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Chapter 7

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Chapter 7

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  1. Chapter 7 Sales and Collection Cycle

  2. Business Process • Making a sale and accounting for sale - related • Decisions - what to sell, how, much to sell for • Ie. Sales discount

  3. Accounts Receivable • Largest current asset • Managing size and conversion to cash • Credit policies • Collection efforts • Selling A/R - factoring

  4. Sales Cycle • Firm sells to customers that pay • Goods and services are delivered • Customers billed correctly • Money received and deposited • Recording to sale • Collecting payment

  5. Timing of Revenue Recognition • Recognized and reported on income statement • Accrual accounting - not concerned about cash collection • GAAP - accrual accounting • Recognized - earnings process is virtually complete, collection reasonably

  6. Study Break 7-1 Cash 100,000 Unearned Rev 100,000 Unearned Rev 50,000 Ticket Rev Earned 50,000 Unearned Rev 33,333 Ticket Rev Earned 33,333

  7. Sales Discounts • If pay bills promptly • 2/10, n/30 • Deducted from sales - income statement • Contra-revenue account

  8. Study Break 7-2 Accounts Receivable 3,500 Sales 3,500 Cash 3,395 Sales Discount 105 Accounts Receivable 3,500

  9. Sales Returns • Return merchandise • Refund - full or partial cash, credit • Separate from sales • Contra-revenue account - see both numbers • Deducted from sales

  10. Payment for Goods and Services • Customers - Two choices - cash or credit • Analyze risks • Controls

  11. Accounting For Cash:Reconciling The Bank Statement • An important part of internal control, segregation of duties • Need for calculating a true cash balance • Two “sides” to be reconciled - SAME • balance per bank • balance per books • Locate errors and make adjustments

  12. Accounting For Cash:Examples • Company books know • Outstanding check • Deposit in transit • Bank knows • Service charge • NSF - nonsufficient funds check • Interest earned • Miscellaneous charges • Miscellaneous credits • Notes collected

  13. ++ deposits in transit -- outstanding checks True cash balance ++ collections for us made by the bank -- NSF checks (from customers) -- Service charges True cash balance Cash (Bank) Reconciliation Has Two “Independent” Parts Balance per bank Balance per books

  14. Study Break 7-3 Balance per book $2,400 Interest 100 Collection 300 Service Charge (100) True cash balance $2,700 Cash 300 Misc Oper Exp 100 Accounts Receivable 300 Interest Revenue 100

  15. Account Receivables • Do not expect to collect 100% • Balance Sheet - business expects to collect • Accounting for uncollectible accounts • Direct write-off method • Not GAAP • Write off when identified • Allowanced method • Estimated and matched • Recorded at end of period • GAAP • Bad debt expense

  16. Two Methods GAAP Not GAAP Allowance Method Direct Write-Off Method Used only when bad debts are a very small item or when credit sales are insignificant. A/R Method Sales Method

  17. Study Break 7-4 • Accounts identified and written off - bad debt expense • 2005 - no journal entries required • 2006 Bad debt expense 35 Accounts receivable 35

  18. GAAP - matching principle - with related sale Estimated - recognize expense Allowance for uncollectible accounts - deducted from Accounts receivable - contra asset account Net realizable value - amount expected to be collected - book value or carrying value Expense - don’t wait until bad debt identified Allowance method

  19. Allowance Method, continued • Two allowance methods - estimating with • Sales - Income Statement Method • Estimate based upon credit sales or total sales • Accounts Receivable - Balance Sheet Method • Accounts receivable - starting point • Aging schedule - length of time outstanding • Problem • Reduction of both accounts receivable and allowance - no effect in net accounts receivable

  20. Study Break 7-5 Bad debt expense 400 Allowance for uncollectible accounts 400 • 500 - 100 = 400 • Estimate - prior year overestimate = current estimate • 9,500 = 10,000 - 500 - net realizable value

  21. Credit Card Sales • Credit card company is responsible for evaluating a persons credit worthiness and collecting payments • Cost compared to benefits

  22. Study Break 7-6 Accounts Receivable 4,850 Credit card expense 150 Sales revenue 5,000 5,000 * .97 = 4,850

  23. Other Accounting Issues Related to Sales: Warranty Costs • Why give warranties? • Sales and marketing tool • Strategic decision • When should expense be recognized? • Time of sale - matching principle • Estimated future costs Warranty

  24. Study Break 7-7 • No warranty expense recorded - previously recorded with sale Estimated warranty liability 500 Cash 500

  25. Finding and using information • Revenue recognized when earned, often before collected • Analysis • Current ratio - quick ratio, acid test ratio • Accounts receivable turnover ratio - measures ability to collect cash from credit customers • # of days to collect

  26. Business risks • Policies and procedures • Preventive controls • Detective controls • Corrective controls