Accounting For Sales PDF

Accounting for Sales
Learning Objectives
After studying this chapter, you should be able to
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
2006 Prentice Hall Business Publishing
Introduction to Financial Accounting, 9/e
Horngren/Sundem/Elliott/Philbrick
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Learning Objectives
After studying this chapter, you should be able to
6. Assess the level of accounts receivable 7. Develop and explain internal control procedures
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Recognition of Sales Revenue

Revenue recognition requires a two-pronged test:
Goods or services must be delivered to the customers ( the revenue must be earned) Cash or an asset virtually assured of being converted into cash must be received (the revenue must be realized)
Most companies recognize revenue at the point of sale
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Measurement of Sales Revenue

A $100 cash sale is recorded as:
Cash Sales Revenue 100 100
A $100 credit sale is recorded as:

Accounts receivable Sales revenue 100
100
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Merchandise Returns and Allowances

Gross sales are the initial revenues or asset inflows based on the initial sales price Gross sales are decreased by the amount of the returns and allowances to calculate the net sales A sales return occurs when a customer returns previously purchased merchandise A sales allowance is a reduction of the original selling price A contra account (Sales Returns and Allowances) combines both returns and allowances in a single account
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Suppose The Disney Store has $900,000 of gross sales on credit and $80,000 of sales returns and allowances The journal entries are:
Accounts receivable Sales Sales returns and allowances Accounts receivable 900,000 900,000 80,000 80,000
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The income statement would show:
Gross sales Deduct: Sales returns and allowances Net sales $900,000 80,000 $820,000
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Cash and Trade Discounts

Trade discounts offer one or more reductions to the gross selling price for a particular class of customers The gross sales revenue recognized from a trade discount sale is the price received after deducting the discount Companies set trade discount terms to be competitive in industries where such discounts are common or to encourage certain customer behavior
2006 Prentice Hall Business Publishing Introduction to Financial Accounting, 9/e Horngren/Sundem/Elliott/Philbrick 9 of 48
Cash and Trade Discounts

Cash discounts are rewards for prompt payment
Credit Terms n/30 Meaning The full billed price (net price) is due on the thirtieth day after the invoice date A 1% discount can be taken for payment within 5 days of the invoice date: otherwise the full billed price is due in 30 days
1/5, n/30
15 E.O.M.
The full price is due within 15 days after the end-of the-month of sale (an invoice dated December 20 is due January 15)
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Recording Charge Card Transactions

There are three major reasons that retailers accept credit cards:
To attract credit customers who would otherwise shop elsewhere To get cash immediately instead of waiting for customers to pay in due course To avoid the cost of tracking, billing and collecting customers accounts
Card companies service charges are typically from 1% to 4% of gross sales

Recording Charge Card Transactions

Suppose VISA charges a company a straight 3% of sales for its credit card services Credit sales of $10,000 will result in cash of only $9,700 [$10,000 (0.03 x $10,000)]
The journal entry is:

Cash Cash discounts for bank cards Sales 9,700 300
10,000
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Accounting for Net Sales Revenue

A detailed income statement might contain multiple elements as follows:
Gross sales Deduct: Sales returns and allowances Cash discounts on sales Net sales $ 1000 $ 270 20
290 $ 710
Reports to shareholders typically omit details and show only net revenues
Cash
Many companies combine cash and cash equivalents on their balance sheets Cash equivalents are highly liquid short-term investments that can easily and quickly be converted into cash. Examples include:
Time deposits Commercial paper 90-day Treasury bills
Cash includes paper money and coins; money orders; and checks
Compensating Balances
Compensating balances are required minimum balances on deposit in a bank to compensate for providing loans Compensating balances increase the effective interest rate that the borrower pays Annual reports must disclose any significant compensating balances
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Management of Cash
Cash management is important because
Although the cash balance may be small at any one time, the flow of cash can be enormous Cash is the most liquid asset, and it is enticing to thieves and embezzlers Adequate cash is essential to the smooth functioning of operations Businesses should not hold excess cash because cash itself does not earn income
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Management of Cash
The major internal control procedures set up to safeguard cash include the following:
Have different individuals receive cash than those who disburse cash Have different individuals handle cash than those who access 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
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Credit Sales and Accounts Receivable

Most sales are on credit, which create Accounts Receivable Credit sales create a new set of problems for measuring revenue and managing the companys assets Credit sales generate potential uncollectible accounts
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Uncollectible Accounts
Granting credit entails both costs and benefits:
The main benefit is the boost in sales and profit that a company generates when it extends credit The most significant cost is uncollectible accounts or bad debtsreceivables that some credit customers are either unable or unwilling to pay The cost of granting credit that arises from uncollectible accounts is called bad debts expense
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Measurement of Uncollectible Accounts

Uncollectible accounts require special accounting procedures There are two basic ways to record uncollectibles:
The specific write-off method The allowance method
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Specific Write-Off Method

The specific write-off method assumes that all sales are fully collectible until proved otherwise When a company identifies a specific customer account as uncollectible, it reduces the Accounts Receivable The journal entry for the write-off of a specific Account Receivable of $40,000 is:
Bad debts expense Accounts receivable
40,000 40,000
Horngren/Sundem/Elliott/Philbrick 21 of 48
Specific Write-Off Method

The specific write-off method fails to apply the matching principle of accrual accounting Matching requires recognition of the bad debts expense at the same time as the related revenue
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Allowance Method
The allowance method has two basic elements:
An estimate of the amounts that will ultimately be uncollectible and A contra account, which contains the estimated uncollectible amount that is deducted from the total Accounts Receivable
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Allowance Method
The contra account is called allowance for uncollectible accounts The contra account recognizes bad debts in general during the proper period before uncollectible accounts from specific individuals are identified in the following period
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Allowance Method
Suppose Compuport
Knows from experience that it will not collect about 2% of sales Has sales in 20X1 of $100,000 Estimates that 2% x $100,000 or $2,000 of the 20X1 sales will be uncollectible Does not know on December 31, 20X1, which customers will fail to pay their accounts
Compuport can still acknowledge the $2,000 worth of bad debts in 20X1
Allowance Method
The journal entries are:
20X1 Sales: Accounts receivable Sales
100,000 100,000
20X1 Allowances: Bad debts expense Allowance for uncollectible accounts
2,000 2,000
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Allowance Method
The journal entry for the write-off of two customer accounts in 20X2 is:
20X2 Write-offs: Allowance for uncollectible accounts Accounts receivable, Jones Accounts receivable, Monterro
2,000 1,400 600
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Applying the Allowance Method Using a Percentage of Sales

Expressing the amount of bad debts as a percentage of total sales is known as the percentage of sales method This approach directly calculates the bad debts expense that appears on the income statement The previous example illustrates this approach
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Applying the Allowance Method Using a Percentage of Accounts Receivable

The percentage of accounts receivable method estimates uncollectible accounts based on the historical relationship between uncollectibles to year-end gross accounts receivablenot sales Additions to the allowance account are calculated to achieve a target ending balance
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Consider the historical experience in the following table:
Accounts Receivable At End Of Year $100,000 80,000 90,000 110000 120,000 112,000 $612,000 $102,000 Bad Debts Deemed Uncollectible and Written Off $ 3,500 2,450 2,550 4,100 5,600 2,200 $20,400 $ 3,400
20X1 20X2 20X3 20X4 20X5 20X6 Six-year total Average (divide by 6)
Average percentage not collected = $3,400 / $102,000 = 3.33%
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Assume the accounts receivable balance is $115,000 at the end of 20X7 The average percentage of accounts receivable not collected is applied to the 20X7 ending balance ($115,000 x 3.33%) The adjusting journal entry is:
Bad debts expense Allowance for bad debts 3,130
3,130
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Applying the Allowance Method Using the Aging of Accounts Receivable

The aging of accounts receivable method directly incorporates the customers payment histories As more time elapses after the sale, collection becomes less likely The $115,000 balance in Accounts Receivable on December 31, 20X7, might be aged as shown on the next slide
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Applying the Allowance Method Using the Aging of Accounts Receivable

Name Oxwall Tools Chicago Castings Estee Sarasota Pipe Ceilcote Other accounts (each detailed) Total Historical bad debt percentages Bad debt allowance to be provided $ 3,772 = $ $ Total 20,000 10,000 20,000 22,000 4,000 39,000 $ 115,000 $ 27,000 72,000 0.10% 72 + $ $ 8,000 25,000 1% 250 + $ $ 1-30 Days $ 20,000 10,000 15,000 $ 5,000 12,000 $ 10,000 3,000 2,000 15,000 5% 750 + $ $ $ 1,000 2,000 3,000 90% 2,700 31-60 Days 61-90 Days More Than 90 Days
The journal entry to record the Bad Debts Expense is $3,772-$700, or $3,072: Bad debts expense Allowance for bad debts
3,072 3,072
Bad Debt Recoveries

When bad debt recoveries occur, the write-off is reversed and the collection is handled as a normal receipt on account The following October journal entries reverse the February write-off of an individual account receivable
Feb. 20X2 Allowance for uncollectible accounts Accounts receivable Accounts receivable Allowance for uncollectible accounts Cash Accounts receivable
2006 Prentice Hall Business Publishing Introduction to Financial Accounting, 9/e
600 600 600 600 600 600

Oct. 20X2
Assessing the Level of Accounts Receivable

One measure of the ability to control receivables is the accounts receivable turnover
Accounts receivable turnover = Credit Sales / Average accounts receivable
Higher turnovers indicate that a company collects its receivables quickly

Lower turnovers indicate slower collection
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Suppose credit sales for Compuport in 20X8 were $1 million and beginning and ending accounts receivable were $115,000 and $112,000, respectively
Accounts receivable turnover = $1,000,000 / 0.5 ($115,000 + $112,000) = 8.81
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The days to collect accounts receivable, or average collection period, is calculated by dividing 365 by the accounts receivable turnover
Days to collect accounts receivable = 365 / Accounts receivable turnover = 365 days / 8.81 = 41.4 days
There is significant variability in accounts receivable turnover levels among industries
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Overview of Internal Control

Internal control is a system of checks and balances that protects company assets and ensures that management maintains accurate financial records. Internal control refers to both administrative controls and accounting controls
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Administrative controls include methods and procedures that facilitate management planning and control of operations. Examples include:
Budgeting procedures Reports on performance Procedures for granting credit to customers
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Accounting controls include the methods and procedures for authorizing transactions, safeguarding assets, and ensuring the accuracy of the financial records Accounting controls should provide reasonable assurance concerning
Authorization transactions are created in accordance with managements intentions Recording transactions are authorized and accurately recorded

Accounting controls should provide reasonable assurance concerning
Safeguarding restrictions on access to assets are appropriate Reconciliation records are verified with other independently kept records or confirmed by physical counts Valuation recorded amounts are periodically reviewed for impairment of values and necessary write-downs Operational Efficiency errors and fraud are prevented while promoting efficient actions
The Accounting System

The accounting system handles many repetitive transactions, which fall primarily into four categories:
Cash disbursements Cash receipts Purchase of goods and services, including employee payroll Sales or other rendering of goods and services
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The Accounting System

Well-designed and well-run accounting systems are positive contributions to organizations and the economy For example, integrated inventory controls and ordering systems allow a computer to interact automatically with suppliers to generate orders and reduce delivery times
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Checklist of Internal Control

The following is a checklist of internal controls that a manager might use to create or evaluate specific procedures for cash, purchases, sales, and payroll
Reliable personnel with clear responsibilities Separation of duties The person with custody of assets should not have access to the records of those assets The same individual should not authorize payments and also sign the check in payment of the bill
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Proper authorization Credit limits to customers Approval of overtime Approval of large expenditures for capital assets Adequate documents Companies use source documents to support the immediate, complete, and tamper-proof recording of data
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Proper procedures Well designed routines permit specialization of effort, division of duties, and automatic checks on each step in the routine Physical safeguards Using safes, locks, guards, guard dogs, and special lighting Limiting access to sensitive areas Vacations and rotation of duties Rotating employees and requiring them to take vacations
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Independent check All phases of the system should undergo periodic review by independent public accountants and internal auditors Cost-benefit analysis The cost of a control should not exceed its benefits
The goal of internal control is not total prevention of fraud, but the achievement of efficient operations and the minimization of temptation
Managements Responsibility
Management bears the primary responsibility for a companys financial statements The audit committee oversees the
Internal accounting controls Financial statements Financial affairs of the corporation
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Accounting for Sales

2006 Prentice Hall Business Publishing

Introduction to Financial Accounting, 9/e

2006 Prentice Hall Business Publishing

Introduction to Financial Accounting, 9/e

Recognition of Sales Revenue

Most companies recognize revenue at the point of sale

2006 Prentice Hall Business Publishing

Introduction to Financial Accounting, 9/e

Measurement of Sales Revenue

A $100 credit sale is recorded as:

2006 Prentice Hall Business Publishing

Introduction to Financial Accounting, 9/e

Merchandise Returns and Allowances

2006 Prentice Hall Business Publishing

Introduction to Financial Accounting, 9/e

Merchandise Returns and Allowances

2006 Prentice Hall Business Publishing

Introduction to Financial Accounting, 9/e

Merchandise Returns and Allowances

2006 Prentice Hall Business Publishing

Introduction to Financial Accounting, 9/e

Cash and Trade Discounts

Cash and Trade Discounts

2006 Prentice Hall Business Publishing

Introduction to Financial Accounting, 9/e

Recording Charge Card Transactions

Card companies service charges are typically from 1% to 4% of gross sales

Recording Charge Card Transactions

The journal entry is:

2006 Prentice Hall Business Publishing

Introduction to Financial Accounting, 9/e

Accounting for Net Sales Revenue

2006 Prentice Hall Business Publishing

Introduction to Financial Accounting, 9/e

2006 Prentice Hall Business Publishing

Introduction to Financial Accounting, 9/e

2006 Prentice Hall Business Publishing

Introduction to Financial Accounting, 9/e

Credit Sales and Accounts Receivable

2006 Prentice Hall Business Publishing

Introduction to Financial Accounting, 9/e

2006 Prentice Hall Business Publishing

Introduction to Financial Accounting, 9/e

Measurement of Uncollectible Accounts

2006 Prentice Hall Business Publishing

Introduction to Financial Accounting, 9/e

Specific Write-Off Method

Introduction to Financial Accounting, 9/e

Specific Write-Off Method

2006 Prentice Hall Business Publishing

Introduction to Financial Accounting, 9/e

2006 Prentice Hall Business Publishing

Introduction to Financial Accounting, 9/e

2006 Prentice Hall Business Publishing

Introduction to Financial Accounting, 9/e

20X1 Allowances: Bad debts expense Allowance for uncollectible accounts

2006 Prentice Hall Business Publishing

Introduction to Financial Accounting, 9/e

2,000 1,400 600

2006 Prentice Hall Business Publishing

Introduction to Financial Accounting, 9/e

Applying the Allowance Method Using a Percentage of Sales