StIce | StIce |Skousen
The
Revenue/Receivables/Cash
Cycle
Chapter 7
Intermediate Accounting
16E
Prepared by: Sarita Sheth | Santa Monica College
COPYRIGHT © 2007
Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are
trademarks used herein under license.
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.
4. Discuss the composition, management, and
control of cash including the bank
reconciliation.
5. Recognize appropriate disclosures for
presenting sales and receivables in the
financial statements.
Learning Objectives- Expanded
Material
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.
Types of Receivables
• Trade receivables – most significant
category resulting from everyday
credit sales of goods/services to
customers.
• Notes receivables- trade receivables
with a formal written promise to pay.
• Nontrade receivables- all other types of
receivables that arise from a variety of
transactions.
Accounting for Sales Revenue
• While earning sales revenue and accounts
receivables, other issues develop:
• Discounts- offered at the time of sale or the
time of payment.
• Sales Returns and Allowances- occur
subsequent to the sale and can occur before
or after payment has been made.
• Bad Debts- must be estimated in the period
when credit sales are made or A/R is
outstanding.
• Warranties for Service/Replacement- after a
sale is made, the warranty period may still
be in place.
Discounts
• Trade discount- reduces the list sales
price to the net sales price charged to
the customer.
• Cash discount- can only be taken if
the customer makes the payment
within a specified time period. There
are two methods to account for this:
– Gross method
– Net Method
Sales Returns and Allowances
Chocolate Cake costing $6 are sold for $10. When
delivered, it was determined that the cakes should
have been lemon. The customer agrees to keep
the merchandise for a $2 reduction in price.
Sales entry:
Accounts Receivable
Sales
10
Cost of Goods Sold
6
Inventory
Sales allowance entry:
Sales Returns and Allowances
Accounts Receivable
10
6
2
2
Sales Returns and Allowances
Suppose that instead of the
allowance, the customer
elects to return the cakes.
Sales return entries:
Sales Returns and Allowances
Accounts Receivable
Inventory
Cost of Goods Sold
10
6
10
6
Sales Discounts and Sales
Returns and Allowances
Income Statement
Sales
$5,000
Less:
Sales discounts
$250
Sales returns and allowances 400
(650)
Net sales
$4,350
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 Warranties
Rony Video & Sound sells
number
of a twoDVDThe
players
with
systems
sold inPast
year
warranty.
2004 and 2005
experience
indicates that
was 5,000 and
10% of all systems will
6,000, respectively.
need
repairs
incosts
the first
Actual
repair
year
and$12,500
20% will
were
in need
repairs
in the
second
2004 and
$55,000
year. The
average repair
in 2005.
cost is $50 per system.
Accounting for Warranties
2004
To record estimated warranty expense:
Warranty Expense
75,000
Estimated Liability for Warranties
75,000
To record the actual cost of doing repairs:
(5,000 x 0.30) x $50
Estimated Liability for Warranties 12,500
Cash
12,500
Accounting for Warranties
2005
To record estimated warranty expense:
Warranty Expense
90,000
Estimated Liability for Warranties
90,000
(6000 x 0.30) x $50
To record estimated warranty expense based on
DVD players sold.
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.
Monitoring Accounts Receivable
Janosonic 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
Monitoring Accounts Receivable
• Accounts receivable turnoverdetermined by dividing net sales by
the average trade accounts receivable
outstanding during the year.
For Janasonic Company, A/R turnover will be:
Accounts Receivable Turnover:
Net sales
$1,650,000
Average net receivables
$354.250
Accounts Receivable Turnover = 4.7 days
Items Classified as Cash
•
•
•
•
•
•
Coins and currency not yet deposited
Demand Deposits
Petty Cash Funds
Cashier’s Checks
Personal Checks
Short term interest-earning securities
A credit balance in the cash account is known
as a cash overdraft and should be reported as a
current liability.
Cash Controls and Management
1.
2.
3.
4.
5.
6.
Specifically assigned responsibilities for
handling cash receipts.
Separation of handling and recording
receipts.
Daily deposits of all cash received.
Voucher system to control cash payments.
Internal audits at irregular intervals.
Double record of cash—bank and books,
with reconciliation performed by someone
outside the accounting function.
Bank Reconciliation
• Bank reconciliation- A comparison of the
bank balance with the book’s balance.
• Common causes for differences between the
two records:
– 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.
Example Bank Reconciliation
Svendsen, Inc.
Bank Reconciliation
November 30, 2005
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
Presentation of Receivables in
the Financial Statements
•
Current receivables may be grouped in the
balance sheet in the following classes:
1. Notes receivable- trade debtors
2. Accounts receivable- trade debtors
3. Other receivables.
•
•
It is possible to combine trade notes and
accounts receivable into a single amount.
Restrictions on any receivables should be
disclosed.
Receivables as a Source of Cash
•
Receivables
may be
converted to
cash:
1. As a sale (either
with or without
recourse).
2. As a secured
borrowing.
Receivables as a Source of Cash
•
FASB Statement No. 140 conditions for
receivables 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.
Sale of Receivables Without
Recourse
• Also known as factoring:
1. Close sold receivables
2. Close accompanying Allowance for Bad
Debts
3. Expense any factoring charges
4. Establish a receivable for any sales price
withheld by the factor
5. Debit Cash for net proceeds of the sale
6. Recognize a gain or loss from factoring
Sale of Receivables with
Recourse
• Purchaser (bank or finance company)
advances cash in return for
receivables, but retains the right to
collect from the seller if debtors fail to
make payment.
• Sale of receivables with recourse is
different from factoring, since
factoring is normally sold on a
nonrecourse basis.
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.
Notes Receivable
•
•
•
Promissory note - an unconditional
written promise to pay a certain sum
of money at a specified time.
Initially recorded at present value.
Two types:
1. Interest-bearing: Interest rate is on the
note.
2. Noninterest-bearing: Interest is implied
in the face amount of the note
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.
Formulas for Discounting
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
Special Valuation Problems
• When a note is exchanged for cash:
– It should be recorded at its face amount
– Any difference face and cash proceeds- record as
premium or discount on the note.
• When a note is exchanged for property,
goods, or services:
– The present value of the note is found in the terms
of the note or supporting documents.
– If there is no current market price for the property,
goods, or services, or the note, then use an
imputed interest rate.
Impact of Uncollectible
Accounts on Cash Flows
• A decrease in receivables can occur
from:
– Customers pay.
– Customers never pay and the account is
written off.
• To find the net cash provided by
operations:
– Adjust for a change in accounts
receivable, and
– Adjust for changes in the allowance for
bad debts account.