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Chapter 9

Chapter 9 Revenue Cycle: Sales, Receivables, and Cash Financial Statement Items Covered in this Chapter Revenue Recognition Revenue Recognition Deliver a product or service Collect cash Struggle with non-paying customers Provide continuing service

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Chapter 9

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  1. Chapter 9 Revenue Cycle:Sales, Receivables,and Cash

  2. Financial Statement ItemsCovered in this Chapter Financial Accounting, 7e Stice/Stice, 2006 © Thomson

  3. Revenue Recognition

  4. Revenue Recognition Deliver a product or service Collect cash Struggle with non-paying customers Provide continuing service The business issues surrounding revenue recognition Financial Accounting, 7e Stice/Stice, 2006 © Thomson

  5. Revenue Recognition Criteria Financial Accounting, 7e Stice/Stice, 2006 © Thomson

  6. Revenue Recognition Criteriaand Exceptions Financial Accounting, 7e Stice/Stice, 2006 © Thomson

  7. How Revenue Is Recognized Revenue is recognized by an increase to Cash or Accounts Receivable and an increase to a revenue account Financial Accounting, 7e Stice/Stice, 2006 © Thomson

  8. How Revenue Is Recognized Example: Transaction 11 from the Veda Landscape Solution scenario: Performed landscaping consulting services for several large clients. Billed these clients $200,000 for these services. Financial Accounting, 7e Stice/Stice, 2006 © Thomson

  9. How Revenue Is Recognized No revenue is recognized when $160,000 of the account is collected Financial Accounting, 7e Stice/Stice, 2006 © Thomson

  10. Pressure to Recognize Revenue There is a tendency for companies to want to recognize revenue prematurely because of • Initial public offerings • Profit goals • Executive bonuses tied to income Financial Accounting, 7e Stice/Stice, 2006 © Thomson

  11. Application of the Revenue Recognition Criteria When the work associated with a sale extends over a significant time period, or when cash collectibility is in doubt, the accountant must use professional judgment in determining the proper time to record the sale Financial Accounting, 7e Stice/Stice, 2006 © Thomson

  12. Selling on Credit and Collecting Cash

  13. Granting Credit Granting credit makes sense if the cash collected from customers exceeds the cost of goods sold plus other incremental costs Financial Accounting, 7e Stice/Stice, 2006 © Thomson

  14. Costs of Granting Credit • Bad debts • Bookkeeping costs • Credit approval system • Billing and collection system • Carrying costs • The opportunity cost of not making a return on the cash that is tied up in the form of accounts receivable • The cost of securing cash from other sources • Credit card sales • Card issuer fees for billing and collections Financial Accounting, 7e Stice/Stice, 2006 © Thomson

  15. Credit Policies Credit period: determines when the cash will be collected • n/30, read “net thirty,” means that payment is due within 30 days from the date of the invoice Sales discounts: cash reductions offered to credit customers who pay their bills early Financial Accounting, 7e Stice/Stice, 2006 © Thomson

  16. Credit Policies 2/10, n/30 • 2% discount if the receivable is paid within 10 days of the invoice date • the full invoice price is due within 30 days Financial Accounting, 7e Stice/Stice, 2006 © Thomson

  17. Credit Policies Sales discounts allowed to customers are subtracted from the Sales account and reported as Net Sales on the income statement Gross Salesrecorded internally Less: Sales discounts takenrecorded internally Net Salespublicly reported Financial Accounting, 7e Stice/Stice, 2006 © Thomson

  18. Accounting for Credit Customers Who Don’t Pay

  19. Credit Customers Who Don’t Pay • Bad debt expense is a natural consequence of selling merchandise on credit • The matching concept requires that bad debts be estimated and reported in the same year that the sales occur • This estimation method is known as the allowance method Financial Accounting, 7e Stice/Stice, 2006 © Thomson

  20. Allowance Method Two estimation procedures • Percentage of sales method • Aging method Under either method an increase to Bad Debts Expense is recorded, along with a corresponding increase to Allowance for Bad Debts (a contra account to Accounts Receivable) Financial Accounting, 7e Stice/Stice, 2006 © Thomson

  21. Percentage of Sales Method An estimate of bad debts expense is made by multiplying a percentage (based on past experience) times credit sales Financial Accounting, 7e Stice/Stice, 2006 © Thomson

  22. Percentage of Sales Method If Sales are $200,000 and historically 3% of credit sales have become uncollectible, the following year-end entry would be made: Financial Accounting, 7e Stice/Stice, 2006 © Thomson

  23. Percentage of Sales Method • The Allowance for Bad Debts account is reported on the balance sheet as a subtraction from Accounts Receivable • The percentage of sales method is an income statement approach which relies on historical or industry data to estimate Bad Debts Expense Financial Accounting, 7e Stice/Stice, 2006 © Thomson

  24. Financial Statement Impact Financial Accounting, 7e Stice/Stice, 2006 © Thomson

  25. The Aging Method • The aging method involves dividing the Accounts Receivable balance into different age categories to estimate the amount of those accounts which will ultimately become uncollectible • This balance sheet approach seeks to estimate an appropriate year-end balance for the Allowance for Bad Debts account Financial Accounting, 7e Stice/Stice, 2006 © Thomson

  26. The Aging Method The chances that an account will ultimately be uncollectible increase as the account gets older Assume the following aging analysis for Accounts Receivable: Financial Accounting, 7e Stice/Stice, 2006 © Thomson

  27. The Aging Method Assigning percentages to each age category yields the following results: Financial Accounting, 7e Stice/Stice, 2006 © Thomson

  28. Write-offs of Bad Debt • The write-off entry is merely a confirmation of what has already been estimated and recorded • The write-off has no impact on the reported amount of net Accounts Receivable or Bad Debts Expense Financial Accounting, 7e Stice/Stice, 2006 © Thomson

  29. Write-offs of Bad Debt Customer has declared bankruptcy; receivable balance of $3,200 is written off: Financial Accounting, 7e Stice/Stice, 2006 © Thomson

  30. The Allowance for Bad DebtsT-Account Financial Accounting, 7e Stice/Stice, 2006 © Thomson

  31. Accounting forWarranties

  32. Like bad debts expense, warranty expense must be estimated and recognized in the same period in which the revenue is recognized The accountant must estimate the expense before all of the facts are in. Warranties Financial Accounting, 7e Stice/Stice, 2006 © Thomson

  33. Warranties The year-end entry to record Veda Landscape’s estimated Shrub Warranty Expense from planting 50 shrubs is Financial Accounting, 7e Stice/Stice, 2006 © Thomson

  34. Warranties The entry to record actual costs of replacing shrubs under warranty is Financial Accounting, 7e Stice/Stice, 2006 © Thomson

  35. Cash Management:Controls and Factoring

  36. Cash • Cash includes coins, currency, money orders, checks, and cash in bank accounts that can be used to satisfy the company’s obligations Financial Accounting, 7e Stice/Stice, 2006 © Thomson

  37. Cash Controls • Cash must be carefully safeguarded because it is easily stolen • Separation of duties • The custody of cash should be separated from the recording of cash • Cash receipts • Deposited daily in bank accounts • Cash expenditures • Made with pre-numbered checks Financial Accounting, 7e Stice/Stice, 2006 © Thomson

  38. Cash Management Two methods of obtaining cash from receivables without waiting for collection from customers: • Assignment • Factoring Financial Accounting, 7e Stice/Stice, 2006 © Thomson

  39. Assignment of Receivables • Specific receivables are used as collateral for a loan • Disclosure in the financial statement notes is required Financial Accounting, 7e Stice/Stice, 2006 © Thomson

  40. Factoring Receivables • Factoring involves one company selling some of its receivables to another company (the factor) who charges a fee for the service • Receivables are usually sold “without recourse” • The factor assumes all the risk of collecting the receivables Financial Accounting, 7e Stice/Stice, 2006 © Thomson

  41. Foreign Currencies

  42. Foreign Currencies A foreign currency transaction occurs when a a U.S. firm makes a sale to a foreign firm that is denominated in a foreign currency An exchange rate gain or loss occurs if the exchange rate changes between the time of the sale and when the receivable is collected Financial Accounting, 7e Stice/Stice, 2006 © Thomson

  43. Foreign Currency Transactions The exchange rate is the rate at which one currency can be exchanged for another (foreign currency exchanged for the U.S. dollar) Financial Accounting, 7e Stice/Stice, 2006 © Thomson

  44. Foreign Currency Transaction Example American Company sold £200,000 of goods on April 2 to a British customer. Payment in British pounds is due July 10. The following exchange rates apply: Financial Accounting, 7e Stice/Stice, 2006 © Thomson

  45. Foreign Currency Transaction Example On April 2 the American Company records the sale of $320,000 (£200,000 × $1.60) On June 30 the company records an exchange loss of $8,000 [£200,000 × ($1.60 - $1.56)]. The loss is reported on the quarterly income statement. Financial Accounting, 7e Stice/Stice, 2006 © Thomson

  46. Foreign Currency Transaction Example On July 10 the company receives payment from its British customer, recording a gain of $2,000 due to the increase in the exchange rate. Financial Accounting, 7e Stice/Stice, 2006 © Thomson

  47. Financial Statement Impact Financial Accounting, 7e Stice/Stice, 2006 © Thomson

  48. Evaluating Credit Policy Budgeting Cash Receipts

  49. Quantity of Receivables • The efficient use of accounts receivable can be evaluated by using two ratios: • Accounts receivable turnover • Average collection period Financial Accounting, 7e Stice/Stice, 2006 © Thomson

  50. Quantity of Receivables The accounts receivable turnover determines how many times during the year a company is collecting its average receivable balance Sales Accounts Receivable Turnover = Average Accounts Receivable Financial Accounting, 7e Stice/Stice, 2006 © Thomson

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