The
Revenue/
Receivables/
Cash Cycle
2
Learning Objectives
 Explain the normal operating cycle of a
business.
 Prepare journal entries to record sales
revenue, including the accounting for
bad debts and warranties for service or
replacement.
 Analyze accounts receivable to measure
how efficiently a firm is using this
operating asset.
3
Learning Objectives
 Discuss the composition, management,
and control of cash, including the use of a
bank reconciliation.
 Recognize appropriate disclosures for
presenting sales and receivables in the
financial statements.
4
Learning Objectives
EXPANDED MATERIAL:
 Explain how receivables may be used as
a source of cash through secured
borrowing or sale.
 Describe proper accounting and
valuation of notes receivable.
 Understand the impact of uncollectible
accounts on the statement of cash flows.
 Use a petty cash fund.
Revenue/Receivables/
Cash Time Line
5
RETURNS
DELIVER COLLECT
cash
a product or
(includes
service
discounts)
ACCEPT STRUGGLE PROVIDE
continuing
with
returned
service
nonpaying
products
customers
The Operating Cycle
of a Business
Cash
Accounts Receivable
Inventory
6
7
Credit Sale and Collection
Assume that John purchased $1,000 of equipment on
account. What entries are made?
When the inventory is sold on account:
Accounts Receivable................ 1,000
Sales..................................
1,000
Sold equipment to John on account.
When the collection takes place:
Cash.......................................... 1,000
Accounts Receivable.........
1,000
Payment from John for equipment
purchased.
8
Receivables
Receivables are all claims against other
entities. They are usually settled in
cash.
• Trade receivables: Receivables arising
from normal operating activities.
• Nontrade receivables: All receivables
arising from activities other than
normal operations.
9
Sales Discounts--Gross Method
Assume $1,000 of equipment is sold on account. The
terms of the agreement are 2/10, n/30. What are the
collection entries?
If paid within the discount period:
Cash............................................
980
Sales Discounts...........................
20
Accounts Receivable..........
1,000
If not paid within the discount period:
Cash........................................…
Accounts Receivable.........
1,000
1,000
10
Sales Returns and Allowances
Felton Company sold $1,000 of merchandise. When
delivered, it was determined that the wrong color had
been sent. The customer agrees to keep the merchandise
for a reduction in price of $100. What are the journal
entries?
Sales entry:
Accounts Receivable (Cash)....… 1,000
Sales..................................….
1,000
Sales allowance entry:
Sales Returns and Allowances..… 100
Accounts Receivable (Cash)..
100
11
Sales Returns and Allowances
Felton Company sold $1,000 of merchandise. One week
later, when it was delivered, $100 in merchandise (cost,
$60) was the wrong color. With Felton’s approval, it
was returned. What are the journal entries?
Sales entry:
Accounts Receivable (Cash)....… 1,000
Sales..................................….
1,000
Sales return entry:
Sales Returns and Allowances..… 100
Accounts Receivable (Cash)..
100
Inventory…………………………
60
Cost of Goods Sold………….
60
Sales Discounts and Sales
Returns and Allowances
Income Statement
Sales.............................................…
Less: Sales Discounts...................... $ 20
Sales Returns and Allowances 100
Net Sales..........................................
$1,000
(120)
$ 880
12
13
Bad Debts
 Occur when customers do not pay for items
or services purchased on credit.
 Bad debts are uncollectible accounts
receivable.
 Bad Debt Expense is reported as a selling
or general and administrative expense.
 Accounts receivable are reported on the
balance sheet at their net realizable value.
Accounting for Uncollectible
Receivables (Direct Method)
14
Write Off:
Bad Debts Expense……………. 400
Accounts Receivable……….
400
To write off an uncollectible account.
This entry is made when the account has been
determined uncollectible. Since this determination
was made after the period in which the sale takes
place, the matching principle is violated. This
method is not accepted under GAAP.
Accounting for Uncollectible
Receivables (Allowance Method)
In this method, an estimate of the total
uncollectible accounts is made at the end of the
period, and an expense is recognized.
Bad Debts Expense………………….. 2,000
Allowance for Doubtful Accounts..
2,000
To record estimated uncollectible accounts.
GAAP requires use of the
“Allowance Method” for
determining bad debts expense.
15
Accounting for Uncollectible
Receivables (Allowance Method)
When the account is then determined to be
uncollectible, the write-off entry is:
Allowance for Doubtful Accounts……...
Accounts Receivable………………
To write off an uncollectible account.
400
400
16
Accounting for Uncollectible
Receivables (Allowance Method)
(1) The Allowance for Doubtful Accounts is a
contra asset account which is subtracted from
Accounts Receivable on the balance sheet.
2) The actual write-off entry does not reduce net
receivables, as shown below:
Accts. Receivable
Less Allowance for
Doubtful Accounts
$100,000
Net Receivables
$ 98,000
2,000
Accts. Receivable
Less Allowance for
Doubtful Accounts
$99,600
Net Receivables
$98,000
1,600
17
Estimating the Allowance for
Uncollectible Accounts
 Percentage of credit
sales.
 Percentage of accounts
receivable.
 Aging receivables.
18
19
Percentage
of Credit
Sales
Example:
Doubtful
Accounts
Expense
The ABC company had credit sales of
$100,000. The current accounts
receivable balance is $30,500. The
allowance for doubtful accounts balance is
$350 (Cr.). Historically, 3 percent of the
credit sales are not collected.
What is the entry to record estimated bad debts?
20
Percentage
of Credit
Sales
Example:
Doubtful
Accounts
Expense
The ABC company had credit sales of
$100,000. The current accounts
receivable balance is $30,500. The
allowance for doubtful accounts balance is
$350 (Cr.). Historically, 3 percent of the
credit sales are not collected.
Bad Debt Expense…………………… 3,000
Allowance for Doubtful Accounts ..
To record estimated uncollectible
accounts for the year.
3,000
21
Percentage
of Credit
Sales
Example:
Doubtful
Accounts
Expense
Allowance for Doubtful Accounts
Balance
Adjusting
Dec. 31, Bal.
350
3,000
3,350
22
Percentage
of Accounts
Receivable
Example: Doubtful
Accounts
Expense
The ABC company had credit sales of
$100,000. The current accounts
receivable balance is $30,500. The
allowance for doubtful accounts balance is
$350. Historically, 5 percent of accounts
receivable are not collectible.
Bad Debt Expense…………………….. 1,175
What
is the for
entry
to record
estimated bad debts?
Allowance
Doubtful
Accounts….
1,175
To record estimated uncollectible
accounts for the year.
($30,500 x .05) - $350
23
Percentage of Accounts Receivable
Allowance for Doubtful Accounts
Balance
Adjusting
Dec. 31, Bal.
350
1,175
1,525
24
Percentage of Accounts Receivable
Allowance for Doubtful Accounts
Balance
What if the allowance
350 Adjusting
account
had a debit
31, Bal.
balanceDec.
of $300?
1,875
1,525
25
Aging Receivables
The ABC company had credit sales of
$100,000. The current accounts
receivable balance is $30,500. The
allowance for doubtful accounts balance is
$350. The firm ages the accounts to
determine
the because
expectedreceivables
uncollectibles.
Remember,
are
involved, the amount derived from
aging provides the desired balance of
the allowance account.
26
Aging Receivables
Age
Current..............
1-30 days..........
31-90 days........
Over 90 days.....
Balance
$21,000
5,000
2,800
1,700
$30,500
Percentage
Estimated to be
Uncollectible
1.5
4.0
20.0
40.0
Amount
$ 315
200
560
680
$1,755
27
Aging Receivables
Allowance for Doubtful Accounts
Balance
Adjusting
Dec. 31, Bal.
350
1,405
1,755
28
Accounting for Warranties
Edna’s Appliances sells washers and
dryers with a one-year warranty. Past
experience indicates that 15% of the
appliances sold will need repairs before
the warranty expires. The average repair
cost is $80. In 2001, 500 washers and
dryers were sold. Actual repair costs for
the year totaled $3,400.
29
Accounting for Warranties
To record estimated warranty expense:
Warranty Expense……………………….. 4,000
Estimated Liability Under Warranties..
4,000
To record estimated warranty expense
based on units sold (500 x $80).
To record estimated warranty expense:
Estimated Liability Under Warranties….. 3,400
Cash………………………………….
3,400
To record cost of actual repairs in 2001.
Assessing Management
of Receivables
Average Collection Period: The
average number of days that elapse
between the time that a sale is made
and the time that cash is collected. It
is calculated by dividing the average
receivables by the average daily sales.
The amount for average daily sales is
determined by dividing net sales by
365.
30
Assessing Management
of Receivables
The Wheeler Company had net sales of $150,000
during 2002. Accounts receivable increased
$35,000 to $40,000 during the same time.
Calculate the average collection period.
Average Collection Period:
Average Accounts Receivable
Average Daily Sales
$37,500
($150,000/365)
Average collection period = 91.25 days
31
32
Composition of Cash





Undeposited coins and
currency (change
funds)
Demand deposits
Petty cash funds
Cashiers’ checks
Personal checks
33
Composition of Cash
Many companies report
investments in very shortterm, interest-earning
securities as cash equivalents
in the balance sheet.
34
Composition of Cash
A credit balance in the cash
account is known as a cash
overdraft and should be
reported as a current liability.
35
Control of Cash






Specifically assigned responsibilities for
handling cash receipts.
Separation of handling and recording receipts.
Daily deposit of all cash received.
Voucher system to control cash payments
Internal audits at irregular intervals.
Double record of cash (bank and book) with
reconciliation performed by someone outside
the accounting function.
36
Bank Reconciliation
A comparison of the bank
balance with the book’s
balance by means of a
summary is a bank
reconciliation.
37
Bank Reconciliation
Common causes of differences:
 Deposits
in transit.
 Outstanding checks.
 Bank debits for items such as
service charges and NSF checks.
 Bank credits for items such as the
bank collecting a note for the
depositor.
 Accounting errors.
Lori’s Florist
Bank Reconciliation
March 31, 2002
Balance per bank.... $4,135
Additions to bank
balance:
Deposits in transit....
500
Total................... $4,635
Deductions from bank
balance:
Outstanding checks:
191....... $251
192....... 125
195....... 75
451
Adj. bank balance $4,184
Balance per books.............. $3,950
Additions to bank
balance:
Direct deposit...................…
450
Interest.............................…
71
Total............................… $4,471
Deductions from book
balance:
Service charge...........…
$
7
NSF check.................…
100
Error in recording check 180
287
Adj. book balance
$4,184
38
39
Bank Reconciliation
All adjustments made to the Balance per Books need to
be recorded:
ADDITIONS:
Cash…………………………………….
Accounts Receivable……………….
Interest Revenue……………………
521
450
71
DEDUCTIONS:
Accounts Receivable (NSF)……………
Miscellaneous General Expense (SC)….
Recording Error, Underwritten check*...
Cash………………………………..
* Debited to original account.
100
7
180
287
Accounts Receivable as a
Source of Cash
• As a sale (either with or
without recourse).
• As a secured borrowing.
40
Accounts Receivable as a
Source of Cash
SFAS 125 specified conditions that must be met if a
transfer of receivables is to be accounted for as a sale:
 The transferred assets have been isolated from the
transferor and its creditors cannot access the
assets.
 The transferee has the right to pledge or exchange
the transferred assets.
 The transferor does not maintain effective control
over the assets through an agreement to
repurchase them before their maturity.
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42
Payment of Accounts
Receivable
Factoring Accounts Receivable
Customers
Factor
Goods and
Services Provided
Accounts
Receivable
Established
Company
Accounting for Factoring
Accounts Receivable
• Close sold receivables.
• Close accompanying Allowance for Bad
Debts.
• Expense any factoring charges.
• Establish a receivable for any sales price
withheld by the factor.
• Debit Cash for net proceeds of the sale.
• Recognize a gain or loss from factoring.
43
Example: Factoring
Accounts Receivable
Assume:
Factored Receivables
Allowance for Bad Debts
Factor Withholding
Sales Price
Journalize this
transaction.
$10,000
$300
5%
$8,500
44
Example: Factoring
Accounts Receivable
45
Cash………………………………. 8,075
Receivable from Factor…………... 425
Allowance for Bad Debts………… 300
Loss from Factoring Receivables... 1,200
Accounts Receivable………….
10,000
Computations:
Cash: $8,500 - 425 = $8,075
Factor Receivable: $8,500 x 5% = $425
Factoring Loss: ($10,000 - 300) - $8,500 = $1,200
Sale of Receivables
with Recourse
Sale of receivables with recourse
is different from factoring, since
factoring is normally sold on a
nonrecourse basis.
46
Sale of Receivables
with Recourse
47
Continuing the previous example, assume
that the receivables were sold with recourse
and it is estimated that the recourse
obligation has a fair value of $500.
Cash Received
$8,500
Estimated Value of Recourse Obligation
500
Net Proceeds
$8,000
Book Value of the Receivables
Net Proceeds to be Received
Loss on Sale of Receivables
$9,700
8,000
$1,700
Sale of Receivables
with Recourse
48
The entry to record the sale:
Cash……………………………….
Receivable from Factor…………...
Allowance for Bad Debts…………
Loss on Sale of Receivables……...
Accounts Receivable………...
Recourse Obligation…………
8,075
425
300
1,700
10,000
500
49
Secured Borrowing
• Assignment of Accounts Receivable
– There are no special accounting problems
involved.
– Simply record the loan.
• Specific Assignment:
– Specified accounts receivable pledged.
– Accounts receivable reclassified on balance
sheet.
– Notes disclosure of loan provisions required.
50
Notes Receivable
A promissory note is an
unconditional written
promise to pay a certain
sum of money at a specified
time.
51
Notes Receivable
• Initially recorded at present value.
• Two types:
– Interest-bearing: Interest rate is stated on
the note.
– Non-interest-bearing: Interest rate is not
specified on the note, but the face amount
includes the interest charge.
52
Example: Notes Receivable
Assume:
Note Receivable
Interest Rate
Time to Maturity
Journalize this note as:
1. An interest-bearing note.
2. A noninterest-bearing note.
$1,000
10%
2 years
53
Example: Notes Receivable
Interest-Bearing Note:
Notes Receivable………………... 1,000
Sales …………………………..
1,000
Noninterest-Bearing Note:
Notes Receivable……………….. 1,210
Sales…………………………..
1,000
Discount on Notes Receivable..
210
(PV of $1,000 @ 10% for 2 years = $1,210)
54
Discounting Notes Receivable
• Discount Rate: The interest rate
charged by the financial institution for
buying a note receivable.
• Discount Period: The time between
the date a note is sold to a financial
institution and its maturity date.
55
Formulas for Discounting Notes
Interest = Face Amount x Interest
Rate x Interest Period
Maturity value = Face Amount + Interest
Discount
Discount
= Maturity Value x
Period x Discount Rate
Proceeds = Maturity value - Discount
56
Example: Discounting
The original note is a 3-month, $1,000 note at
14% interest. What is the journal entry if the
note was discounted after one month at 16%?
Interest
Maturity value
Discount
Proceeds
=
=
=
=
$1,000 x .14 x 3/12
$1,000 + $35
$1,035 x .16 x 2/12
$1,035 - $27.60
Cash…………………………….
Interest Revenue……………...
Note Receivable……………...
=
=
=
=
$ 35.00
$1,035.00
$ 27.60
$1,007.40
1,007.40
7.40
1,000.00
57
The End