1 Chapter 7 Sales and Collection Cycle

2 Business Process Making a sale and accounting for sale - related Decisions - what to sell, how, much to sell for Ie. Sales discount

3 Accounts Receivable Largest current asset Managing size and conversion to cash Credit policies Collection efforts Selling A/R - factoring

4 Sales Cycle Firm sells to customers that pay Goods and services are delivered Customers billed correctly Money received and deposited Recording to sale Collecting payment

5 Timing of Revenue Recognition Recognized and reported on income statement Accrual accounting - not concerned about cash collection GAAP - accrual accounting Recognized - earnings process is virtually complete, collection reasonably

6 Study Break 7-1 Cash100,000 Unearned Rev100,000 Unearned Rev50,000 Ticket Rev Earned50,000 Unearned Rev33,333 Ticket Rev Earned33,333

7 Sales Discounts If pay bills promptly 2/10, n/30 Deducted from sales - income statement Contra-revenue account

8 Study Break 7-2 Accounts Receivable3,500 Sales3,500 Cash3,395 Sales Discount105 Accounts Receivable3,500

9 Sales Returns Return merchandise Refund - full or partial cash, credit Separate from sales Contra-revenue account - see both numbers Deducted from sales

10 Payment for Goods and Services Customers - Two choices - cash or credit Analyze risks Controls

11 Accounting For Cash: Reconciling The Bank Statement An important part of internal control, segregation of duties Need for calculating a true cash balance Two “sides” to be reconciled - SAME balance per bank balance per books Locate errors and make adjustments

12 Accounting For Cash: Examples Company books know Outstanding check Deposit in transit Bank knows Service charge NSF - nonsufficient funds check Interest earned Miscellaneous charges Miscellaneous credits Notes collected

13 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

14 Study Break 7-3 Balance per book $2,400 Interest 100 Collection300 Service Charge(100) True cash balance $2,700 Cash300 Misc Oper Exp100 Accounts Receivable300 Interest Revenue100

15 Account Receivables Do not expect to collect 100% Balance Sheet - business expects to collect Accounting for uncollectible accounts Direct write-off method Not GAAP Write off when identified Allowanced method Estimated and matched Recorded at end of period GAAP Bad debt expense

16 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

17 Study Break 7-4 Accounts identified and written off - bad debt expense no journal entries required 2006 Bad debt expense35 Accounts receivable35

18 Allowance method GAAP - matching principle - with related sale Estimated - recognize expense Allowance for uncollectible accounts - deducted from Accounts receivable - contra asset account Net realizable value - amount expected to be collected - book value or carrying value Expense - don’t wait until bad debt identified

19 Allowance Method, continued Two allowance methods - estimating with Sales - Income Statement Method  Estimate based upon credit sales or total sales Accounts Receivable - Balance Sheet Method  Accounts receivable - starting point  Aging schedule - length of time outstanding Problem Reduction of both accounts receivable and allowance - no effect in net accounts receivable

20 Bad debt expense400 Allowance for uncollectible accounts = 400 Estimate - prior year overestimate = current estimate 9,500 = 10, net realizable value Study Break 7-5

21 Credit Card Sales Credit card company is responsible for evaluating a persons credit worthiness and collecting payments Cost compared to benefits

22 Accounts Receivable4,850 Credit card expense150 Sales revenue5,000 5,000 *.97 = 4,850 Study Break 7-6

23 Other Accounting Issues Related to Sales: Warranty Costs Why give warranties? Sales and marketing tool Strategic decision When should expense be recognized? Time of sale - matching principle Estimated future costs Warranty

24 Study Break 7-7 No warranty expense recorded - previously recorded with sale Estimated warranty liability500 Cash500

25 Finding and using information Revenue recognized when earned, often before collected Analysis Current ratio - quick ratio, acid test ratio Accounts receivable turnover ratio - measures ability to collect cash from credit customers # of days to collect

26 Business risks Policies and procedures Preventive controls Detective controls Corrective controls