Copyright 2003 Prentice Hall Publishing Company1 Chapter 7 Sales and Collection Cycle

Copyright 2003 Prentice Hall Publishing Company2 Controlling CASH l Cash has universal appeal and ownership is difficult to prove. l Both cash receipts and cash payments should be recorded immediately when received and made. l Checks should be prenumbered and kept secure.

Copyright 2003 Prentice Hall Publishing Company3 Safeguarding Cash l Separation of duties n Different people receive and disburse the cash. n Procedures for the record keeping of cash receipts and disbursements are separate. n Handling the cash and record keeping are completely separate.

Copyright 2003 Prentice Hall Publishing Company4 Procedures l Use pre-numbered checks, and keep a log of electronic transfers. l Payment approval, check signing, and electronic funds transfer should be assigned to different individuals. l Bank accounts and cash balances should be reconciled monthly.

Copyright 2003 Prentice Hall Publishing Company5 Accounting For Cash: Reconciling The Bank Statement l An important part of internal control l Need for calculating a true cash balance l Two “sides” to be reconciled n balance per bank n balance per books l If there are any mistakes or transactions that have not been recorded in the company’s books, the company’s records should be updated.

Copyright 2003 Prentice Hall Publishing Company6 Terminology Bank statement Monthly report prepared by bank that contains details of a company’s deposits, disbursements, and bank charges. Bank reconciliation Report prepared by the company after receiving the bank statement that compares the bank statement with the company’s records to verify the accuracy of both.

Copyright 2003 Prentice Hall Publishing Company7 More Terminology Outstanding check A check written by the company that has been recorded on the company’s records but has not yet cleared the bank Deposit in transit A deposit that the company has made and recorded, but it has not reached the bank’s record keeping system yet.

Copyright 2003 Prentice Hall Publishing Company8 More Terminology NSF check A “bad” check written by a customer that must be deducted from the company’s records. The company recorded the check as a cash receipt (and then deposited it), but the check writer didn’t have the money in his or her account to cover it. The bank will have already deducted it from the company’s balance (in the bank’s records), but the company will have to make an adjustment to their records.

Copyright 2003 Prentice Hall Publishing Company9 More Terminology Credit memo An addition to the company’s balance in the bank’s records for a reason such as the bank having collected a note for the company (from a third party who owed the company). Debit memo A deduction from the company’s balance in the bank’s records for a reason such as a bank service charge.

Copyright 2003 Prentice Hall Publishing Company10 Cash (Bank) Reconciliation Has Two “Independent” Parts ++ deposits in transit outstanding checks -- True cash balance ++ collections for us made by the bank NSF checks (from customers) -- Service charges True cash balance Balance per bank Balance per books

Copyright 2003 Prentice Hall Publishing Company11 l A/R are the expected future cash receipts of a company. They are typically small and are expected to be received within 30 days. l N/R are used when longer credit terms are necessary. The note specifies the maturity date, the rate of interest, and other credit terms. Accounts And Notes Receivable

Copyright 2003 Prentice Hall Publishing Company12 Value Of Receivables l Receivables are reported at their face value less an allowance for accounts which are likely to be uncollectible. l The amount which is actually expected to be collected is called the net realizable value (NRV). l GAAP requires that A/R be reported at NRV.

Copyright 2003 Prentice Hall Publishing Company13 Used only when bad debts are a very small item or when credit sales are insignificant. GAAPNot GAAP Two Methods Allowance MethodDirect Write-Off Method A/R Method Sales Method

Copyright 2003 Prentice Hall Publishing Company14 The Most Common Method Allowance method n Estimate the bad debt expense as an adjustment when it is time to prepare the financial statements. n Record the amount as a reduction in ACCOUNTS RECEIVABLE, even though you don’t know whose accounts will be “bad.”

Copyright 2003 Prentice Hall Publishing Company15 Allowance Method, continued n We will base the estimate on: »Sales, or »Accounts Receivable n This method attempts to match the expense (bad debt) with the revenue (sale) by recording the expense in the same period as the sale even though the company has not specifically identified which accounts will go unpaid.

Copyright 2003 Prentice Hall Publishing Company16 The Other Method Direct Write-Off n No estimates of bad debts are made. n Only when a specific account is known to be uncollectible (customer files bankruptcy, for example) is bad debt expense recorded. n This doesn’t do a very good job of matching the revenue (sale) with the expense (bad debt), because a company often discovers an account is uncollectible in a period subsequent to the one in which the sale was made.

Copyright 2003 Prentice Hall Publishing Company17 1. Provided services to customers for $9,000, on account. Assets = Liab. + Cont. Cap. + Ret. Earnings AR+9000 Sales l Income Statement: l Statement of Changes in Equity: l Statement of Cash Flows: Increases income Increases equity No effect on cash flow

Copyright 2003 Prentice Hall Publishing Company18 2. Collected $6,000 Cash From Account Receivable. 2. Collected $6,000 Cash From Account Receivable. Assets = Liab. + Cont. Cap. + Ret. Earnings Cash (6000) AR l Income Statement: l Statement of Changes in Equity: l Statement of Cash Flows: no effect on income no effect on equity increases cash flow

Copyright 2003 Prentice Hall Publishing Company19 3. At year-end it was estimated that $200 of accounts receivable will never be collected. Assets = Liab. + Cont. Cap. + Ret. Earnings (200) AFDA (200) expense l Income Statement: l Statement of Changes in Equity: l Statement of Cash Flows: Decreases income Decreases equity No effect on cash flow

Copyright 2003 Prentice Hall Publishing Company20 How Do We Report AR On The Balance Sheet? Net Realizable Value of AR = what we expect to collect On the balance sheet: Accounts Receivable$3,000 less allowance for uncollectible accounts (200) Net AR$2,800

Copyright 2003 Prentice Hall Publishing Company21 4. The $50 account receivable of Jane Doe was written-off as uncollectible. Assets = Liab. + Cont. Cap. + Ret. Earnings +50 AFDA (50) AR l Income Statement: l Statement of Changes in Equity: l Statement of Cash Flows: no effect on income no effect on equity no effect on cash flow

Copyright 2003 Prentice Hall Publishing Company22 Effect of Transaction 4 on AR Net Realizable Value Before Event 4After Event 4 AR$3,000AR $2,950 Allow. 200Allow. 150 N.R.V.$2,800N.R.V. $2,800 Net realizable value of accounts receivable did not change as a result of the write-off.

Copyright 2003 Prentice Hall Publishing Company23 Allowance Method, Continued l One way to estimate bad debt expense is to use a percentage of current period sales. n Expense = (% * sales) l Another way to estimate bad debt expense is to use a percentage of ending A/R (or an aging schedule) n Expense = (% * A/R) – allowance balance

Copyright 2003 Prentice Hall Publishing Company24 Other Accounting Issues Related to Sales: Warranty Costs l Why give warranties? l When should expense be recognized? Warranty We will repair or replace this item...