Chapter 6 Reporting and Interpreting Sales Revenue and Accounts Receivable

1. Chapter 6Reporting and Interpreting Sales Revenue and Accounts Receivable Acct 2301 Zining Li

2. Key Terms • Sales revenues • Sales returns • Sales discount ( 2/10, n/30) • Credit card discount • All of these three are contra-revenue accounts • Accounts receivable • Allowance for doubtful account (contra-asset account) • Net realizable value of A/R • Bad debt expense

3. Accounting for Sales Revenue Sales (revenue) reported on the Income Statement are net of credit card sales discount, sales discount, and sale returns. Sales Revenue Less: Credit card discounts (a contra-revenue account) Sales discounts (a contra-revenue account) Sales returns and allowances (a contra-revenue account) Net Sales (reported on the income statement)

4. Accounting for Credit Card Discount Assume the credit card company charges a fee of 3% When sales of $1,000 are made by credit card purchases: Dr. Cash $970 Dr. Credit-card discount 30 Cr: Sales Revenue $1,000

5. Accounting for Sales Discount Suppose the credit term is 2/10, n/30 When sales of $1,000 are made on account Dr. Accounts Receivable $1,000 Cr: Sales Revenue $1,000 When customers pay within 10 days, they enjoy 2% discount Dr. Cash $980 Dr. Sales Discount 20 Cr. Accounts Receivable $1,000 When customers pay after 10 days, they have to pay the full amount Dr. Cash $1,000 Cr. Accounts Receivable $1,000

6. Accounting for Sales Returns When sales of $1,000 are made on account Dr. Accounts Receivable $1,000 Cr: Sales Revenue $1,000 When returns of $150 are made Dr. Sales Return $150 Cr. Accounts Receivable $150 When customers pay off the rest Dr. Cash $850 Cr. Accounts Receivable $850

7. E6-3: Clem Retailers • Nov 20: sold two items of merchandise to Customer B, who charged the $350 sales price on her visa card. Visa charges Clem a 2% credit card fee • Nov 25: sold 20 items of merchandise to Customer C at an invoice price of $4,500 (total); terms 3/10, n/30. • Nov 28: sold 10 identical items of merchandise to Customer D at an invoice price of $9,000 (total); terms 3/10, n/30. • Nov 29: Customer D returned one of the items purchased on Nov 28th; the item was defective and credit was given to the customer • Dec 06: Customer D paid the account balance in full • Dec 20: Customer C paid in full for the invoice of Nov 25 Required: 1. Provide journal entries for above transactions when necessary. 2. Assume that Sales Returns and Allowances, Sales Discounts, and Credit Card Discounts are treated as contra-revenues, determine the net sales for the two months ended December 31, 2011

8. Nov 20--- Dr. Cash $343 Dr. Credit-card discount 7 Cr: Sales Revenue 350 Note: COGS will also be recorded at the time of sales. Nov 25--- Dr. Acct. Receivable $4,500 Cr: Sales Revenue 4,500 Nov 28--- Dr. Acct. Receivable $9,000 Cr: Sales Revenue 9,000 Nov 29--- Dr. Sales returns and allowance $900 Cr: Acct. Receivable 900 Note: COGS will also be adjusted at the time of sales returns.

9. Dec 06--- Dr. Cash $7,857 Dr. Sales discount 243 Cr: Acct. Receivable 8,100 Dec 20--- Dr. Cash $4,500 Cr: Acct. Receivable 4,500 Sales revenue ($350 + $4,500 + $9,000) $13,850 Less: Sales returns and allowances (1/10 x $9,000 from D) 900 Less: Sales discounts (9/10 x $9,000 from D x 3%) 243 Less: Credit card discounts ($350 from B x 2%) 7 Net sales $12,700

10. Measuring and Reporting Accounts Receivable • Accounts receivable vs. Notes receivable • Net Realizable Value of A/R Accounts Receivable Less: Allowance for doubtful accounts (a contra-asset account) = Net Realizable Value of Accounts Receivable • Allowance for doubtful accounts • contra-asset account • the estimated amount of uncollectible A/R

11. Accounting for Bad Debt Expenses • An adjustment to account for expenses for potential default accounts receivable • Bad debt expenses are estimated and recorded in the same accounting period when credit sales are made; • NOT at the time when some accounts receivable are determined to be uncollectible. • Matching Principle

12. Accounting for Bad Debt Expenses • Journal entry to record Bad Debt Expense: Dr. Bad Debt Expense $XX Cr. Allowance for doubtful accounts $XX • Effects on financial statements: • Net income is decreased; • Assets are decreased, • Shareholders’ Equity is decreased

13. Methods for Estimating the Amount of Bad Debt Expense • Sales Method • The amount of bad debt expense is a percentage of credit sales generated in current accounting period • Accounts Receivable Method • The amount of doubtful accounts is estimated based on the balance and age of accounts receivable at the end of the accounting period • The amount of bad debt expense is then a plug-in number

14. Sales Method Example: During Oct. 2006, total credit sales revenue was $20,000. The company estimates 1% of this credit sale to be uncollectible. On Dec 2nd, the account receivable of $3,000 for Oct 2006 credit sales was determined to be uncollectible. • Assuming the company prepares its financial statement at Oct. 30st, provide the journal entry to record the bad debt expense. • What is the effect on the financial statements of recording bad debt expense?

15. Accounts Receivable Method • The amount of doubtful accounts is estimated as a percentage of the balanceof accounts receivable at the end of the accounting period. • The amount of bad debt expense is then a plug-in number.

16. Steps in Accounts Receivable Method • Estimate the dollar amount of uncollectible accounts based on a percentage of the ending balance of accounts receivable; • The estimated uncollectible accounts (from step1) is the (desired) ending balance of allowance for doubtful accounts; • Bad Debt Expense = Ending balance of allowance for doubtful accounts – the pre-adjustment balance of allowance for doubtful accounts.

17. Example: Accounts Receivable Method • Following is the summary of transactions that Cart Corp. had in year 2005 and year 2006. Year 2005 was the first year of operations. Please determine and record the bad debt expense for both years. • In Year 2005: • Provided $5,000 services on account; • Collected $4,000 cash from accounts receivables; • Adjusting entry booked to reflect the estimate of 5% of ending A/R balance to be uncollectible. • In Year 2006: • Provided $6,000 services on account. • Collected $4,500 cash from accounts receivables. • Adjusting entry booked to reflect the estimate of 5% of ending A/R balance to be uncollectible.

18. Aging Schedule of A/R • In estimating the percentage of uncollectible accounts receivable, the age of each account receivable is taken into consideration; • A higher percentage is used to estimate the uncollectible amount for an older accounts receivable;

19. Example: Aging Schedule of A/R At the beginning of the year, the company had a credit balance in the Allowance for Doubtful accounts of $4,000. Prepare the adjusting journal entry to recognize the company's bad debt expense for the year.

20. Write-off of Uncollectible Accounts • No expenses are recorded when certain A/R are found to be uncollectible (why ?) • Rather, the balance of A/R is reduced by the amount of uncollectible accounts (why?) • Allowance for doubtful accounts is also reduced by the same amount (why?) Dr. Allowance for doubtful accounts $$ Cr. Accounts Receivable $$

21. Example of writing off A/R Suppose Dart Corp. had a beginning balance of A/R of $20,000 and allowance of $1,500. During a period, it had credit sale of $5,000, collections of A/R of $8,000. It estimates its bad debt expense based on 2% of credit sales. During the period, a customer failed to pay off the account of $980 he owed and the company wrote the account off. • Please provide the journal entry to record the write-off • Provide the T-accounts of A/R and the Allowance account.

22. Determine the bad debt expense for year 2006 and net realizable value of A/R at 12/31/2006 In Year 2005: • Provided $5,000 services on account; • Collected $4,000 cash from accounts receivables; • Adjusting entry booked to reflect the estimate of 5% of ending A/R balance to be uncollectible. In Year 2006: • Wrote off $120 of accounts receivable • Provided $6,000 services on account. • Collected $4,500 cash from accounts receivables. • Adjusting entry booked to reflect the estimate of 5% of ending A/R balance to be uncollectible.

23. One more exercise … During the period, a company had $2,000,000 in credit sales. The Company assumes that approximately 1% of total sales on account will prove uncollectible. At the beginning of the year, the company had a credit balance in the Allowance for Doubtful accounts of $4,000. During the year, the company wrote-off $2,300 of identified uncollectible accounts. • Prepare the adjusting journal entry to recognize the company's bad debt expense for the year; • Determine the ending balance of accounts receivable and the allowance for doubtful accounts.

24. Effect of Change in A/R on Cash vs. Net Income

25. How to infer Cash Flows from Sales Revenue and Changes in A/R • Cash collected from customers = Sales revenue – increase in A/R • Cash collected from customers = Sales revenue + decrease in A/R • Cash from operations = Net Income – increase in A/R • Cash from operations = Net Income + decrease in A/R

26. Accounts Receivable Turnover • How many times accounts receivable was created and collected during the period • Efficiency of accounts receivable management Net Sales Average Net Accounts Receivable