SECTION X. ACCOUNTING FOR REVENUE & ACCOUNTS RECEIVABLE
SECTION X. ACCOUNTING FOR SALES REVENUE AND
ACCOUNTS RECEIVABLE
A. IAS 18 AND OTHER ACCOUNTING ISSUES
IAS 18 Revenue addresses the accounting treatment of revenue arising from
ordinary activities.
Revenue is defined as gross inflow of economic benefits arising from ordinary
activities of the enterprise when those inflows result in increases in equity, except for
increases in equity due to contributions from equity participants. Amounts collected
on behalf of third parties (e.g. sales taxes and VAT) are not economic benefits
flowing to the enterprise and are not considered revenue.
Key issues in accounting for revenue are:
• How to measure revenue recognized and
• When to recognize revenue – the primary issue relating to revenue.
Measurement
Revenue should be recognized at the fair value of the consideration received or
receivable.
When goods or services are exchanged for goods and services of a similar nature
and value the exchange is not considered as one that generates revenue.
When goods or services are exchanged for dissimilar goods or services, the
exchange is recognized as one that generates revenue. The amount of revenue is
the fair value of the goods or services received adjusted for any cash or cash
equivalents transferred in the exchange.
Timing
Sale of goods
Revenue is recognized when all of the following conditions have been met:
• Transfer to the buyer of the significant risks and rewards of ownership;
• Enterprise no longer has management involvement or effective control of the
goods;
• The amount of revenue can be measured reliably;
• It is probable that the economic benefits associated with the sale will flow to
the enterprise;
• The costs incurred (or to be incurred) relating to the sale can be measured
reliably.
Sale of services
Revenue is recognized when all of the following conditions have been met:
• The amount of revenue can be measured reliably;
• It is probable that the economic benefits associated with the sale will flow to
the enterprise;
• The stage of completion of the transaction can be measured reliably;
• The costs incurred (or to be incurred) relating to the sale can be measured
reliably.
Revenue may also arise from the use by others of assets of the enterprise yielding
interest, royalties or dividends.
Revenue should be recognized on the following bases:
• Interest – on a time proportional basis.
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SECTION X. ACCOUNTING FOR REVENUE & ACCOUNTS RECEIVABLE
•
•
Royalties – on an accrual basis in accordance with the relevant agreement.
Dividends – when the shareholder’s right to receive payment is established.
Disclosure
The enterprise should disclose:
• The accounting policies adopted for recognition of revenue.
• The amount of each significant category of revenue (i.e. goods, services,
interest, royalties and dividends).
• The amount of revenue arising from exchanges of goods or services in each
category.
• Contingent liabilities and contingent assets (IAS 37). These would arise from
warranty costs, claims, penalties or possible losses.
An appendix is attached to IAS 18 that describes a number of situations and
illustrates how the standard should be applied.
IAS 18 does not apply to revenue arising from leases (IAS 17), dividends from
investments in associates accounted for under the equity method (IAS 28), insurance
contracts of insurance enterprises, changes in the fair value of financial assets and
liabilities (IAS 39), changes in the value of other current assets, certain transactions
relating to agricultural activity (IAS 41) and extraction of mineral ores.
OTHER ACCOUNTING ISSUES RELATING TO REVENUE AND SALES:
Expenses
In accordance with the matching principle, costs and expenses incurred in earning
revenue are recognized in the same period as the revenue earned.
The expenses may be direct expenses (e.g. cost of goods sold); period expenses
(e.g. administrative salaries); or allocated expenses (e.g. depreciation).
Bad Debt Expense
Credit sales and Accounts Receivable from customers is, for many enterprises, a
significant part of their business and a material part of revenue and current assets.
When customers purchase “on account”, the probability that they will pay the amount
they owe is less than 100%, because for a variety of reasons some customers do not
pay. If the sale is recorded at face value both Revenue and Assets are overstated.
Therefore, both IAS and Mongolian Guidelines require recognition of the amount of
the sales and receivables that will not be collected. This is accomplished by the use
of a “contra” asset account—Allowance for Doubtful Accounts.
It is a violation of the Matching Principle to simply write off Accounts Receivable
when they finally prove to be uncollectible (Direct Method). Using this method, in
most cases the sale (revenue) would be recorded in one period and later in another
period after all attempts to collect had been exhausted, the bad debt expense would
be recognized. Revenue and expense would not be matched. To avoid this, the
Allowance Method is required whereby an estimate of uncollectibles is recorded in
bad debt expense and in the Allowance for Doubtful Accounts. This action does not
affect the individual customer accounts in the Accounts Receivable subsidiary ledger.
The Allowance is a contra account to Accounts Receivable. It appears on the
Balance Sheet as a credit amount reducing Accounts Receivable. The effect is to
match the expense to the period of the sale and to avoid overstatement of the asset
Accounts Receivable.
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SECTION X. ACCOUNTING FOR REVENUE & ACCOUNTS RECEIVABLE
There are two ways to estimate bad debt expense for the allowance method. The
enterprise can choose which method to use but once the method has been chosen it
should be applied consistently. One way is based on a percentage of total credit
sales (emphasizes matching); the other way is based on a percentage of the
accounts receivable balance (emphasizes net realizable value of the asset). Both
are acceptable for IAS and Mongolian accounting (Methodology for Financial
Statement Preparation Part 2 Balance Sheet paragraph 10.)
Example: If annual credit sales are Tog 150,000,000 and the company history
indicates that approximately 2 % of these sales will not be collectible, then bad debt
expense for the year would be estimated at 3,000,000. The entry would be:
Dr Bad Debt Expense
3,000,000
Cr Allowance for Doubtful Accounts
3,000,000
If the balance of Accounts Receivable is 35,000,000 and the balance in the
Allowance account was 0 before estimating the bad debt expense then the Balance
Sheet would show: Accounts Receivable
35,000,000
Less Allowance for Doubtful Accounts
(3,000,000)
Net Accounts Receivable
32,000,000
To use the percentage of Accounts Receivable approach, receivables are usually
analyzed by age (e.g. current, overdue < 30 days, 31-60 days, 61-90 days, etc.) and
a percentage based on past collection experience applied to arrive at an estimate of
the uncollectible portion of the balance in Accounts Receivable. This amount is
compared to the current balance in the Allowance for Doubtful Accounts and the
necessary entry is made to adjust the Allowance to the calculated amount.
Example: The Accounts Receivable balance at 31 December is 2,500,000 and
Allowance for Doubtful Accounts has a credit balance of 15,000. Analysis of an
aging schedule indicates that 4% of the receivables are likely to be uncollectible. 4%
of 2,500,000 = 100,000. The balance in the Allowance at year end should be
100,000.
The entry would be:
Dr Bad Debt Expense
85,000
Cr Allowance for Doubtful Accounts
85,000
The Balance Sheet would show:
Accounts Receivable
2,500,000
Less Allowance for Doubtful Accounts
(100,000)
Net Accounts Receivable
2,400,000
Using either method for estimating bad debt expense and the allowance to be shown
on the Balance Sheet, the accounting entries for writing off uncollectible accounts is
the same. The Allowance is provided because the exact identity of the individual
accounts that will be uncollectible is not known at the time the estimate is made.
When an account is proven to be uncollectible, the following entry is made to write it
off.
Dr Allowance for Doubtful Accounts
XXX
Cr Accounts Receivable (customer M)
XXX
Suppose that miraculously Customer M pays after all. The entries would be:
To reinstate the Receivable:
Dr Accounts Receivable (customer M)
XXX
Cr Allowance for Doubtful Accounts
XXX
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SECTION X. ACCOUNTING FOR REVENUE & ACCOUNTS RECEIVABLE
And to record the cash receipt:
Dr Cash
XXX
Cr Accounts Receivable (customer M)
XXX
See Mongolian Guidelines 3.4.1 for entries.
Bad Debt Expense Exercise 1
Cyber Software Co. estimates its uncollectible amount based on an analysis of
Accounts Receivable. On 31 December the following aging schedule for the
company’s Tog 2,400,000 outstanding receivables was prepared:
Days
Current – not due
1-30 days past due
31-60 days past due
61-120 days past
due
121 or more days
Amount
1,000,000
600,000
300,000
100,000
400,000
2,400,000
Estimated uncollectible
%
Amount
2%
20,000
4%
24,000
10 %
30,000
40 %
40,000
90 %
360,000
474,000
The Allowance for Doubtful Accounts presently has a 200,000 credit balance.
1. What entry should be made to record the estimate of uncollectible accounts?
2. Prepare the entry to write off the following accounts:
i. Customer M
6,000 Togrogs
ii. Customer K
15,000 Togrogs
3. Prepare the entries to record the subsequent receipt of 10,000 from Customer
K. He is not expected to pay more.
4. What circumstances would cause the Allowance for Doubtful Accounts to
have a debit balance prior to adjustment?
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SECTION X. ACCOUNTING FOR REVENUE & ACCOUNTS RECEIVABLE
Bad Debt Expense Exercise 2
Smart Copy Printing Company estimates its uncollectible accounts based on the
percentage of its credit sales. In 2002, Smart Copy had sales of Tog 180,000,000.
40% of these were credit sales. Past experience shows that 3% of credit sales are
not collectible. The Allowance for Doubtful Accounts has a credit balance of Tog
80,000.
1. What entry should be made to record the estimate of uncollectible accounts?
2. What consideration is given to the balance in Allowance for Doubtful
Accounts? How is this different from the entry made when using the
Percentage of Accounts Receivable for estimating uncollectible accounts?
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SECTION X. ACCOUNTING FOR REVENUE & ACCOUNTS RECEIVABLE
SOLUTION
Bad Debt Expense Exercise 1
1a. What entry should be made to record the estimate of uncollectible accounts?
Dr Bad Debt Expense
274,000
Cr Allowance for Doubtful Accounts
274,000
Desired balance is 474,000 credit Adjustment required is 274,000.
1b. Prepare the entry to write off the following accounts:
i. Customer M
6,000 Togrogs
ii. Customer K
15,000 Togrogs
Dr Allowance for Doubtful Accounts
21,000
Cr Accounts Receivable Customer M
Cr Accounts Receivable Customer K
6,000
15,000
1c. Prepare the entries to record the subsequent receipt of 10,000 from Customer
K. He is not expected to pay more.
Dr Accounts Receivable Customer K
10,000
Cr Allowance for Doubtful Accounts
10,000
And
Dr Cash
10,000
Cr Accounts Receivable Customer K
10,000
1d. What circumstances would cause the Allowance for Doubtful Accounts to
have a debit balance prior to adjustment?
This will happen when the actual uncollectible accounts that are written off
exceed the estimated allowance.
Bad Debt Exercise 2
2a. Dr Bad Debt Expense
Cr Allowance for Doubtful Accounts
2,160,000
2,160,000
2b. The estimate based on credit sales estimates bad debts based on credit
sales for the period. The percentage of Accounts Receivable estimates the net
collectible amount of accounts receivable and adjusts the Allowance
accordingly.
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SECTION X. ACCOUNTING FOR REVENUE & ACCOUNTS RECEIVABLE
B. METHODOLOGY FOR CONVERTING SALES ACCOUNTING
Issues to Review
In order to convert the sales accounting system of an entity, accountants must have
knowledge of the following subjects:
•
•
•
•
•
•
Definition of revenue.
Accounting treatments for revenue recognition.
Method to account for the Value Added Tax for goods sold as well as the
Excise Tax.
Accounting entries for cash and credit sales.
Accounting method for the sales returns and discounts.
The following formula for cost flows of cost of goods sold:
Add:
Equal:
Subtract:
Equals to:
•
•
•
•
•
Beginning balance of finished goods
Cost of goods produced (purchased)
Cost of goods available for sale
Ending balance of finished goods
Cost of goods sold
Accounting method for recording sales on credit.
Accounting method for recording bad debt expense and allowance for bad
debt.
Accounting method to recognize and record sales on consignment.
Accounting for unearned revenue.
Please review IAS 11 for recognizing revenue in the construction industry.
Accountants should learn about these issues by studying IAS and the guidelines
approved by Minister of Finance and Economy. This knowledge will be a prerequisite
for converting the sales accounting system of an enterprise that intends to implement
IAS. Accounting for receivables is discussed in Part 3 of Chapter 2 of the Accounting
Guidelines approved by Resolution No. 116 by Minister of Finance, and accounting
for sales revenue is discussed in Part 11 of Chapter 5 of the same Guidelines.
Main Problems and Weaknesses in Sales Accounting
Problems and Weaknesses
Cost of goods sold is not recorded
separately and is included in the sales
and administrative costs.
Impact on Financial Statements
Gross profit and expenses are
misstated.
Even if the cost of goods sold is recorded,
it does not meet the cost formula
requirement.
The VAT on sales is included in the total
sales amount rather than recorded
separately as a payable.
The VAT recorded on the books of the
company differs from the amount of VAT
The accuracy and fairness of financial
statement are impaired.
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Sales revenue for the period is
overstated and VAT tax payable and
profit are also misstated.
The balance of VAT tax payable is
likely to be incorrect and the fairness
SECTION X. ACCOUNTING FOR REVENUE & ACCOUNTS RECEIVABLE
reported to the tax authority.
and reliability of financial statements
are impaired.
Because revenue is recognized at a
wrong time, sales revenue and profit
are reported incorrectly.
Revenue is recorded in the wrong
period.
If sales are made on consignment,
revenue is recognized when goods are
transferred to a sales agent.
Unearned revenue is not recorded
correctly.
Suggested Steps for Converting Sales Accounting System
It is recommended that the following general steps be followed in order to convert the
sales accounting system. We recommend that the following steps be used
specifically by those enterprises which have converted their previous financial
statements to IAS and are producing new reports:
1. Verify whether sales revenue was invoiced in the correct amount. Verify that
sales invoices and other supporting documents are valid for prior periods.
2. Verify whether the sales revenue invoiced is recorded in appropriate
accounts;
3. Review the appropriateness of the new main and sub accounts used for sales
accounts, which usually include sales revenue, VAT payable, accounts
receivable and cash accounts;
4. Review whether or not there are accounts receivable balances at the
beginning of the period from sales made in prior periods. Ascertain whether
these receivables have been collected during the current account period in
order to verify the validity of the receivables and correctness of recording.
5. Review whether the VAT is invoiced and accounted for separately when sales
are invoiced.
6. Determine if there is discrepancy between the VAT recorded in the accounts
and the VAT tax report.
7. On the basis of the above reviews, the accountant needs to identify major
accounting issues and errors requiring special attention during conversion of
the sales accounting to comply with the approved guidelines.
New
accounting policies and methods for sales are defined in order to meet IAS
requirements. The old practices that resulted in accounting errors should be
eliminated.
8. The sales for the current accounting period are recognized in compliance with
IAS and correctly reflected in the related journals and ledgers. If sales are
made in cash, the sales revenue is reflected in the Cash Receipts Journal. If
sales are made on credit, the revenue is recorded in the Sales Journal.
Attention should be paid to dividing the total amount invoiced (in case of sales
on credit) or the total amount received (in case of cash sales) into sales
revenue and VAT payable (VAT applicable to sales).
9. Journal entries for sales revenue are recorded in the General Ledger at the
end of an accounting period.
Specific considerations:
•
Some entities may not have invoiced any VAT on sales when sales were
made, or VAT was recorded incorrectly even if it was invoiced. Possible
reasons for that may be lack of awareness of the requirements of the tax laws
and proper accounting methods for recording VAT. For such enterprises, a
major part of the sales accounting conversion will be accounting and reporting
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SECTION X. ACCOUNTING FOR REVENUE & ACCOUNTS RECEIVABLE
sales revenue and VAT payables based on correct accounting methods and
treatments. This action will result in eliminating errors and discrepancies
between the company’s books and the VAT reports.
Result of Conversion of the Sales Accounting System
The entity should achieve the following results from converting the sales accounting
system:
• Sales revenue is recognized in the correct amount and correct accounting
period;
• Cost of goods sold is appropriately stated and accounted for;
• VAT on sales is invoiced according to the stated rules and is appropriately
accounted for;
• VAT on sales as recorded agrees with the VAT tax reported to the tax
authorities.
• The validity of the VAT payable balance is confirmed by the VAT report
approved by tax authorities.
• Accounts receivable are recorded in detail with regard to sales on credit;
reconciliation of receivables is made; and bad debt expense is accounted for
in accordance with a selected method.
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