.
17

Example


Amount of revenue recognized:
• Sales for the year were Rs2,000 for
cash and Rs6,000 on credit.
• Historically we don’t collect about 5%
of our credit sales due to customer
bankruptcies or unable to locate
customer.
• A customer, The XYZ Company went
bankrupt. They owed us Rs175.







Entry for revenue?
Entry for bad debts - direct write-off
(not-GAAP)?
Entries for bad debts (allowance
method)?

18

Example






Balances in Accounts
• Accounts receivable dr 3,000.
 Consisting of 2,000 current and 1,000
overdue.
• Allowance for doubtful accounts cr 50.
Estimated amount of accounts that are
uncollectible:
• 2% for current and 10% for non-current
accounts.
What entry do we make at the end of the year
to accrue for bad debts?
19

Allowance Method (continued)




Allowance… is a contra-asset
account.
Collection of a bad debt that was
written-off:


Cash
 Allowance for Doubtful Accounts

20

Sales Discounts


Sales terms are “2/10 net 30”
• Customer gets 2% cash discount if paid
within 10 days.
• Otherwise, total amount is due within
30 days.




What does “1/15 net 45” mean?
What is the effective annual rate of
savings by taking advantage of
terms of “2/10 net 30”?
21

Alternative Methods of
Accounting for Sales Discounts


Record initial sale at gross.
 At collection of net amount record
discount as a reduction from gross
sales.



Record initial sale at gross.
 At collection of net amount record
discount as an expense of the period.



Record initial sale at net.
 Record amounts not taken as discounts
as additional revenue.

22

Example


We sold Rs10,000 of mdse. Sales
terms are 2/10, n/30.
Customers paid us for Rs8,000 of
the merchandise billed within 10
days. The remaining Rs2,000
was paid within 30 days.
• Record at gross.
• Record at net.
23

Credit Card Sales


If cash received by merchant
immediately (Bank plan, MC, Visa):




Cash
Sales discount
Sales revenue

970
30
1000

24

Credit Card Sales (continued)


If cash received by merchant in 30
days (American Express, Discover):




Accounts receivable
Sales discount
Sales revenue

970
30
1000

25

Sales Returns & Allowances


Similar to bad debt expense,
 Estimate percentage of revenues that
will eventually result in returns or
allowances.
 Adjusting entry at end of period.
 Actual return or allowance.

26

Example
 On average 2% of our Rs10,000 of sales
is returned. Adjusting entry at end of
period?
 Entry for return of Rs80 of goods?
 Same for direct write-off method?

27

Sales Returns & Allowances
(Continued)




Provision for Returns and Allowances
is a liability account.
Alternative:
 Not accrue for returns and allowances
but write them off as they occur.
 Is this GAAP?

28

Adjustment vs. Expense





Realization concept suggests
adjustment to revenue.
In practice both methods are found.
Consistency:
 Same handling from year to year.




Allows same company results to be
compared from year to year.
Comparisons between companies may be
distorted.
29

Warranty Costs








Amounts are estimated (usually as a
percentage of sales).
Part of Cost of goods sold.
Record accrual (adjusting entry)
Record the actual expenditures.
Allowance… is a liability account.
Est. warranty exp. Is part of costs of
sales.
30

Warranty Expenses Example




We estimate that warranty expenses
will be 4% of our Rs10,000 of sales.
Entry?
We spent Rs120 on parts and Rs250
on labor for repairs under warranty.
Entry?

31

Interest Revenue




Amount earned by lender during the
period.
2 approaches
• Interest paid at maturity.


Interest is explicit.

• Discounted loan.




Interest is implicit.

Accounted for separately from sale.
32

Example: Interest Revenue


On January 1, 19x1 sold a customer
Rs1,000 of mdse. We received a
promissory note for Rs1,000 plus 8%
interest to be paid in one year.
• Entry for sale?
• Entry for accrual of interest on December 31,
19x1?
• Entry for receipt of payment on note on
January 1, 19x2?



On January 1, 19x1, we sold mdse. and
received a promissory note for Rs5,000
with no interest. The note is due in one
year. The market rate of interest on such
a note is 9%.
• Entry at sale:
• Year end adjusting entry (12/31/19x1)
• Entry when customer pays note (1/1/19x2)

33

Monetary& Non-monetary
Assets







Monetary assets are money or claims to
receive fixed sums of money.
Non-monetary assets are items used in
future production and sales of goods
and services.
Balance sheet distinction
 Current and non-current assets.
 Not monetary and non-monetary.





Non-monetary assets (except
inventory) on BS at unexpired cost.
(Cost less depreciation)
Monetary assets: Cash reported at face.
AR at NRV. Other at fair value.

34

Cash



Funds available for disbursement.
May include liquid short term
investments.
• Highly liquid debt instruments with
original maturities of 90 days or less.

35

Receivables


Trade receivables
• Accounts receivables from usual sales of
products or services for non-financial
institutions.



Other receivables are shown
separately.
 E.g., Due from employees, advances or
loans.
36

Marketable Securities





Must be marketable.
E.g., commercial paper, treasury
bills, publicly traded stocks and
bonds issued by companies.
Also called “Temporary Investments.”

37

Accounting for Marketable
Securities


Three categories
 Held-to-maturity: debt securities,


Valued at cost.

 Trading securities: debt or equity held
for current resale, valued at market.


Realized (i.e., if sold during period) and
unrealized (not yet sold but market price
has changed) gain or loss included in
current year’s income.
38

Accounting for Marketable
Securities (Continued)


Available-for-sale securities:
 Debt or equity securities that do not fit
either of the other 2 categories.
 Reported at market value.
 Realized gains and losses go through
income.
 Unrealized gains and losses directly
credited (or debited) to a stockholders’
equity account.

39

Analysis of Monetary Assets





Current ratio = CA/CL
Acid-test ratio = quick ratio = monetary
CA/CL= (CA - inventories - prepaid
items) /CL.
Days cash = cash/(cash expenses 
365)
 Cash expenses  total expenses depreciation.





Days receivable = average collection
period = Receivables/(Sales  365)
Ratios differ by industry.

40

41