COPYRIGHT © 2008 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license. 1 Chapter 6 Selling a Product or Service Albrecht, Stice, Stice, Swain

2 Three Major Activities of a Business Operating Activities –Selling products and services. –Acquire inventory for resale. –Acquire and pay for other operating items. Always associated with the primary activities of a business.

3 Three Major Activities of a Business Investing Activities –Buying and selling property, plant, and equipment. –Buying and selling stocks and bonds of other companies. Financing Activities –Debt Financing –Equity Financing These activities occur less often and the amounts are usually quite large.

4 Revenue Recognition Recognize revenue when: The earning process is substantially complete. Cash has either been collected or collection is reasonably assured

5 Application of Revenue Recognition Criteria How do most companies handle revenue recognition? –Record sales when goods are shipped to customers. –Recognize credit sales as revenues before cash is collected. –Recognize revenues from services when the service is performed, not necessarily when cash is received.

6 Credit Sale and Collection When the inventory is sold on account: Jan. 10Accounts Receivable ,000 Sales Revenue ,000 Sold equipment to FlyHigh on account. When the collection takes place: Feb. 1Cash ,000 Accounts Receivable ,000 Payment from FlyHigh for equip. sold. On January 10, Hatch Aerospace sold FlyHigh Airlines $10,000 of equipment on account. Hatch Aerospace received payment on February 1. What entries are made?

7 Sales Discounts –A reduction in the selling price that is allowed if payment is received within a specified period of time. –Often quoted as “2/10 n/30” meaning a 2% discount is offered if paid within 10 days. The full amount is due within 30 days. When the payment is received within discount period: Cash Sales Discounts Accounts Receivable To record discount taken by customer.

8 Sales Returns and Allowances –A reduction in sales due to the return of, or allowance for reduction in the price of, merchandise previously sold. When merchandise is returned: Sales Returns and Allowances Cash Accounts Receivable To record merchandise returned by customer.

9 Computing Net Sales Gross Sales – Sales Discounts – Sales Returns and Allowances = Net Sales Contra Account –An account that is offset or deducted from another account. –Sales Discounts and Sales Returns are contra accounts deducted from Gross Sales.

10 Controls of Cash Separation of duties. –Handling of cash separated from recording the cash in the accounting records. –Someone cannot just keep the cash and not record it. Daily deposits of all cash receipts. –Prevents the accumulation of large amounts of cash. Payment of all expenditures by prenumbered checks. –Documents all payments so none are forgotten or hidden.

11 Paying on Credit Accounts Receivable –A current asset representing money due for services performed or merchandise sold on credit. Bad debt –An uncollectible account receivable. –If you sell on credit, you are going to have bad debts!

12 Direct Write-Off Method Direct write-off method –Recording of losses as expenses during the period in which accounts receivable are determined to be uncollectible. Violates the matching principle! When the account is deemed uncollectible: Bad debt expense ,500 Accounts Receivable ,500 To write off an uncollectible account.

13 The Allowance Method –Estimating the losses from uncollectible accounts as expenses during the period in which the sale occurs. When sales are made: Bad debt expense ,500 Allowance for Bad Debts ,500 To record the estimated bad debt expense for the year. When accounts are deemed uncollectible: Allowance for Bad Debts Accounts Receivable To write off bad debt.

14 Reinstating Accounts Receivable When payment is made: Accounts Receivable Allowance for Bad Debts To reinstate the balance previously written off. Cash Accounts Receivable Received payment in full of previously written off account. When someone pays after their account is written off.

15 The Estimation Process Percentage of sales –Based on prior years experience. –Any existing balance in the allowance account is not considered in the adjusting entry. Percentage of total receivables –Based on percentage of ending receivables balance. –The estimated percentage is the ENDING balance in the allowance account. Adjusting entry is what gets the allowance to that amount. Aging accounts receivable –Apply different estimates of uncollectible receivables to different receivable age. –The estimated percentage is the ENDING balance in the allowance account. Adjusting entry is what gets the allowance to that amount.

16 Managing Receivables It’s a balance! Extending credit to increase sales Vs. Collecting cash quickly to reduce your need to borrow

17 Measuring the Management of Receivables Accounts Receivable Turnover –How many times during the year a company collects its receivables. Sales Revenue Average Accounts Receivable

18 Measuring the Management of Receivables Average Collection Period –The average number of days it takes to collect a credit sale. 365 Accounts Receivable Turnover Calculated as sales divided by average accounts receivable. (Shown in previous slide).

Bank Statement The Big Bank Bank Statement January 30, 2001 Cash Balance, January 1, Deposits – Checks processed Cash Balance, January 30,

20 Bank Reconciliations Differences between the bank statement and the cash account. –Timing differences. Outstanding checks. Deposits in transit. –Banking entries. Service charges. NSF checks. Direct deposits. Interest paid. –Accounting Errors. Journal entries need to be made to record these entries on the company’s books.

21 Reconciling the Bank Account Beg. Bank balance + Deposits in transit – Outstanding checks +/– Bank errors =Adj. Bank Balance Beg. Book balance + Interest paid + Direct deposits – Service charges – NSF checks +/– Accounting errors =Adj. Book Balance Account is reconciled when both the adjusted balances are equal.

An Example of Bank Reconciliation Bal per bank stmt$14,422 Additions to Bank Bal Deposit in Transit 3,100 Total$17,522 Deductions from bank Balance Outstanding Checks #631$326 # # (937) Adj. Bank Bal$16,585 Bal per Books $13,937 Additions to book bal Direct deposit $3,200 Interest 60 3,260 Total $17,197 Deductions from book bal Service charge $ 7 Bank transfer 425 Error recording Ck #630(Jones wages) 180 (612) Adj. Book Bal $16,585