Robert N. West © VEMBA Accounting Revenue and Monetary Assets © The McGraw-Hill Companies, Inc., Part One: Financial Accounting

Robert N. West © VEMBA Accounting The Business Operating Cycle Slide 5-1 Purchase materials Convert materials into a finished product Inspect the product Receive an order for the product from a customer Ship the product and send the customer an invoice Customer acknowledges receipt of the item Store the product in a warehouse Collect cash from the customer

Robert N. West © VEMBA Accounting 1.Sales order receivednonone 2.Deposit or advancenonone payment received 3.Goods being producedFor certain long-percentage of term contractscompletion 4.Production completed;For precious metalsproduction goods storedand certain agri- cultural products 5.Goods shipped orusuallydelivery 6.Customer pays accountcollection isinstallment receivableuncertain Timing of Revenue Recognition Slide 5-2 Typical Revenue Recognition Revenue Recognition Event at This Time Method

Robert N. West © VEMBA Accounting dr.Inventory on consignment1,000 cr.Merchandise inventory1,000 Consignment Shipments Slide 5-3 Goods costing $1,000 were shipped out on consignment.

Robert N. West © VEMBA Accounting dr.Cost of goods sold1,000 cr.Inventory on consignment1,000 dr.Accounts receivable1,400 cr.Sales revenue1,400 Consignment Shipments Slide 5-4 These goods are sold by the consignee for $1,400.

Robert N. West © VEMBA Accounting Customer Project Year-End Payments Costs Percent Year Received Incurred Complete Revenues Expenses Income 1$120,000$160,00020$ 0$ 0$ ,000400, ,000240, ,000800,000100,000 Total$900,000$800,000$900,000$800,000$100,000 Completed-Contract Method Slide 5-5 If the amount of income to be earned on the contract cannot be reliably estimated, then revenue is to be recognized only when the project has been completed.

Robert N. West © VEMBA Accounting 1$120,000$160,00020$180,000$160,000$ 20, ,000400, ,000400,00050, ,000240, ,000240,000 30,000 Total$900,000$800,000$900,000$800,000$100,000 Customer Project Year-End Payments Costs Percent Year Received Incurred Complete Revenues Expenses Income Percentage-of-Completion Method Slide 5-6 GAAP assumes that the percentage-of- completion method will be used to account for long-term contracts.

Robert N. West © VEMBA Accounting Bad Debts Slide 5-7 Check out the aging schedule in Illustration 5-4. Check out the aging schedule in Illustration 5-4. The firm expects bad debts of $7,132. The firm expects bad debts of $7,132.

Robert N. West © VEMBA Accounting The accounts receivable section of the December 31, 1997 balance sheet would appear as follows: Accounts receivable$262,250 less: allowance for doubtful accounts 7,132 accounts receivable, net$255,118 dr. Bad Debts Expense7,132 cr. Allowance for Doubtful7,132 Bad Debts Slide 5-8 The adjusting entry would be:

Robert N. West © VEMBA Accounting Bad Debts Slide 5-9 If sometime in 1998 the Essel Company decided that James Johnson was never going to pay his bill of $250, the following entry would be made: dr. Allowance for Doubtful Accounts250 cr. Accounts Receivable250 The accounts receivable section of the balance sheet immediately after the write-off entry would show-- Accounts receivable$262,000 less: allowance for doubtful accounts 6,882 accounts receivable, net$255,118 Note the the net amount of accounts receivable is unchanged. Note the the net amount of accounts receivable is unchanged.

Robert N. West © VEMBA Accounting Sales Discounts Slide 5-10 Sold $1,000 of merchandise on credit terms of 2/10, net/30.

Robert N. West © VEMBA Accounting Sales Discounts Slide 5-10 Sold $1,000 of merchandise on credit terms of 2/10, net/30. dr. Accounts Receivable980 cr. Sales Revenue980 If payment is made within the discount period: dr. Cash980 cr. Accounts Receivable980

Robert N. West © VEMBA Accounting Sales Discounts Slide 5-11 If payment is made after the discount period: dr. Cash1,000 cr.Discounts Not Taken20 Accounts Receivable980 The 2 percent discount really amounts to an annual rate of 32 percent. The 2 percent discount really amounts to an annual rate of 32 percent.

Robert N. West © VEMBA Accounting Credit Card Sales Slide 5-12 Bank plan (MasterCard and Visa) dr. Cash970 Sales Discounts (Credit Cards)30 cr. Sales Revenue1,000 Other plans (American Express and Discover) dr. Accounts Receivable970 Sales Discounts (Credit Cards)30 cr. Sales Revenue 1,000

Robert N. West © VEMBA Accounting Interest Revenue Slide 5-13 On September 1, 1997, a bank loaned $10,000 for one year at 9 percent interest, the interest and principal to be paid on August 31, The bank’s entry on September 1, 1997 is: dr. Loan Receivable10,000 cr.Cash10,000 On December 31, 1997, an adjusting entry is made to record the fact that interest for one-third of a year, $300, was earned in 1997: dr. Loan Interest Receivable300 cr.Interest Revenue300

Robert N. West © VEMBA Accounting Interest Revenue Slide 5-14 On September 1, 1997, a bank loaned $10,000 for one year at 9 percent discounted. dr. Loan Receivable10,000 cr. Cash9,100 Unearned Interest Revenue900 On December 31, 1997, an adjusting entry is made to record the fact that $300 of interest was earned in dr. Unearned Interest Revenue300 cr.Interest Revenue300

Robert N. West © VEMBA Accounting Interest Revenue Slide 5-15 On August 31, 1998, when the loan is repaid, the entry is: dr. Cash10,000 cr. Loans Receivable10,000 After repayment by the borrower, an adjusting entry is also made by the bank to record the fact that $600 interest was earned in dr. Unearned Interest Revenue600 cr.Interest Revenue600

Robert N. West © VEMBA Accounting Current Ratio Slide 5-16 Current assets Current liabilities Current Ratio = $1,245.1 $1,214.6 Current Ratio = 1.03 Current Ratio =

Robert N. West © VEMBA Accounting Slide 5-17 Acid-Test Ratio Cash, temporary investments, and accounts receivable (net) Monetary Current assets Current liabilities Acid-Test Ratio = $634.9 $1,214.6 Acid-Test Ratio = 0.52 Acid-Test Ratio =

Robert N. West © VEMBA Accounting Slide 5-18 Cash Cost Per Day Expenses (net of depreciation) 365 Cash Cost Per Day = $5, Cash Cost Per Day = $14.65 per day Cash Cost Per Day =

Robert N. West © VEMBA Accounting Slide 5-20 Days’ Cash Cash Cash costs per day Days’ Cash = $98.1 $14.65 Days’ Cash = 7 daysDays’ Cash =

Robert N. West © VEMBA Accounting Chapter 5 The End

Robert N. West © VEMBA Accounting Remaining Slides You can browse through the remaining slides at your own discretion. Most of these slides show the journal entries underlying bad debt accounting. I will not test this material, but you may find it useful to give it a quick look.

Robert N. West © VEMBA Accounting Trade Receivables Arise from the sale of services or products on credit

Robert N. West © VEMBA Accounting Trade Receivables On June 4, 19X8 ABC Company sold $3,000 of merchandise on credit to a customer. Prepare the journal entry.

Robert N. West © VEMBA Accounting Trade Receivables Even though cash was not received, the revenue is still considered earned at this point because the earnings process is assumed to be complete.

Robert N. West © VEMBA Accounting Trade Receivables On July 7, 19X8 ABC Company receives the $3,000 from the customer. Prepare the journal entry.

Robert N. West © VEMBA Accounting Trade Receivables This entry does not affect the company’s profitability nor the company’s total assets.

Robert N. West © VEMBA Accounting Management Issues Selling merchandise on credit helps to increase my sales, but it also delays the receipt of cash! Wow! Buying merchandise on credit let’s me hold on to my cash longer!!

Robert N. West © VEMBA Accounting Management Issues Maybe I can offer a discount to credit customers to entice them to pay sooner...

Robert N. West © VEMBA Accounting Management Issues 2/10,net/30 Percentage of Discount Net Amount Is Due in This # of Days Otherwise, Net (or All) Is Due # of Days Discount Is Available

Robert N. West © VEMBA Accounting Management Issues Assume that a customer owes ABC Company $3,000. The payment terms are 2/10, net/30, and the customer pays within the discount period. Prepare the journal entry.

Robert N. West © VEMBA Accounting Management Issues The sales discount amount is used in presenting net sales figures on the income statement.

Robert N. West © VEMBA Accounting Management Issues I wonder if this will be one of my credit customers who ends up not paying the balance owed to me?

Robert N. West © VEMBA Accounting Net Realizable Value Net realizable value is the amount expected to be collected.

Robert N. West © VEMBA Accounting Uncollectible Accounts Matching Principle An estimate of the expense relating to selling goods on credit should be recorded in the period when the revenue is earned. We must use an estimate because we do not know which specific customers will default.

Robert N. West © VEMBA Accounting Uncollectible Accounts The adjusting entry to record the estimate of uncollectible accounts is as follows:

Robert N. West © VEMBA Accounting Uncollectible Accounts Estimation Methods Percentage of Credit Sales Percentage of Accounts Receivable

Robert N. West © VEMBA Accounting Percentage of Credit Sales Based on past history, I can determine the percentage of credit sales that I never collected. Then, the amount of my adjusting entry could be determined as: Current Year Credit Sales × Bad Debt% Estimated Bad Debt Expense

Robert N. West © VEMBA Accounting Percentage of Credit Sales As of 12/31/X3 Tools-R-Us had total sales of $550,000, of which $75,000 were cash sales. Historically, Tools-R-Us has had a bad debt percentage of 1% based on credit sales. Prepare the 12/31/X3 entry for Tools-R-Us. $550,000 Total Sales - 75,000 Cash Sales 475,000 Credit Sales ×.01 $ 4,750

Robert N. West © VEMBA Accounting Percentage of Credit Sales As of 12/31/X3 Tools-R-Us had total sales of $550,000, of which $75,000 were cash sales. Historically, Tools-R-Us has had a bad debt percentage of 1% based on credit sales. Prepare the 12/31/X3 entry for Tools-R-Us. Contra asset account

Robert N. West © VEMBA Accounting Percentage of Credit Sales If Tools-R-Us had accounts receivable of $100,000 at 12/31/X3, what amount should be reported on the 12/31/X3 balance sheet?

Robert N. West © VEMBA Accounting Percentage of Accounts Receivable Based on past history, I can determine the bad debt percentage for each accounts receivable age group.

Robert N. West © VEMBA Accounting Percentage of Accounts Receivable Then, I can compute the estimated uncollectible amount for each category by: Aged Category Balance × Bad Debt% Estimated Uncollectible Amt.

Robert N. West © VEMBA Accounting Percentage of Accounts Receivable

Robert N. West © VEMBA Accounting Percentage of Accounts Receivable By adding the estimated uncollectible total for each aged category, I can determine the desired balance for the allowance for uncollectible accounts.

Robert N. West © VEMBA Accounting Percentage of Accounts Receivable

Robert N. West © VEMBA Accounting Percentage of Accounts Receivable The adjusting entry is made for the difference between (1) The total estimated uncollectible amount and (2) The balance before adjustment in the Allowance for Uncollectible Accounts

Robert N. West © VEMBA Accounting Percentage of Accounts Receivable Assume that the balance in the allowance for uncollectible accounts is $350 (credit) before any adjustment is made. Determine the amount of the journal entry to record uncollectible accounts.

Robert N. West © VEMBA Accounting Percentage of Accounts Receivable

Robert N. West © VEMBA Accounting Write-off of Accounts Receivable Occasionally it will become apparent that a specific account receivable will not be collected.

Robert N. West © VEMBA Accounting Write-off of Accounts Receivable At this point, the specific account receivable should be written off:

Robert N. West © VEMBA Accounting Write-off of Accounts Receivable No effect on the income statement No effect on total assets No effect on net realizable value

Robert N. West © VEMBA Accounting Recovery of Accounts Receivable Written Off If an account that has been written off subsequently becomes collectible, simply reverse the write-off entry.

Robert N. West © VEMBA Accounting Factoring Selling accounts receivable at face value less a service charge With recourse Without recourse

Robert N. West © VEMBA Accounting Pledging Using accounts receivable as collateral for a loan Company normally retains title of receivables Proceeds from receivable used to repay the loan

Robert N. West © VEMBA Accounting Note Receivable Promissory Notes Maker Payee Principal Interest Maturity Date

Robert N. West © VEMBA Accounting Analyzing Trade Receivables Average receivable collection period Average accounts receivable balance Total credit sales /365 days = This ratio provides a rough measure of the length of time that a company’s accounts receivable have been outstanding.