Chapter 7
Sales and Collection Cycle
Copyright 2003
Prentice Hall Publishing Company
1
Controlling CASH



Cash has universal appeal
and ownership is difficult to
prove.
Both cash receipts and cash
payments should be recorded
immediately when received
and made.
Checks should be
prenumbered and kept secure.
Copyright 2003
Prentice Hall Publishing Company
2
Safeguarding Cash
 Separation
of duties
 Different
people receive and disburse
the cash.
 Procedures for the record keeping of
cash receipts and disbursements are
separate.
 Handling the cash and record keeping
are completely separate.
Copyright 2003
Prentice Hall Publishing Company
3
Procedures



Use pre-numbered checks, and keep a log of
electronic transfers.
Payment approval, check signing, and
electronic funds transfer should be assigned
to different individuals.
Bank accounts and cash balances should be
reconciled monthly.
Copyright 2003
Prentice Hall Publishing Company
4
Accounting For Cash:
Reconciling The Bank Statement




An important part of internal
control
Need for calculating a true cash
balance
Two “sides” to be reconciled
 balance per bank
 balance per books
If there are any mistakes or
transactions that have not been
recorded in the company’s books,
the company’s records should be
updated.
Copyright 2003
Prentice Hall Publishing Company
5
Terminology
Bank statement
Monthly report prepared by bank that
contains details of a company’s deposits,
disbursements, and bank charges.
Bank reconciliation
Report prepared by the company after
receiving the bank statement that
compares the bank statement with the
company’s records to verify the accuracy
of both.
Copyright 2003
Prentice Hall Publishing Company
6
More Terminology
Outstanding check
A check written by the company that has
been recorded on the company’s records
but has not yet cleared the bank
Deposit in transit
A deposit that the company has made and
recorded, but it has not reached the bank’s
record keeping system yet.
Copyright 2003
Prentice Hall Publishing Company
7
More Terminology
NSF check
A “bad” check written by a customer that
must be deducted from the company’s
records. The company recorded the check
as a cash receipt (and then deposited it),
but the check writer didn’t have the money
in his or her account to cover it. The bank
will have already deducted it from the
company’s balance (in the bank’s records),
but the company will have to make an
adjustment to their records.
Copyright 2003
Prentice Hall Publishing Company
8
More Terminology
Credit memo
An addition to the company’s balance in
the bank’s records for a reason such as
the bank having collected a note for the
company (from a third party who owed the
company).
Debit memo
A deduction from the company’s balance
in the bank’s records for a reason such as
a bank service charge.
Copyright 2003
Prentice Hall Publishing Company
9
Cash (Bank) Reconciliation
Has Two “Independent” Parts
Balance per bank
++ deposits in transit
++
-- outstanding
checks
-True cash balance
Copyright 2003
Balance per books
++ collections for us
made by the bank
++
-- NSF checks (from
customers)
-- Service charges
True cash balance
Prentice Hall Publishing Company
10
Accounts And Notes Receivable


A/R are the expected future
cash receipts of a company.
They are typically small and are
expected to be received within
30 days.
N/R are used when longer
credit terms are necessary. The
note specifies the maturity
date, the rate of interest, and
other credit terms.
Copyright 2003
Prentice Hall Publishing Company
11
Value Of Receivables



Receivables are reported at their
face value less an allowance for
accounts which are likely to be
uncollectible.
The amount which is actually
expected to be collected is called
the net realizable value (NRV).
GAAP requires that A/R be
reported at NRV.
Copyright 2003
Prentice Hall Publishing Company
12
Two Methods
GAAP
Not GAAP
Allowance Method
Direct Write-Off
Method
A/R
Method
Sales
Method
Copyright 2003
Used only when bad debts
are a very small item or
when credit sales are
insignificant.
Prentice Hall Publishing Company
13
The Most Common Method
Allowance method
Estimate the bad debt expense as an
adjustment when it is time to prepare the
financial statements.
 Record the amount as a reduction in
ACCOUNTS RECEIVABLE, even though
you don’t know whose accounts will be
“bad.”

Copyright 2003
Prentice Hall Publishing Company
14
Allowance Method, continued

We will base the estimate on:
» Sales, or
» Accounts Receivable

This method attempts to match the
expense (bad debt) with the revenue (sale)
by recording the expense in the same
period as the sale even though the
company has not specifically identified
which accounts will go unpaid.
Copyright 2003
Prentice Hall Publishing Company
15
The Other Method
Direct Write-Off
No estimates of bad debts are made.
 Only when a specific account is known to be
uncollectible (customer files bankruptcy, for
example) is bad debt expense recorded.
 This doesn’t do a very good job of matching
the revenue (sale) with the expense (bad
debt), because a company often discovers an
account is uncollectible in a period subsequent
to the one in which the sale was made.

Copyright 2003
Prentice Hall Publishing Company
16
1. Provided services to customers for $9,000,
on account.
Assets
=
Liab. + Cont. Cap.
+
Ret. Earnings
+9000 AR



+9000 Sales
Income Statement: Increases income
Statement of Changes in Equity: Increases equity
Statement of Cash Flows: No effect on cash flow
Copyright 2003
Prentice Hall Publishing Company
17
2. Collected $6,000 Cash From Account
Receivable.
Assets
=
Liab. + Cont. Cap.
+
Ret. Earnings
+6000 Cash
(6000) AR



Income Statement: no effect on income
Statement of Changes in Equity: no effect on equity
Statement of Cash Flows: increases cash flow
Copyright 2003
Prentice Hall Publishing Company
18
3. At year-end it was estimated that $200 of
accounts receivable will never be collected.
Assets
=
Liab. + Cont. Cap.
(200) AFDA
+
Ret. Earnings
(200) expense
Income Statement: Decreases income
 Statement of Changes in Equity: Decreases equity
 Statement of Cash Flows: No effect on cash flow

Copyright 2003
Prentice Hall Publishing Company
19
How Do We Report AR On The
Balance Sheet?
Net Realizable Value of AR = what we expect to collect
On the balance sheet:
Accounts Receivable
less allowance for
uncollectible accounts
$3,000
Net AR
$2,800
Copyright 2003
(200)
Prentice Hall Publishing Company
20
Effect of Transaction 4 on
AR Net Realizable Value
Before Event 4
AR
$3,000
Allow.
200
N.R.V.
$2,800
After Event 4
AR
$2,950
Allow.
150
N.R.V. $2,800
Net realizable value of accounts receivable
did not change as a result of the write-off.
Copyright 2003
Prentice Hall Publishing Company
22
Allowance Method, Continued

One way to estimate bad debt expense
is to use a percentage of current period
sales.


Expense = (% * sales)
Another way to estimate bad debt
expense is to use a percentage of
ending A/R (or an aging schedule)

Expense = (% * A/R) – allowance balance
Copyright 2003
Prentice Hall Publishing Company
23
Other Accounting Issues
Related to Sales: Warranty
Costs


Why give warranties?
When should expense be recognized?
We will
repair or
replace this
item...
Warranty
Copyright 2003
Prentice Hall Publishing Company
24