Introduction to Financial Accounting Horngren Sundem Elliott Philbrick

Introduction to Financial Accounting Horngren | Sundem | Elliott | Philbrick Accounting for Sales 11 e Chapter 6

Learning Objective 1 Recognize Revenue Items at the Proper Time on the Income Statement

LO-1 Sales Revenue q Critical to measurement of net income § Directly increases net income § Reduces net income by triggering recognition of certain expenses q Changes in revenue and net income have profound impact on stock prices Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall. 6 -3

Existing Standard for Revenue Recognition q LO-1 Two-pronged test § Company has delivered goods or services to the customer; that is, it has earned the revenue § Company has received cash or an asset virtually assured of being converted into cash; that is, the revenue is realized or realizable Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall. 6 -4

Learning Objective 2 Account for Sales, Including Sales Returns and Allowances, Sales Discounts, and

Measurement of Sales Revenue q LO-2 Measured in terms of cash-equivalent value of asset received § A $100 cash sale § A $100 credit sale Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall. 6 -6

LO-2 Measurement of Sales Revenue q Is complex when the cash-equivalent value of the asset received is not obvious § Receiving goods or services instead of cash q Cash-equivalent value of the goods or services received must be estimated § Cash received less than the listed price of item § Inability or unwillingness of customer to pay amount owed Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall. 6 -7

Measurement of Sales Revenue LO-2 Gross sales: Total amount of sales before deducting returns, allowances, and discounts q Net sales: Total amount of sales after deducting returns, allowances, and discounts q § Amount actually received that constitutes revenue to the company Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall. 6 -8

Merchandise Returns and Allowances q LO-2 Sales returns or purchase returns § Merchandise returned by the customer q Sales allowance or purchase allowance § A reduction of the original selling price q Both sales returns and sales allowances are deducted from gross sales to determine net sales Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall. 6 -9

Merchandise Returns and Allowances q LO-2 Contra revenue account § Used instead of reducing the revenue account directly § Combines both returns and allowances § Helps monitor changes in the level of returns and allowances § Helps in forecasting demand managing inventory Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall. 6 -10

Merchandise Returns and Allowances LO-2 A company has $900, 000 gross sales on credit and $80, 000 sales returns and allowances q Journal entries q Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall. 6 -11

LO-2 Trade and Cash Discounts Trade discounts: Reductions to the gross selling price for a particular class of customers q Cash discounts: Reductions in the amount owed by customers due to prompt payment q Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall. 6 -12

Gross Method for Cash Discounts q LO-2 Product sold at $30, 000 on terms 2/10, n/60 § Sale of equipment § Cash collected at discount § Full cash collected Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall. 6 -13

Net Method for Cash Discounts q LO-2 Using net method for the cash discounts § Sale of equipment § Cash collected at discount § Full cash collected Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall. 6 -14

Advantages of Cash Discounts LO-2 Encourage prompt payment thus reduce seller’s need for cash q Reduce risk of bad debts q A way to compete with other sellers q Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall. 6 -15

LO-2 Recording Charge Card Transactions q Credit card companies charge retailers a fee § Retailers receive an amount less than the listed sales price q Retailers accept cards to: § Attract credit customers who would otherwise shop elsewhere § Get cash immediately instead of waiting for credit customers to pay § Avoid the cost of tracking, billing, and collecting customers’ accounts Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall. 6 -16

Recording Charge Card Transactions (cont. ) q LO-2 Example - Credit sales of $10, 000 and 3% of sales charged as credit card services Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall. 6 -17

Accounting for Net Sales Revenue q LO-2 A detailed income statement contains multiple elements

Learning Objective 3 Estimate and Interpret Uncollectible Accounts Receivable Balances Copyright © 2014 Pearson

Credit Sales q LO-3 Create challenges for measuring revenue and managing company’s assets § Requires management of expected future payments, accounts receivable, to ensure their collection in a timely manner Benefits - Boost in sales and profit q Costs - Administration and bad debts q § Requires clerical time and effort § Delay in receiving payments Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall. 6 -20

Uncollectible Accounts q LO-3 Receivables that credit customers are unable or unwilling to pay § Also called bad debts q Bad debt expense: Loss arising from uncollectible accounts Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall. 6 -21

LO-3 Specific Write-Off Method of accounting for bad debt losses that assumes all sales are fully collectible until proven otherwise q Does not misstate economic situation if uncollectibles are small and infrequent q Fails to apply matching principle of accrual accounting q Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall. 6 -22

Bad Debt Recoveries LO-3 Accounts receivable that were previously written off as uncollectible but then collected at a later date q To maintain the customer’s true payment history: q § Reverse the write-off § Handle collection as normal receipt on account Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall. 6 -23

LO-3 Bad Debt Recoveries q Recovery in 20 X 3 of $500 that was written off in year 20 X 2 § Reversing write-off of account § Recording collection on account Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall. 6 -24

Allowance Method q LO-3 A method of accounting for bad debt losses that uses: § Estimates of the amount of sales or receivables that will ultimately be uncollectible § A contra account that contains the estimated uncollectible amount to be deducted from the total accounts receivable Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall. 6 -25

Allowance Method q LO-3 Allowance for uncollectible accounts § A contra asset account that measures the amount of receivables estimated to be uncollectible § Also called allowance for doubtful accounts or allowance for bad debts Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall. 6 -26

Allowance Method q LO-3 Following are the associated journal entries Copyright © 2014 Pearson

Allowance Method q LO-3 Superior in accurately measuring: § Annual accrual accounting income § Year-end accounts receivable asset q Relies on: § Historical experience § Information about economic circumstances and customer composition Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall. 6 -28

Allowance Method q LO-3 Represented in balance sheet as: Copyright © 2014 Pearson Education,

Bad Debt Recoveries and the Allowance Method q Write off uncollectible account in 20 x 2 q Reverse write-off in 20 x 3 q Collection of account in 20 x 3 Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall. LO-3 6 -30

Learning Objective 4 Assess the Level of Accounts Receivable Copyright © 2014 Pearson Education,

LO-4 Accounts Receivable Turnover Measure of the ability to control receivables q Derived by dividing credit sales by average accounts receivable for the period during which the sales are made q Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall. 6 -32

Accounts Receivable Turnover LO-4 A turnover of 12 - On average, the company collects receivables after 1 month q High turnover - Indicates that a company collects its receivables quickly q § Lower turnovers indicate slower collection cycles Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall. 6 -33

LO-4 Accounts Receivable Turnover q Days to collect accounts receivable § Number of days taken to collect receivables § 365 ÷ Accounts receivable turnover § Called average collection period q Problems in comparing accounts receivable turnover § Companies do not disclose their credit sales q Computations available to the public are generally based on total sales Copyright © 2014 Pearson Education, Inc. Publishing as Prentice Hall. 6 -34

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