Learning Objectives (LO)

After studying this chapter, you should be able to

Accounting for Sales

CHAPTER

1. Recognize revenue items at the proper time on the income statement 2. Account for cash and credit sales 3. Compute and interpret sales returns and allowances, sales discounts, and bank credit card sales 4. Manage cash and explain its importance to the company 5. Estimate and interpret uncollectible accounts receivable balances

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Learning Objectives (LO)

After studying this chapter, you should be able to
6. Assess the level of accounts receivable 7. Develop and explain internal control procedures 8. Prepare a bank reconciliation

LO 1 Revenue Recognition
The timing of revenue recognition is important since it is critical to the measurement of income. Cash-basis revenues are recognized when cash is collected for goods or services. Accrual basis recognition of revenue occurs at the point of sale. Both IFRS and U.S. GAAP require the following two criteria be met for revenue recognition:
Revenue is earned goods or services must be delivered to the customer Revenue is realized cash or an asset virtually assured to be converted into cash is received

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LO 1 Revenue Recognition
Percentage of Completion Method recognizes revenue on long term contracts as production occurs and assigns the associated expenses to abide by the matching principle. US GAAP considers the usage of the method

LO 2 Cash and Credit Sales Revenue

Revenue is recorded at the present cash value of the asset received. Cash sales
Cash Sales Revenue 100 100 100 100

appropriate only if:

the progress measures are dependable contract obligations are explicit both seller and the buyer are expected to meet their obligations.

Credit sales
Accounts Receivable Sales Revenue

Gross sales total amount of sales before deducting returns, allowances and discounts. Net sales gross sales less returns, allowances and discounts.
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IFRS is not that specific with these requirements

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LO 3 Sales Returns, Allowances, Trade and Cash Discounts, Credit Card Fees
Income Statement
Gross Sales $1,400 Less Sales Returns ($100) Contra Revenue Sales Allowances ($10) Accounts Trade Discounts ($10) (Debit Balance) Cash Discounts ($2) Credit Card Fees ($3) $125 Net Sales $1,275 Reports to shareholders typically omit details and show only net revenues

LO 3 Sales Returns
Sales Returns - previously purchased merchandise returned to the seller for any reason
Accounts Receivable Sales Revenue Cost of Goods Sold Inventory 100 100 60 60
The purchase

Sales Returns 100 Accounts Receivable Inventory 60 Sales Returns and Allowances

100 60 Contra Account

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LO 3 Sales Allowances
Sales Allowance reduction of the original selling price mostly to settle customer complaints
Accounts Receivable Sales Revenue Cost of Goods Sold Inventory 100 100 60 60

LO 3 Cash and Trade Discounts

Trade discounts reductions to the gross sales price for a particular class of customers or for differing order sizes. Cash discounts reductions of invoice prices for prompt payment; rewards extended to the customers
Example: Customer buys 10 at $10 a piece and gets 10% off
Accounts Receivable Trade Discounts Sales Revenue
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Purchaser notes lower price ($90) at another store and asks for a $10 price reduction
Sales Returns and Allowances Accounts Receivable
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LO 3 Cash Discounts
n/30 The full billed price (net price) due in 30 days after the invoice date. 15 E.O.M. The full price is due within 15 days after the end of the month of sale. 2/10/n30 2% off invoice price, if paid within 10 days of invoice date; net amount due in 30 days after invoice date.

LO 3 Cash Discounts

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LO 3 Cash Discounts
Should cash discounts (2/10/n30) be taken?
Choices Get 2 % reduction if pay within 10 days Get to use your own funds for 20 days at a 2% interest cost (what you sacrificed by not taking it) 360/20 days = 18 20-day periods in a year 18 x 2% each period = 36% annual interest rate If can/must borrow at < 36% annual interest - take the discount > 36% annual interest - forego discount
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LO 3 Charge Cards
Benefits of accepting charge cards:
Attract credit customers who would otherwise shop elsewhere or forego a purchase Get cash immediately instead of waiting for customers to pay in due course Avoid the cost of tracking, billing, and collecting customers accounts.

Costs of accepting charge cards:

Typically 1-4% of gross sales, depending on the issuer of the card or sales volumes
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LO 4 - Cash
Cash and cash equivalents or usually listed on the balance sheets as a single amount Cash money (at hand or in the bank), money orders, checks Cash equivalents - highly liquid short-term (less than 90 days until maturity) investments that can easily and quickly be converted into cash (examples: time deposits, commercial paper, 90day Treasury bills, etc.) Compensating balances - required minimum cash balances on deposit in a bank to compensate for one or more services
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LO 4 - Cash
Cash management is important and therefore justifies strong internal controls
Although the cash balance may be small at any one time, the flow of cash may be enormous Cash, being the most liquid asset, is enticing to thieves and embezzlers Adequate cash is essential to run the business Cash earns little to no return (generally the least productive of all the assets); holding excess cash is inefficient Cash loses purchasing power during inflationary times justifying holding little excess cash
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LO 4 - Cash
The major internal control procedures set up to safeguard cash include:
Separate persons receive and disburse cash Separate persons handle cash and accessing accounting records Record and deposit cash receipts immediately Make disbursements using serially numbered checks, and require proper authorization by someone other than the person writing the check Reconcile bank accounts monthly by someone who does not write the checks

L O 5 - Uncollectible Accounts
Two methods to measure uncollectible accounts
Specific Write-off Method: assumes all receivables are collectable until proven otherwise; is used by companies that rarely experience bad debts; writesoff the specific receivable when it is apparent that it will not be collected. Pros : less costly, Cons : violates the matching principle. Allowance method: estimates the amount of uncollectible accounts at year end; net income and receivables are reduced to reflect potential uncollectible accounts. Pros : better matching, Cons : prone to manipulations
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L O 5 - Uncollectible Accounts
Specific Write -off Method
Bad Debts Expense Accounts Receivable 200 200

LO 6 - Assessing Accounts Receivable

Cash sales produce cash instantly Credit sales generally cause sales to increase but they also delay cash receipts.
Major credit cards Just a few days before credit card company transfers cash to the company Some treat these receivables as cash equivalents Company credit cards using last years data How long did it take to collect receivables Is that length of time acceptable?
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Allowance method
Adjusting entry at year-end (* Contra Receivable)
Bad Debts Expense 4000 Allowance of Doubtful Accounts * 4000

Write off a $200 account this or next year

Allowance for Doubtful Accounts * 200 Accounts Receivable, Jones
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LO 6 - Assessing Accounts Receivable

Accounts Receivable Turnover Ratio
Credit Sales Average Receivables $1,000,000 $115,000 + $112,000 2 = 8.81

LO 7 - Internal Control
Internal control - a system of checks and balances that ensures company actions are proper and approved by management
Administrative controls are methods and procedures that facilitate management planning and control of operations, through Reporting (org. chart, responsibilities and relationships) Budgeting Performance evaluation Procedures for granting credit to customers Protecting assets, etc.
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On average, receivables were created then collected 8.81 times in the past year Higher turnovers indicate that a company collects its receivables faster

Number of days to collect Accounts Receivable

365 days per year Receivables Turnover Ratio 365 8.81 = 41.4 days

On average, last year receivables were collected 41.4 days after being created
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LO 7 - Internal Control
Accounting controls include the methods and procedures for authorizing transactions, safeguarding assets, and ensuring the accuracy of the financial records.
Authorization Transactions are executed in accordance with management's general or specific intentions. Recording All authorized transactions are recorded in the correct amounts, periods, and accounts. No fictitious transactions are recorded. Safeguarding Precautions and procedures appropriately restrict access to assets. Reconciliation Records are compared with other independently kept records and physical counts. Valuation Recorded amounts are periodically reviewed for impairment of values and necessary write-downs. Operating efficiency Management should recognize that an internal control system's purpose is as much a positive one (promote efficiency) as a negative one (preventing errors and fraud).
Introduction to Financial Accounting, 10/e

LO 7 - Internal Control
Good internal control systems should have the following in place:
Reliable personnel with clear responsibilities Separation of duties Proper authorization Adequate documentation (source documents) Well-documented policies and procedures Physical safeguards over items of value Bonding, vacations and rotation of duties Independent review of all systems Cost-benefit considerations should apply

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