Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Reporting and Interpreting Sales Revenue, Receivables, and Cash Chapter 6

6-2 Learning Objectives Apply the revenue principle to determine the accepted time to record sales revenue for typical retailers, wholesalers, manufacturers, and service companies.

6-3 Accounting for Sales Revenue The revenue principle requires that revenues be recorded when earned: Goods or services have been delivered. Collection is reasonably assured. Amount of customer payments known.

6-4 Learning Objectives Analyze the impact of credit card sales, sales discounts, and sales returns on the amounts reported as net sales.

6-5 Reporting Net Sales Companies record credit card discounts, sales discounts, and sales returns and allowances separately to allow management to monitor these transactions.

6-6 Credit Card Sales Companies accept credit cards for several reasons: 1.To increase sales. 2.To avoid providing credit directly to customers. 3.To avoid losses due to bad checks. 4.To avoid losses due to fraudulent credit card sales. 5.To receive payment quicker. Companies accept credit cards for several reasons: 1.To increase sales. 2.To avoid providing credit directly to customers. 3.To avoid losses due to bad checks. 4.To avoid losses due to fraudulent credit card sales. 5.To receive payment quicker.

6-7 When credit card sales are made, the company must pay the credit card company a fee for the service it provides. Credit Card Sales

6-8 When companies allow customers to purchase merchandise on an open account, the customer promises to pay the company in the future for the purchase. Sales on Account

6-9 2/10, n/30 Sales Discounts When customers purchase on open account, they may be offered a sales discount to encourage early payment. Read as: “Two ten, net thirty”

6-10 2/10, n/30 Discount Percentage # of Days in Discount Period Otherwise, the Full Amount Is Due Maximum Days in Credit Period Sales Discounts

6-11 To Take or Not Take the Discount With discount terms of 2/10,n/30, a customer saves $2 on a $100 purchase by paying on the 10 th day instead of the 30 th day. Annual Interest Rate = 365 Days 20 Days 365 Days 20 Days × 2.04% = 37.23% $2 $98 = 2.04% Interest Rate for 20 Days = Amount Saved Amount Paid

6-12 Sales Returns and Allowances Debited for damaged merchandise. Debited for returned merchandise. Contra revenue account.

6-13 Learning Objectives Analyze and interpret the gross profit percentage.

6-14 Gross Profit Percentage In 2003, Deckers reported gross profit of $51,345,000 on sales of $121,055,000. Gross Profit Percentage Gross Profit Net Sales = All other things equal, a higher gross profit results in higher net income.

6-15 Gross Profit Percentage $51,345,000 $121,055,000 == 42.4% Gross Profit Percentage Gross Profit Net Sales = Gross Profit Percentage All other things equal, a higher gross profit results in higher net income.

6-16 Measuring and Reporting Receivables Accounts Receivable Trade receivables are amounts owed to the business for credit sales of goods, or services. Nontrade receivables are amounts owed to the business for other than business transactions.

6-17 $1,200 Goleta, CA January 5, 2006 Sixty days after date I promise to pay to the order of Deckers Outdoor Corporation One thousand two hundred Dollars Payable at First Goleta National Bank Value received with interest at per annum No. Due Goodson Sporting Goods 10242March 6, % Ivan Goodson Measuring and Reporting Receivables – Notes Receivable Due Date Maker Interest Rate Principal Term Payee

6-18 Learning Objectives Estimate, report, and evaluate the effects of uncollectible accounts receivable (bad debts) on financial statements.

6-19 Accounting for Bad Debts Bad debts result from credit customers who will not pay the business the amount they owe, regardless of collection efforts.

6-20 Matching Principle Bad Debt Expense Sales Revenue Record in same accounting period. Accounting for Bad Debts

6-21 Most businesses record an estimate of the bad debt expense by an adjusting entry at the end of the accounting period. Accounting for Bad Debts

6-22 Recording Bad Debt Expense Estimates Deckers estimated bad debt expense for 2003 to be $504,000. Prepare the adjusting entry. Deckers estimated bad debt expense for 2003 to be $504,000. Prepare the adjusting entry.

6-23 Bad Debt Expense is normally classified as a selling expense and is closed at year-end. Contra asset account Recording Bad Debt Expense Estimates Deckers estimated bad debt expense for 2003 to be $504,000. Prepare the adjusting entry. Deckers estimated bad debt expense for 2003 to be $504,000. Prepare the adjusting entry.

6-24 Allowance for Doubtful Accounts Amount the business expects to collect. Balance Sheet Disclosure

6-25 Writing Off Uncollectible Accounts When it is clear that a specific customer’s account receivable will be uncollectible, the amount should be removed from the Accounts Receivable account and charged to the Allowance for Doubtful Accounts.

6-26 Deckers’ total write-offs for 2003 were $876,000. Prepare a summary journal entry for these write-offs. Deckers’ total write-offs for 2003 were $876,000. Prepare a summary journal entry for these write-offs. Writing Off Uncollectible Accounts

6-27 Writing Off Uncollectible Accounts Deckers’ total write-offs for 2003 were $876,000. Prepare a summary journal entry for these write-offs. Deckers’ total write-offs for 2003 were $876,000. Prepare a summary journal entry for these write-offs.

6-28 Assume that before the write-off, Deckers’ Accounts Receivable balance was $11,000,000 and the Allowance for Doubtful Accounts balance was $1,000,000. Let’s see what effect the total write-offs of $876,000 had on these accounts. Assume that before the write-off, Deckers’ Accounts Receivable balance was $11,000,000 and the Allowance for Doubtful Accounts balance was $1,000,000. Let’s see what effect the total write-offs of $876,000 had on these accounts. Writing Off Uncollectible Accounts

6-29 Notice that the total write-offs of $876,000 did not change the net realizable value nor did it affect any income statement accounts. Writing Off Uncollectible Accounts

6-30 Methods for Estimating Bad Debts Percentage of credit sales or Aging of accounts receivable Percentage of credit sales or Aging of accounts receivable ????

6-31 Percentage of Credit Sales Bad debt percentage is based on actual uncollectible accounts from prior years’ credit sales. Focus is on determining the amount to record on the income statement as Bad Debt Expense.

6-32 Percentage of Credit Sales

6-33 Percentage of Credit Sales In 2006, Kid’s Clothes had credit sales of $600,000. Past experience indicates that bad debts are one percent of sales. What is the estimate of bad debts expense for 2006? In 2006, Kid’s Clothes had credit sales of $600,000. Past experience indicates that bad debts are one percent of sales. What is the estimate of bad debts expense for 2006? $600,000 ×.01 = $6,000 Now, prepare the adjusting entry.

6-34 Percentage of Credit Sales

6-35 Now let’s discuss another method that is used to account for uncollectible accounts.

6-36 Aging of Accounts Receivable Focus is on determining the desired balance in the Allowance for Doubtful Accounts on the balance sheet.

6-37 Aging Schedule Each customer’s account is aged by breaking down the balance by showing the age (in number of days) of each part of the balance. An aging of accounts receivable for Kid’s Clothes in 2006 might look like this... Each customer’s account is aged by breaking down the balance by showing the age (in number of days) of each part of the balance. An aging of accounts receivable for Kid’s Clothes in 2006 might look like this...

6-38 Based on past experience, the business estimates the percentage of uncollectible accounts in each time category. Aging Schedule

6-39 These percentages are then multiplied by the appropriate column totals. Aging Schedule

6-40 The column totals are then added to arrive at the total estimate of uncollectible accounts of $1,201. Aging Schedule

6-41 Aging of Accounts Receivable Record the Dec. 31, 2006, adjusting entry assuming that the Allowance for Doubtful Accounts currently has a $50 credit balance.

6-42 After posting, the Allowance account would look like this... Aging of Accounts Receivable

6-43 Allowance for Doubtful Accounts Notice that the balance after adjustment is equal to the estimate of $1,201 based on the aging analysis performed earlier. Aging of Accounts Receivable

6-44 Aging of Accounts Receivable

6-45 Learning Objectives Analyze and interpret the accounts receivable turnover ratio and the effects of accounts receivable on cash flows.

6-46 Deckers reported 2003 net sales of $121,055,000. December 31, 2002, receivables were $18,745,000 and December 31, 2003, receivables were $20,851,000. This ratio measures how many times average receivables are recorded and collected for the year. Receivables Turnover Net Sales Average Net Trade Receivables Receivables Turnover =

6-47 = 6.1 $121,055,000 ($18,745,000 + $20,851,000) ÷ 2 Receivables Turnover = This ratio measures how many times average receivables are recorded and collected for the year. Net Sales Average Net Trade Receivables Receivables Turnover =

6-48 Focus on Cash Flows Sales Revenue Add Decrease in Accounts Receivable Subtract Increase in Accounts Receivable Cash Collected from Customers

6-49 Learning Objectives Report, control, and safeguard cash.

6-50 Cash and Cash Equivalents Checks Money Orders Bank DraftsCertificates of Deposit T-Bills

6-51 Internal Control of Cash Cash is the asset most susceptible to theft and fraud. Properly account for assets. Ensure the accuracy of financial records. Safeguard assets. Internal control refers to policies and procedures that are designed to:

6-52 Separation of Duties Custody Recording Authorization Internal Control of Cash

6-53 Daily Deposits Purchase Approval Prenumbered Checks Payment Approval Cash Controls Check Signatures Bank Reconciliations Internal Control of Cash

6-54 Bank Reconciliation Provides information for reconciling journal entries. Explains the difference between cash reported on bank statement and cash balance on company’s books.

6-55 Balance per Bank + Deposits in Transit - Outstanding Checks ± Bank Errors = Correct Balance Balance per Book + Deposits by Bank (credit memos) - Service Charge - NSF Checks ± Book Errors = Correct Balance Bank Reconciliation

6-56 Balance per Bank + Deposits in Transit - Outstanding Checks ± Bank Errors = Adjusted Balance All reconciling items on the book side require an adjusting entry to the cash account. Balance per Book + Deposits by Bank (credit memos) - Service Charge - NSF Checks ± Book Errors = Correct Balance Bank Reconciliation

6-57 Prepare a July 31 bank reconciliation statement and the resulting journal entries for the Simmons Company. The July 31 bank statement indicated a cash balance of $9,610, while the cash ledger account on that date shows a balance of $7,430. Additional information necessary for the reconciliation is shown on the next page. Prepare a July 31 bank reconciliation statement and the resulting journal entries for the Simmons Company. The July 31 bank statement indicated a cash balance of $9,610, while the cash ledger account on that date shows a balance of $7,430. Additional information necessary for the reconciliation is shown on the next page. Bank Reconciliation

6-58 Outstanding checks totaled $2,417. A $500 check mailed to the bank for deposit had not reached the bank at the statement date. The bank returned a customer’s NSF check for $225 received as payment of an account receivable. The bank statement showed $30 interest earned on the bank balance for the month of July. Check 781 for supplies cleared the bank for $268 but was erroneously recorded in our books as $240. A $486 deposit by Acme Company was erroneously credited to our account by the bank. Outstanding checks totaled $2,417. A $500 check mailed to the bank for deposit had not reached the bank at the statement date. The bank returned a customer’s NSF check for $225 received as payment of an account receivable. The bank statement showed $30 interest earned on the bank balance for the month of July. Check 781 for supplies cleared the bank for $268 but was erroneously recorded in our books as $240. A $486 deposit by Acme Company was erroneously credited to our account by the bank. Bank Reconciliation

6-59 Bank Reconciliation

6-60 Bank Reconciliation

6-61 Bank Reconciliation

6-62 Recording Discounts and Returns Chapter Supplement A

6-63 On January 2, a Deckers factory store’s credit card sales were $3,000. The credit card company charges a 3% service fee. Prepare the Deckers journal entry. On January 2, a Deckers factory store’s credit card sales were $3,000. The credit card company charges a 3% service fee. Prepare the Deckers journal entry. Credit Card Sales

6-64 On January 2, a Deckers factory store’s credit card sales were $3,000. The credit card company charges a 3% service fee. Prepare the Deckers journal entry. On January 2, a Deckers factory store’s credit card sales were $3,000. The credit card company charges a 3% service fee. Prepare the Deckers journal entry. Credit Card Discounts are reported as a contra-revenue account. Credit Card Sales

6-65 On January 6, Deckers sold $1,000 of merchandise on credit with terms of 2/10, n/30. Prepare the Deckers journal entry. On January 6, Deckers sold $1,000 of merchandise on credit with terms of 2/10, n/30. Prepare the Deckers journal entry. Sales Discounts

6-66 Sales Discounts On January 6, Deckers sold $1,000 of merchandise on credit with terms of 2/10, n/30. Prepare the Deckers journal entry. On January 6, Deckers sold $1,000 of merchandise on credit with terms of 2/10, n/30. Prepare the Deckers journal entry.

6-67 On January 14, Deckers receives the appropriate payment from the customer for the January 6 sale. Prepare the Deckers journal entry. On January 14, Deckers receives the appropriate payment from the customer for the January 6 sale. Prepare the Deckers journal entry. Sales Discounts

6-68 $1,000 × 2% = $20 sales discount $1,000 - $20 = $980 cash receipt Contra-revenue account Sales Discounts On January 14, Deckers receives the appropriate payment from the customer for the January 6 sale. Prepare the Deckers journal entry. On January 14, Deckers receives the appropriate payment from the customer for the January 6 sale. Prepare the Deckers journal entry.

6-69 Sales Discounts If the customer remits the appropriate amount on January 20 instead of January 14, what entry would Deckers make?

6-70 Since the customer paid outside of the discount period, a sales discount is not granted. Sales Discounts If the customer remits the appropriate amount on January 20 instead of January 14, what entry would Deckers make?

6-71 Sales Returns and Allowances On July 8, before paying, a customer returns $500 of sandals originally purchased on account from Deckers. The sandals originally cost Deckers $300. Prepare the Deckers journal entry. On July 8, before paying, a customer returns $500 of sandals originally purchased on account from Deckers. The sandals originally cost Deckers $300. Prepare the Deckers journal entry.

6-72 Sales Returns and Allowances On July 8, before paying, a customer returns $500 of sandals originally purchased on account from Deckers. The sandals originally cost Deckers $300. Prepare the Deckers journal entry. On July 8, before paying, a customer returns $500 of sandals originally purchased on account from Deckers. The sandals originally cost Deckers $300. Prepare the Deckers journal entry.

6-73 Applying the Revenue Principle in Special Circumstances Chapter Supplement B

6-74 Delayed Revenue Recognition: Installment Method Generally, revenue is recognized when:  An exchange has taken place.  The earnings process is nearly complete.  Collection is probable. Generally, revenue is recognized when:  An exchange has taken place.  The earnings process is nearly complete.  Collection is probable. Uncertain collectibles result in delaying revenue recognition until cash is collected. Installment method: revenue is recognized as cash is collected, often over several accounting periods.

6-75 Revenue Recognition Before the Earnings Process is Complete: Long-Term Construction Contracts Completed Contract Method Percentage-of- Completion Method Let’s look at an example of the percentage-of-completion method.  Revenue and expenses are recognized in the year the contract is completed.  Construction-in progress years show no revenue or expenses.  Revenue and expenses recognized each year as work is accomplished.  Revenues each year are based on the ratio of costs incurred to total costs.

6-76 Revenue Recognition Before the Earnings Process is Complete: Long-Term Construction Contracts Acme Construction is constructing a building for Jones Foods over a three-year period for a total price of $50,000,000. Acme reported the following progress in year one: How much revenue and expense should be recognized on the project in year one using the percentage of completion method?

6-77 Revenue Recognition Before the Earnings Process is Complete: Long-Term Construction Contracts Acme Construction is constructing a building for Jones Foods over a three-year period for a total price of $50,000,000. Acme reported the following progress in year one: Total costs incurred to date Percent complete = Estimate of total project cost $10,000,000 Percent complete = $40,000,000 = 25%

6-78 Revenue Recognition Before the Earnings Process is Complete: Long-Term Construction Contracts Acme Construction is constructing a building for Jones Foods over a three-year period for a total price of $50,000,000. Acme reported the following progress in year one:

6-79 End of Chapter 6