1. 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. 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. 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. 4 Revenue Recognition Recognize revenue when: The earning process is substantially complete. Cash has either been collected or collection is reasonably assured. 1. 2.

5. 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. 6 Credit Sale and Collection When the inventory is sold on account: Jan. 10Accounts Receivable..........10,000 Sales Revenue.............10,000 Sold equipment to FlyHigh on account. When the collection takes place: Feb. 1Cash.......................10,000 Accounts Receivable.......10,000 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. 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............................. 196 Sales Discounts.................... 4 Accounts Receivable............. 200 To record discount taken by customer.

8. 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....... 150 Cash.......................... 50 Accounts Receivable............ 100 To record merchandise returned by customer.

9. 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. 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. 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. 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.................. 1,500 Accounts Receivable............. 1,500 To write off an uncollectible account.

13. 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.................. 1,500 Allowance for Bad Debts.......... 1,500 To record the estimated bad debt expense for the year. When accounts are deemed uncollectible: Allowance for Bad Debts............. 600 Accounts Receivable............. 600 To write off bad debt.

14. 14 Reinstating Accounts Receivable When payment is made: Accounts Receivable................ 600 Allowance for Bad Debts.......... 600 To reinstate the balance previously written off. Cash............................. 600 Accounts Receivable............. 600 Received payment in full of previously written off account. When someone pays after their account is written off.

15. 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. 16 Managing Receivables It’s a balance! Extending credit to increase sales Vs. Collecting cash quickly to reduce your need to borrow

17. 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. 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).

19. 19 Warranty Costs Estimates of warranty costs are made and recorded at the time of sale. (Estimate usually based as a percentage of sales.) The company will show an existing warranty liability at year end. When warranty repairs are made, the liability is reduced. Entry at time of sale: Warranty Expense....................500 Estimated Warranty Liability......... 500 To record estimated service costs on sale. Entry when repairs are made: Estimated Warranty Liability............ 200 Wages Payable.................... 150 Supplies.......................... 50 To record actual warranty costs.

20. 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. 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.

22. 22 Foreign Currency Transactions A sale in which the price is denominated in a currency other than the seller’s home country currency. –Receivable is entered at date of sale using current exchange rate. –Receivable is adjusted at period end to reflect change in exchange rate. A gain or loss is recognized. –A gain or loss is recognized when the receivable is paid reflecting movement in exchange rate since period end.

23. 23 Foreign Currency Example On November 6, 2009, the company provided services to a client in Thailand for 100,000 Thai baht. On November 6, the exchange rate was 50 baht for one U.S. dollar. The exchange rate on December 31 was 40 baht for one U.S. dollar. The company received payment on the account on March 23, 2010 when the exchange rate was 100 baht for one U.S. dollar. Make all of the necessary journal entries.

24. 24 Foreign Currency Example When the services are performed: Accounts Receivable (fc)............ 2,000 Service Revenue................ 2,000 To record service revenue denominated in Thai baht (100,000 Thai baht ÷ 50 Thai baht per dollar = $2,000). At year end: Accounts Receivable (fc)............ 500 Foreign Currency Gain........... 500 To record exchange gain on receivable denominated in Thai baht (100,000 Thai baht ÷ 40 Thai baht per dollar = $2,500, $2,500 – $2,000 = $500).

25. 25 Foreign Currency Example When receivable is paid: Cash............................. 1,000 Foreign Currency Loss..............1,500 Accounts Receivable............. 2,500 To record the receipt of receivable denominated in Thai baht (100,000 Thai baht ÷ 100 Thai baht per dollar = $1,000, $1,000 – $2,500 = $1,500).