Chapter 6 Accounting for Sales

Recognize Revenue Items at the Proper Time on the Income Statement Learning Objective 1 Recognize Revenue Items at the Proper Time on the Income Statement

Sales Revenue Critical to measurement of net income LO-1 Sales Revenue Critical to measurement of net income Directly increases net income Reduces net income by triggering recognition of certain expenses Changes in revenue and net income have profound impact on stock prices

Existing Standard for Revenue Recognition LO-1 Existing Standard for Revenue Recognition Two-pronged test Company has delivered goods or services to the customer; that is, it has earned the revenue Company has received cash or an asset virtually assured of being converted into cash; that is, the revenue is realized or realizable

Learning Objective 2 Account for Sales, Including Sales Returns and Allowances, Sales Discounts, and Bank Credit Card Sales

Measurement of Sales Revenue LO-2 Measurement of Sales Revenue Measured in terms of cash-equivalent value of asset received A $100 cash sale A $100 credit sale

Measurement of Sales Revenue LO-2 Measurement of Sales Revenue Is complex when the cash-equivalent value of the asset received is not obvious Receiving goods or services instead of cash Cash-equivalent value of the goods or services received must be estimated Cash received less than the listed price of item Inability or unwillingness of customer to pay amount owed

Measurement of Sales Revenue LO-2 Measurement of Sales Revenue Gross sales: Total amount of sales before deducting returns, allowances, and discounts Net sales: Total amount of sales after deducting returns, allowances, and discounts Amount actually received that constitutes revenue to the company

Merchandise Returns and Allowances Sales returns or purchase returns Merchandise returned by the customer Sales allowance or purchase allowance A reduction of the original selling price Both sales returns and sales allowances are deducted from gross sales to determine net sales

Merchandise Returns and Allowances Contra revenue account Used instead of reducing the revenue account directly Combines both returns and allowances Helps monitor changes in the level of returns and allowances Helps in forecasting demand and managing inventory

Merchandise Returns and Allowances A company has $900,000 gross sales on credit and $80,000 sales returns and allowances Journal entries

Trade and Cash Discounts LO-2 Trade and Cash Discounts Trade discounts: Reductions to the gross selling price for a particular class of customers Cash discounts: Reductions in the amount owed by customers due to prompt payment

Gross Method for Cash Discounts LO-2 Gross Method for Cash Discounts Product sold at $30,000 on terms 2/10, n/60 Sale of equipment Cash collected at discount Full cash collected

Net Method for Cash Discounts LO-2 Net Method for Cash Discounts Using net method for the cash discounts Sale of equipment Cash collected at discount Full cash collected 6-14

Advantages of Cash Discounts LO-2 Advantages of Cash Discounts Encourage prompt payment thus reduce seller’s need for cash Reduce risk of bad debts A way to compete with other sellers

Recording Charge Card Transactions LO-2 Recording Charge Card Transactions Credit card companies charge retailers a fee Retailers receive an amount less than the listed sales price Retailers accept cards to: Attract credit customers who would otherwise shop elsewhere Get cash immediately instead of waiting for credit customers to pay Avoid the cost of tracking, billing, and collecting customers’ accounts

Recording Charge Card Transactions (cont.) LO-2 Recording Charge Card Transactions (cont.) Example - Credit sales of $10,000 and 3% of sales charged as credit card services

Accounting for Net Sales Revenue LO-2 Accounting for Net Sales Revenue A detailed income statement contains multiple elements

Estimate and Interpret Uncollectible Accounts Receivable Balances Learning Objective 3 Estimate and Interpret Uncollectible Accounts Receivable Balances

LO-3 Credit Sales Create challenges for measuring revenue and managing company’s assets Requires management of expected future payments, accounts receivable, to ensure their collection in a timely manner Benefits - Boost in sales and profit Costs - Administration and bad debts Requires clerical time and effort Delay in receiving payments

Uncollectible Accounts LO-3 Uncollectible Accounts Receivables that credit customers are unable or unwilling to pay Also called bad debts Bad debt expense: Loss arising from uncollectible accounts

Specific Write-Off Method LO-3 Specific Write-Off Method Method of accounting for bad debt losses that assumes all sales are fully collectible until proven otherwise Does not misstate economic situation if uncollectibles are small and infrequent Fails to apply matching principle of accrual accounting

LO-3 Bad Debt Recoveries Accounts receivable that were previously written off as uncollectible but then collected at a later date To maintain the customer’s true payment history: Reverse the write-off Handle collection as normal receipt on account

LO-3 Bad Debt Recoveries Recovery in 20X3 of $500 that was written off in year 20X2 Reversing write-off of account Recording collection on account

Allowance Method A method of accounting for bad debt losses that uses: Estimates of the amount of sales or receivables that will ultimately be uncollectible A contra account that contains the estimated uncollectible amount to be deducted from the total accounts receivable

Allowance Method Allowance for uncollectible accounts A contra asset account that measures the amount of receivables estimated to be uncollectible Also called allowance for doubtful accounts or allowance for bad debts

LO-3 Allowance Method Following are the associated journal entries

Allowance Method Superior in accurately measuring: Relies on: Annual accrual accounting income Year-end accounts receivable asset Relies on: Historical experience Information about economic circumstances and customer composition

LO-3 Allowance Method Represented in balance sheet as:

Bad Debt Recoveries and the Allowance Method Write off uncollectible account in 20x2 Reverse write-off in 20x3 Collection of account in 20x3

Assess the Level of Accounts Receivable Learning Objective 4 Assess the Level of Accounts Receivable

Accounts Receivable Turnover LO-4 Accounts Receivable Turnover Measure of the ability to control receivables Derived by dividing credit sales by average accounts receivable for the period during which the sales are made

Accounts Receivable Turnover LO-4 Accounts Receivable Turnover A turnover of 12 - On average, the company collects receivables after 1 month High turnover - Indicates that a company collects its receivables quickly Lower turnovers indicate slower collection cycles

Accounts Receivable Turnover LO-4 Accounts Receivable Turnover Days to collect accounts receivable Number of days taken to collect receivables 365 ÷ Accounts receivable turnover Called average collection period Problems in comparing accounts receivable turnover Companies do not disclose their credit sales Computations available to the public are generally based on total sales