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chapter 7
The Revenue/
Receivable/Cash
Cycle
An electronic presentation
by Douglas Cloud
Pepperdine University
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Learning Objectives
1. Explain the normal operating cycle of a
business.
2. Prepare journal entries to record sales
revenue, including the accounting for
bad debts and warranties for service or
replacement.
3. Analyze accounts receivable to measure
how efficiently a firm is using this
operating asset.
Continued
3
Learning Objectives
4. Discuss the composition, management, and
control of cash, including the use of a bank
reconciliation.
5. Recognize appropriate disclosures for
presenting sales and receivables in the
financial statements.
Continued
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Learning Objectives
EXPANDED LEARNING OBEJCTIVES:
6. Explain how receivables may be used as
a source of cash through secured
borrowing or sale.
7. Describe proper accounting and
valuation of notes receivable
8. Understand the impact of uncollectible
accounts on the statement of cash flows.
Revenue/Receivables/Cash
Timeline
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RETURNS
DELIVER COLLECT
cash
a product or
(includes
service
discounts)
ACCEPT STRUGGLE PROVIDE
continuing
with
returned
services
nonpaying
products
customers
The Operating Cycle
of a Business
Cash
Inventory
Accounts
Receivables
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The Operating Cycle
of a Business
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Assume that Acme Manufacturing sold merchandise to
Harper Company on account.
When the inventory is sold on account:
Accounts Receivable
1,000
Sales
1,000
Sold merchandise to Harper
Company on account.
When the collection takes place:
Cash
Accounts Receivable
Payment received on account.
1,000
1,000
The Operating Cycle
of a Business
Receivables are all claims against other
entities. They are usually settled in cash.
• Trade receivables: Receivables arising
from normal operating activities.
• Notes receivable: Trade receivables
evidenced by a formal written promise to
pay.
• Nontrade receivables: All receivables
arising from activities other than normal
operations.
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The Operating Cycle
of a Business
Nontrade receivables arise from a variety
of transactions, such as—
(1) The sale of securities or property other
than inventory
(2) Deposits to guarantee contract
performance or expense payments
(3) Claims for rebates and tax refunds
(4) Dividends and interest receivable
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Accounting for Sales Revenues
A trade
discount may
vary by
customer,
depending on
the volume of
business or size
or order.
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Accounting for Sales Revenues
A cash (sales)
discount is
offered to
customers to
encourage
prompt payment
of bills.
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Accounting for Sales Revenues
Gross Method
Assume on March 15, $1,000 of merchandise is sold on
account. The terms of the agreement are 2/10, n/30.
The firm uses the gross method for record sales on
account.
Entry on date of sale:
Accounts Receivable
Sales
1,000
1,000
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Accounting for Sales Revenues
Gross Method
If paid within the discount period:
Cash
Sales Discounts
Accounts Receivable
If not paid within the discount period:
Cash
Accounts Receivable
980
20
1,000
1,000
1,000
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Accounting for Sales Revenues
Net Method
This time, assume that all sales on account are recording
using the net method. Again, the terms of the agreement
are 2/10, n/30.
At the point of sale (March 15):
Accounts Receivable
980
Sales
980
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Accounting for Sales Revenues
Net Method
If paid within the discount period:
Cash
Accounts Receivable
980
If not paid within the discount period:
Cash
1,000
Sales Discounts Not Taken
Accounts Receivable
980
20
980
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Sales Returns and Allowances
Red sweaters costing $600 are sold for $1,000.
When delivered, it was determined that the sweaters
should have been green. The customer agrees to
keep the merchandise for a $200 reduction in price.
Sales entry:
Accounts Receivable
1,000
Sales
1,000
Cost of Goods Sold
Inventory
Sales allowance entry:
Sales Returns and Allowances
Accounts Receivable
600
600
200
200
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Sales Returns and Allowances
Suppose that instead of the allowance,
the customer elects to return the
sweaters.
Sales return entries:
Sales Returns and Allowances
Accounts Receivable
Inventory
Cost of Goods Sold
1,000
1,000
600
600
Sales Discounts and Sales
Returns and Allowances
Income Statement
Sales
Less: Sales discounts
Sales returns and allowances
Net sales
$15,000
$250
400
(650)
$14,350
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Accounting for 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)
Write Off:
Bad Debts Expense
Accounts Receivable
To write off an
uncollectible account.
400
400
Since
This this
entry
determination
is made whenwas
themade
account
afterhas
the
been
period
determined
in which uncollectible.
the sale takes place,
The direct
the
matching
write-offprinciple
method isisused
violated.
by small
This
method
businesses
is not
because
accepted
of its
under
simplicity.
GAAP.
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Accounting for Uncollectible
Receivables (Allowance Method)
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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
Allowance for Bad Debts
To record estimated
uncollectible accounts.
2,000
GAAP requires the use of the
allowance method.
2,000
Accounting for Uncollectible
Receivables (Allowance Method)
When the account is then determined to be
uncollectible, the write-off entry is:
Allowance for Bad Debts
Accounts Receivable
To write off an uncollectible
account.
400
400
Note: Bad Debt Expense is not debited.
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Accounting for Uncollectible
Receivables (Allowance Method)
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What happens if the written off receivable is
later collected? Assume that the customer from
Slide 22 pays the $400 written-off debt a month
after the write-off.
Accounts Receivable
Allowance for Bad Debts
To reverse the entry made to
write off the account.
400
Note: Before the payment entry, the debt
must be restored.
400
Accounting for Uncollectible
Receivables (Allowance Method)
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What happens if the written off receivable is
later collected? Assume that the customer from
Slide 22 pays the $400 written-off debt a month
after the write-off.
Cash
Accounts Receivable
To record collection of the
account.
400
400
Accounting for Uncollectible
Receivables (Allowance Method)
(1) 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 for $400 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
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Estimating the Allowance for
Uncollectible Accounts
 Percentage of credit
sales
 Percentage of accounts
receivable
 Aging receivables
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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. Historically, 2 percent of the credit
sales are not collected.
What is the entry to record estimated bad debts?
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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. Historically, 2 percent of the credit
sales are not collected.
Bad Debt Expense
2,000
Allowance for Doubtful Accounts
To record estimated uncollectible
accounts for the year.
2,000
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Percentage of Credit Sales
Allowance for Doubtful Accounts
Balance
Adjusting
Dec. 31, Bal.
350
2,000
2,350
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Percentage
of Accounts
Receivable
Example: Doubtful
Accounts
Expense
The XYZ company had credit sales of
$693,000. The current accounts
receivable balance is $50,000. The
allowance account balance is $600.
Historically, 3 percent of accounts
receivable are not collectible.
What is the required adjusting entry to
record estimated bad debts?
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Percentage of Accounts Receivable
Bad Debt Expense
900
Allowance for Doubtful Accounts
900
To record estimated uncollectible
accounts for the year.
($50,000 x .03) – $600
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Percentage of Accounts Receivable
Allowance for Doubtful Accounts
That’s the
desired
ending
balance.
Balance
Adjusting
Dec. 31, Bal.
600
900
1,500
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Percentage of Accounts Receivable
Allowance
Doubtful
Accounts
IWhat
see! if
The
thefor
ending
allowance
balance
account
be “forced”
had
to be the
Balancemust
350a debit
Adjusting
1,850
balance
calculated
of $350?
amount.
Dec. 31, Bal. 1,500
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Aging Receivables
The ABC company had credit sales of
$100,000. The current accounts
receivable balance is $47,550. The
allowance for doubtful accounts balance is
$620. 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.
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Aging Receivables
Classification
(in days)
Not yet due
1-30 past due
31-60 past due
61-90 past due
91-180 past due
181-365 past due
+365 past due
Uncollectible Estimated
Accounts Amount of
Experience Uncollectible
Balance Percentage Accounts
$40,000
3,000
1,200
650
500
800
1,400
$47,550
2%
5
10
20
30
50
$ 800
150
120
130
150
400
1,120
$2,870
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Aging Receivables
Bad Debt Expense
2,250
Allowance for Doubtful Accounts
To record estimated uncollectible
accounts for the year.
Required balance
Current balance
Adjusting entry
2,250
$2,870
(620)
$2,250
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Aging Receivables
Allowance for Doubtful Accounts
Balance
Adjusting
Dec. 31, Bal.
620
2,250
2,870
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Accounting for Warranties
MJW Video & Sound sells
compact stereo systems with a
two-year warranty. Past
experience indicates that 10%
of all systems will need
repairs in the first year and
20% will need repairs in the
second year. The average
repair cost is $50 per system.
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Accounting for Warranties
The number of systems
sold in 2004 and 2005 was
5,000 and 6,000,
respectively. Actual repair
costs were $12,500 in 2004
and $55,000 in 2005.
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Accounting for Warranties
To record estimated warranty expense:
2004
Warranty Expense
75,000
Estimated Liability Under Warranties
75,000
To record estimated warranty
expense based on systems sold.
(5,000 x
0.30) x $50
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Accounting for Warranties
To record the actual cost of doing repairs:
2004
Estimated Liability Under Warranties
Cash
To record cost of actual repair
work in 2004.
12,500
12,500
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Accounting for Warranties
To record estimated warranty expense:
2005
Warranty Expense
90,000
Estimated Liability Under Warranties
90,000
To record estimated warranty
expense based on systems sold.
(6000 x
0.30) x $50
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Monitoring Accounts Receivable
Average Collection Period: The
average number of days that lapse
between the time that a sale is made
and the time that cash is collected. It
is calculated by dividing the average
daily sales by the average receivables
outstanding.
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Monitoring Accounts Receivable
WS Corporation had average receivables of
$354,250 and average daily sales of $1,650,000.
The average collection period can be calculated as
follows:
Average Collection Period:
Average receivable
Average daily sales
$354,250
= ($1,650,000/365)
Average collection period = 78 days
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Monitoring Accounts Receivable
Accounts receivable turnover is determined by
dividing net sales by the average trade accounts
receivable outstanding during the year. For WS
Corporation, the 2005 turnover is:
Accounts Receivable Turnover:
Net sales
=
Average net receivables
$1,650,000
$354.250
Receivables turnover for year = 4.7 times
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Cash Management and Control
What items are classified as “cash”?
o
o
o
o
o
Undeposited Coins
and currency (change
funds)
Demand deposits
Petty cash funds
Cashier’s checks
Personal checks
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Composition of Cash
Many companies report
investments in very shortterm, interest-earning
securities as cash equivalents
in the balance sheet.
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Composition of Cash
A credit balance in the cash
account is known as a cash
overdraft and should be
reported as a current liability.
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Management and Control of Cash
1) Specifically assigned responsibilities for
handling cash receipts
2) Separation of handling and recording receipts
3) Daily deposits of all cash received
4) Voucher system to control cash payments
5) Internal audits at irregular intervals
6) Double record of cash—bank and books, with
reconciliation performed by someone outside
the accounting function
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Bank Reconciliation
A comparison of the bank
balance with the book’s
balance by means of a
summary is a bank
reconciliation.
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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.
Svendsen, Inc.
Bank Reconciliation
November 30, 2005
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Balance per bank.... $2,979.72 Balance per books............. $2,952.49
Additions to bank
Additions to bank
balance:
balance:
Deposits in transit....
658.50 Interest earned...............….
98.50
Error by bank
12.50 Error by depositor.........….
18.00
Total................... $3,650.72
Total............................ $3,068.99
Deductions from bank
balance:
Outstanding checks:
Listed individually (703.83)
Corrected bank bal. $2,946.89
Deductions from book
balance:
Service charge..............
NSF check....................
Corrected book bal.
$ ( 3.16 )
(118.94 )
$2,946.89
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Bank Reconciliation
All adjustments made to the Balance per Books need to
be recorded:
Cash
98.50
Interest Revenue
98.50
To record interest earned.
Cash
18.00
Advertising Expense
18.00
To record correction for check in
payment of advertising recorded
as $64 instead of the actual amount,
$46.
Continued
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Bank Reconciliation
Accounts Receivable
Miscellaneous General Expense
Cash
To record customer’s
uncollectible check and bank
charges for November.
Note:
118.94
3.16
122.10
When the item is a plus under
“Balance per books,” Cash is
debited. When it is a minus,
Cash is credited.
Presentation of Sales and Receivables in
the Financial Statements
Receivables qualifying as current items
may be grouped for presentation on the
balance sheet in the following classes:
1) Notes receivable—trade debtors
2) Accounts receivable—trade debtors
3) Other receivables
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Accounts Receivable as a
Source of Cash
• As a sale (either with or
without recourse.
• As a secured borrowing.
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Accounts Receivable as a
Source of Cash
SFAS 140 specified conditions that must be met if a
transfer of receivables is to be accounted for as a sale:
1. The transferred assets have been isolated from the
transferor and its creditors cannot access the
assets.
2. The transferee has the right to pledge or exchange
the transferred assets.
3. The transferor does not maintain effective control
over the assets through either (a) an agreement to
repurchase them before their maturity or (b) the
ability to cause the transferee to return specific
assets.
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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
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Example: Factoring
Accounts Receivable
Assume:
Factored Receivables
Allowance for Bad Debts
Factor Withholding
Sales Price
$10,000
300
5%
$ 8,500
Let’s journalize this
transaction
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Example: Factoring
Accounts Receivable
Cash
Receivable from Factor
Allowance for Bad Debts
Loss from Factoring Receivables
Accounts Receivable
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8,075
425
300
1,200
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.
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Sale of Receivables
with Recourse
When receivables are sold with
recourse, a purchaser of
receivables retains the right to
collect from the seller when the
seller’s customers fail to make
payments when due.
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Sale of Receivables
with Recourse
A firm raises funds by selling $5,000 of
its receivables for $4,300. The receivables
have a net realizable value of $4,700. The
receivables are sold with recourse and the
seller estimates (as required by SFAS No.
140) that the recourse obligation has a fair
value of $250. Assume in this illustration
that the factor does not withhold a
percentage of the purchase price.
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Sale of Receivables
with Recourse
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Cash received
Estimated value of recourse obligation
Net proceeds
$4,300
(250)
$4,050
Book value of the receivables
Net proceeds to be received
Loss on sale of receivables
$4,700
(4,050)
$ 650
Sale of Receivables
with Recourse
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The entry to record the sale:
Cash
Allowance for Bad Debts
Loss on Sale of Receivables
Accounts Receivable
Recourse Obligation
4,300
300
650
5,000
250
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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.
– Footnote disclosure of loan provisions
required.
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Notes Receivable
A promissory note is an
unconditional written
promise to pay a certain
sum of money at a
specified time.
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Notes Receivable
• Initially recorded at present value.
• Two types:
– Interest-bearing: Interest rate is stated on
the note.
– Noninterest-bearing: Interest is implied
in the face amount of the note.
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Example: Notes Receivable
Assume:
Note Receivable
Interest Rate
Time to Maturity
$1,000
10%
2 years
Journalize this note as:
1. An interest-bearing note.
2. A noninterest-bearing note.
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Example: Notes Receivable
Interest-Bearing Note:
Notes Receivable
1,000
Sales
1,000
Noninterest-Bearing Note:
Notes Receivable
Sales
Discount on Notes Receivable
(PV of $1,000 @ 10% for
2 years = $1,210)
1,210
1,000
210
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Discounting Notes Receivables
• 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.
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Formulas for Discounting Notes
Interest = Face amount x Interest
rate x Interest period
Maturity value = Face amount + Interest
Discount = Maturity value x Discount
period x Discount rate
Proceeds = Maturity value - Discount
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chapter 7
The End
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