1. Reporting and Interpreting Sales Revenue, Receivables, and Cash
Chapter 6
Chapter 6: Reporting and Interpreting Sales Revenue, Receivables and Cash

2. Accounting for Sales Revenue
The revenue principle requires that revenues be recorded when earned.
Goods or services have been delivered.
There is persuasive evidence of a customer payment arrangement
The revenue principle requires that revenues be recorded when earned. delivery has occurred or services have been rendered, there is persuasive evidence
of an arrangement for customer payment, the price is fixed or determinable, and collection is
reasonably assured). Revenues are considered to be earned when the following conditions are met:
1. Goods have been delivered or services have been rendered.
2. There is persuasive evidence of an arrangement for customer payment.
3. The price for the goods or services is known.
4. Collection from the customer is reasonably assured.
Price is fixed or determinable.
Collection is reasonably assured.

3. Reporting Net Sales
Companies record credit card discounts, sales discounts, and sales returns and allowances separately to allow management to monitor these transactions.
Companies record credit card discounts, sales discounts, and sales returns and allowances separately to allow management to monitor these transactions. Credit card discounts, sales discounts, and sales returns and allowances are contra-revenue accounts, deducted from sales revenue in the income statement to arrive at net sales.

4. Accounting for Bad Debts
Bad debts result from credit customers who will not pay the amount they owe, regardless of collection efforts.
Matching Principle
Bad Debt Expense
Sales Revenue
Record in same accounting period.
Businesses extend credit to customers to stimulate sales, but credit sales are not without costs. Some customers may be unwilling or unable to pay off their accounts receivable. Bad debts result from credit customers who will not pay the amount they owe, regardless of collection efforts. Companies must account for the fact that these customers may not be able to pay the amounts they owe. We will focus on the allowance method of accounting for bad debts.
The allowance method attempts to match bad debts expense in the period with the related revenue.
Since the actual amount of bad debts may not be known with certainty at the end of an accounting period, businesses record an estimate of the bad debt expense with an adjusting entry.
Most businesses record an estimate of the bad debt expense with an adjusting entry at the end of the accounting period.

5. Recording Bad Debt Expense Estimates
Deckers estimated bad debt expense for 2008 to be $27,567,000. Prepare the adjusting entry.
To illustrate the adjusting entry to record the estimate for bad debts, we will look at an example from Deckers Outdoor Corporation. Deckers estimated bad debt expense for 2008 to be $27,567,000.
In the adjusting entry, Deckers debits bad debt expense and credits allowance for doubtful accounts for $27,567, Bad debt expense is normally classified as a selling expense on the income statement. Allowance for doubtful accounts is a contra asset account that is deducted from accounts receivable on the balance sheet.
Contra asset account
Bad Debt Expense is normally classified as a selling expense and is closed at year-end.

6. Allowance for Doubtful Accounts
Balance Sheet Disclosure
Amount the business expects to collect.
Because we do not want to overstate assets, we must show accounts receivable at its net realizable value on the balance sheet. The allowance for doubtful accounts is subtracted from the accounts receivable balance to determine net realizable value. This is the amount of accounts receivable that we actually think we will collect.

7. Estimating Bad Debts ─ Percentage of Credit Sales Method
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.
Using the percentage of credit sales method, a bad debt percentage is based on records of actual uncollectible accounts from prior years’ credit sales. The focus is on determining the amount to record on the income statement as bad debt expense.
When using the percentage of credit sales method, the bad debt expense estimate at the end of the period is determined by multiplying current period credit sales by an established bad debt loss rate percentage. The bad debt loss rate percentage is determined based on past history of the company and current economic trends.

8. Estimating Bad Debts ─ Aging of Accounts Receivable
When using the aging of accounts receivable method, a desired balance in the Allowance account is calculated. The amount of the journal entry is impacted by the current balance in the Allowance account. For example if the allowance account has a credit balance, that amount is subtracted to determine the amount of the journal entry.
However, if the allowance account has a debit balance, that amount is added to the desired balance to determine the amount of the adjustment for the journal entry. A debit balance in the allowance account results when specific write-offs for the year are larger than the balance provided at the beginning of the year.

9. Focus on Cash Flows Add Decrease in Accounts Receivable
Subtract Increase in Accounts Receivable
Cash Collected from Customers
Sales
Revenue
When there is a decrease in accounts receivable for the year, cash collections from customers are more than sales revenue. Using the indirect method of preparing the cash flow from operating activities portion of the statement of cash flows, we add the decrease in accounts receivable to reported net income.
When there is an increase in accounts receivable for the year, cash collections from customers are less than sales revenue. Using the indirect method of preparing the cash flow from operating activities portion of the statement of cash flows, we subtract an increase in accounts receivable from reported net income.

10. Cash and Cash Equivalents
Money Orders
Checks
Cash and Cash Equivalents
Cash includes currency, coins, and amounts on deposit in bank accounts, checking accounts, and savings accounts. Cash equivalents are short-term, highly liquid investments that are easily converted into a known amount of cash, are close to maturity, and are not sensitive to interest rate changes. Cash and cash equivalents are usually combined on the balance sheet.
Certificates of Deposit
Bank Drafts
T-Bills

11. Internal Control of Cash
Internal control refers to policies and procedures designed to:
Properly account for assets.
Safeguard assets.
Ensure the accuracy of financial records.
Cash is the asset most susceptible to theft and fraud.
An internal control system is a collection of policies and procedures that safeguards assets, ensures reliable accounting, promotes efficient operations, and urges adherence to company policies and applicable laws and regulations.
Specifically, internal controls should assist companies in maintaining adequate accounting information, ensure that all transactions are legitimate and properly authorized, and detect or prevent the unauthorized use of company assets. Of all assets, cash is the most susceptible to theft and fraud. For that reason, effective cash controls are essential.
Separation of duties is one internal control practice that companies use to protect cash. The person handling cash should not be responsible for recording cash transactions. All disbursements should be duly authorized.
Separation of Duties
Authorization
Recording
Custody

12. Internal Control of Cash
Bank Reconciliations
Cash
Controls
Daily Deposits
Purchase Approval
In addition to separation of duties, internal controls for cash include:
Promptly reconciling bank statements.
Proper authorization for purchases.
Proper authorization for cash payments.
Making all payments using prenumbered checks.
Allowing only a limited number of persons authorized to sign checks.
Requiring daily deposits of cash receipts.
Payment Approval
Check Signatures
Prenumbered Checks

13. Bank Reconciliation
Explains the difference between cash reported on bank statement and cash balance on company’s books and provides information for reconciling journal entries.
Balance per Bank
Balance per Book
+ Deposits by Bank
(credit memos)
+ Deposits in Transit
- Outstanding Checks
All businesses should prepare a bank reconciliation each month. The bank reconciliation should not be prepared by the same person who handles cash or accounts for cash transactions. A bank reconciliation explains the difference between the cash balance in the general ledger account and the amount shown on the bank statement. A bank reconciliation will identify any errors that need to be corrected by the company or the bank. Why are the balances different on the bank statement and on the cash ledger? Because of timing differences.
When we prepare a bank reconciliation, there are two sections. In one section, we reconcile the bank statement balance to the correct balance. In the other section, we reconcile the book balance to the correct balance. The correct balances in both sections should be equal.
On the bank’s side, we will start with the balance on the bank statement and adjust it for outstanding checks, deposits in transit, and errors made by the bank.
On the book’s side, we will start with the cash balance in the ledger and adjust it for collections made by the bank on our behalf, interest earned, bank service charges, customer checks that were drawn on accounts that were nonsufficient, and errors we made.
Examples of collections made by the bank on our behalf are when the bank acts as a collection box for customer payments or when the bank collects a note receivable for us from a customer.
- Service Charge
- NSF Checks
± Bank Errors
± Book Errors
= Correct Balance
= Correct Balance

14. Bank Reconciliation
Explains the difference between cash reported on bank statement and cash balance on company’s books and provides information for reconciling journal entries.
All reconciling items on the book side require an adjusting entry to the cash account.
Balance per Bank
Balance per Book
+ Deposits by Bank
(credit memos)
+ Deposits in Transit
All reconciling items on the book side require an adjusting entry to the cash account.
Now, let’s look at an example of a bank reconciliation.
- Outstanding Checks
- Service Charge
- NSF Checks
± Bank Errors
± Book Errors
= Correct Balance
= Correct Balance

15. End of Chapter 6
End of chapter 6.