Chapter 6
Selling a Product
or Service
Albrecht, Stice, Stice, Swain
COPYRIGHT © 2008 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are
trademarks used herein under license.
1
Three Major Activities of a
Business
• Operating Activities
– Selling products and services.
– Acquire inventory for resale.
– Acquire and pay for other operating
items.
• Always associated with the primary
activities of a business.
2
Three Major Activities of a
Business
• Investing Activities
– Buying and selling
property, plant, and
equipment.
– Buying and selling
stocks and bonds
of other companies.
• Financing Activities
– Debt Financing
– Equity Financing
These activities occur
less often and the
amounts are usually
quite large.
3
Revenue Recognition
Recognize revenue when:
1.
The earning process is
substantially complete.
2.
Cash has either been
collected or collection
is reasonably assured.
4
Application of Revenue
Recognition Criteria
• How do most companies handle revenue
recognition?
– Record sales when goods are shipped to
customers.
– Recognize credit sales as revenues before
cash is collected.
– Recognize revenues from services when the
service is performed, not necessarily when
cash is received.
5
Credit Sale and Collection
On January 10, Hatch Aerospace sold FlyHigh
Airlines $10,000 of equipment on account. Hatch
Aerospace received payment on February 1. What
entries are made?
When the inventory is sold on account:
Jan. 10 Accounts Receivable. . . . . . . . . .10,000
Sales Revenue. . . . . . . . . . . . .
10,000
Sold equipment to FlyHigh on account.
When the collection takes place:
Feb. 1
Cash . . . . . . . . . . . . . . . . . . . . . . .10,000
Accounts Receivable . . . . . . .
10,000
Payment from FlyHigh for equip. sold.
6
Sales Discounts
• Sales Discounts
– A reduction in the selling price that is allowed if
payment is received within a specified period of time.
– Often quoted as “2/10 n/30” meaning a 2% discount is
offered if paid within 10 days. The full amount is due
within 30 days.
When the payment is received within discount period:
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Sales Discounts. . . . . . . . . . . . . . . . . . . .
Accounts Receivable. . . . . . . . . . . . .
196
4
200
To record discount taken by customer.
7
Sales Returns and Allowances
• Sales Returns and Allowances
– A reduction in sales due to the return of, or
allowance for reduction in the price of,
merchandise previously sold.
When merchandise is returned:
Sales Returns and Allowances . . . . . . .
Cash . . . . . . . . . . . . . . . . . . . . . . . . . .
Accounts Receivable . . . . . . . . . . . .
150
50
100
To record merchandise returned by customer.
8
Computing Net Sales
• Contra Account
– An account that is offset or deducted from another
account.
– Sales Discounts and Sales Returns are contra
accounts deducted from Gross Sales.
Gross Sales
– Sales Discounts
– Sales Returns and Allowances
= Net Sales
9
Controls of Cash
• Separation of duties.
– Handling of cash separated from recording the cash
in the accounting records.
– Someone cannot just keep the cash and not record it.
• Daily deposits of all cash receipts.
– Prevents the accumulation of large amounts of cash.
• Payment of all expenditures by prenumbered
checks.
– Documents all payments so none are forgotten or
hidden.
10
Paying on Credit
• Accounts Receivable
– A current asset representing money due for
services performed or merchandise sold on
credit.
• Bad debt
– An uncollectible account receivable.
– If you sell on credit, you are going to have bad
debts!
11
Direct Write-Off Method
• Direct write-off method
– Recording of losses as expenses during the
period in which accounts receivable are
determined to be uncollectible.
When the account is deemed uncollectible:
Bad debt expense . . . . . . . . . . . . . . . . . . 1,500
Accounts Receivable. . . . . . . . . . . . .
1,500
To write off an uncollectible account.
• Violates the matching principle!
12
The Allowance Method
• The Allowance Method
– Estimating the losses from uncollectible accounts as
expenses during the period in which the sale occurs.
When sales are made:
Bad debt expense . . . . . . . . . . . . . . . . . . 1,500
Allowance for Bad Debts. . . . . . . . . .
1,500
To record the estimated bad debt expense for the year.
When accounts are deemed uncollectible:
Allowance for Bad Debts. . . . . . . . . . . . .
Accounts Receivable . . . . . . . . . . . . .
To write off bad debt.
600
600
13
Reinstating Accounts Receivable
• When someone pays after their account is
written off.
When payment is made:
Accounts Receivable. . . . . . . . . . . . . . . .
Allowance for Bad Debts. . . . . . . . . .
600
600
To reinstate the balance previously written off.
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Accounts Receivable . . . . . . . . . . . . .
600
600
Received payment in full of previously written off account.
14
The Estimation Process
• Percentage of sales
– Based on prior years experience.
– Any existing balance in the allowance account is not considered
in the adjusting entry.
• Percentage of total receivables
– Based on percentage of ending receivables balance.
– The estimated percentage is the ENDING balance in the
allowance account. Adjusting entry is what gets the allowance to
that amount.
• Aging accounts receivable
– Apply different estimates of uncollectible receivables to different
receivable age.
– The estimated percentage is the ENDING balance in the
allowance account. Adjusting entry is what gets the allowance to
that amount.
15
Managing Receivables
It’s a balance!
Extending credit
to increase sales
Vs.
Collecting cash
quickly to reduce
your need to borrow
16
Measuring the Management of
Receivables
• Accounts Receivable Turnover
– How many times during the year a company
collects its receivables.
Sales Revenue
Average Accounts Receivable
17
Measuring the Management of
Receivables
• Average Collection Period
– The average number of days it takes to collect
a credit sale.
365
Accounts Receivable Turnover
Calculated as sales
divided by average
accounts receivable.
(Shown in previous slide).18
Warranty Costs
• Estimates of warranty costs are made and recorded at
the time of sale. (Estimate usually based as a
percentage of sales.)
• The company will show an existing warranty liability at
year end.
• When warranty repairs are made, the liability is reduced.
Entry at time of sale:
Warranty Expense . . . . . . . . . . . . . . . . . . . .
Estimated Warranty Liability. . . . . . . . .
500
500
To record estimated service costs on sale.
Entry when repairs are made:
Estimated Warranty Liability . . . . . . . . . . . .
Wages Payable . . . . . . . . . . . . . . . . . . . .
Supplies . . . . . . . . . . . . . . . . . . . . . . . . . .
To record actual warranty costs.
200
150
50
19
Bank Reconciliations
• Differences between the bank statement
and the cash account.
– Timing differences.
• Outstanding checks.
• Deposits in transit.
– Banking entries.
•
•
•
•
Service charges.
NSF checks.
Direct deposits.
Interest paid.
– Accounting Errors.
Journal entries need
to be made to record
these entries on the
company’s books.
20
Reconciling the Bank Account
Beg. Bank balance
+ Deposits in transit
– Outstanding checks
+/– Bank errors
=Adj. Bank Balance
Account is
reconciled when
both the adjusted
balances are equal.
Beg. Book balance
+ Interest paid
+ Direct deposits
– Service charges
– NSF checks
+/– Accounting errors
=Adj. Book Balance
21
Foreign Currency Transactions
• A sale in which the price is denominated in
a currency other than the seller’s home
country currency.
– Receivable is entered at date of sale using
current exchange rate.
– Receivable is adjusted at period end to reflect
change in exchange rate. A gain or loss is
recognized.
– A gain or loss is recognized when the
receivable is paid reflecting movement in
exchange rate since period end.
22
Foreign Currency Example
On November 6, 2009, the company provided
services to a client in Thailand for 100,000 Thai
baht. On November 6, the exchange rate was 50
baht for one U.S. dollar. The exchange rate on
December 31 was 40 baht for one U.S. dollar.
The company received payment on the account
on March 23, 2010 when the exchange rate was
100 baht for one U.S. dollar. Make all of the
necessary journal entries.
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Foreign Currency Example
When the services are performed:
Accounts Receivable (fc) . . . . . . . . . . . . 2,000
Service Revenue . . . . . . . . . . . . . . . .
2,000
To record service revenue denominated in Thai baht
(100,000 Thai baht ÷ 50 Thai baht per dollar = $2,000).
At year end:
Accounts Receivable (fc) . . . . . . . . . . . .
500
Foreign Currency Gain . . . . . . . . . . .
500
To record exchange gain on receivable denominated
in Thai baht (100,000 Thai baht ÷ 40 Thai baht per
dollar = $2,500, $2,500 – $2,000 = $500).
24
Foreign Currency Example
When receivable is paid:
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,000
Foreign Currency Loss . . . . . . . . . . . . . . 1,500
Accounts Receivable . . . . . . . . . . . . .
2,500
To record the receipt of receivable denominated in
Thai baht (100,000 Thai baht ÷ 100 Thai baht per dollar
= $1,000, $1,000 – $2,500 = $1,500).
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