Chapter 7

1. Chapter 7 Reporting and Interpreting Sales Revenue, Receivables, and Cash They’re all inter-related. Whenever you sell you get cash, or A/R.

2. Accounting for Sales Revenue The revenue recognition principlerequires that revenues be recorded when earned: 1) An exchange has taken place between yourself and third party & is measurable (doesn’t have to be exact). 2) The earnings process is nearly complete. Upon delivery, or substantially/nearly complete criteria. Ex: Dec 2nd, ordered. Dec 5th order is delivered. Count it for the 5th. 3) Collection is probable. Reasonably certain that we will be paid.

3. Reporting Net Sales Companies record sales discounts, sales returns and allowances, and credit card discounts separately to allow management to monitor these transactions. Returns decrease our sales. That’s not an expense. We reduce sales not increase expenses. These are “Contra Revenues”. This is also true for sales discounts, ex “If you pay quickly, you can pay less”. We record gross sale, and discount on that sale.

4. Credit Card Sales to Consumers Companies acceptcredit cardsfor several reasons: • To increase sales. • Credit is such a big thing in the retail world. People don’t carry cash or cheque. • To avoid providing credit directly to customers. • To avoid losses due to bad cheques. • To receive payment quicker. They get the money right away. • No effect on merchandiser if you don’t pay your credit card bill. Don’t have to worry about bad debts. When credit card sales are made, the company must pay the credit card company a fee or the service it provides.

5. Credit Card Sales to Consumers On January 2, a store had credit card sales of $3,000. The credit card company charges a 3% service fee. Prepare the journal entry to record these sales. Credit Card Discounts are reported as a contra-revenue account.

6. Sales to Businesses on Account When companies allow customers to purchase merchandise on anopen account, the customer promises to pay the company in the future for the purchase. Available in most business-business or wholesaler-retailer relationships.

7. Percentage of Discount Number of Days Discount Is Available Otherwise, the Full Amount Is Due Number of Days When the Full Amount Is Due Sales to Businesses on Account When customers purchase on open account, they may be offered a sales discount to encourage early payment. 2/10, n/30 Read as: “Two ten, net thirty”

8. Sales to Businesses on Account On January 6, Gildan sold $1,000 of merchandise on credit with terms of 2/10, n/30. Prepare the journal entry to record the sale. We initially record the sale of the full amount (Gross Recording Method assumes that the consumer doesn’t take discount) Net Recording method assumes the do take it, but we don’t use this secondary method.

9. Sales to Businesses on Account On January 14, Gildan receives the appropriate payment from the customer for the January 6 sale. Prepare the required journal entry. $1,000 × 2% = $20 sales discount (XR) $1,000 - $20 = $980 cash receipt

10. Sales to Businesses on Account If the customer remits the appropriate amount on January 20 instead of January 14, what entry would Gildan record? 14 days after sale date = no discount. Because we’re using the Gross method, we reduce the amount oweing on A/R. Generally A/R will be split up into A/R for each ‘borrower’. All together they create the ‘main general A/R control account’ Since the customer paid after the discount period, a sales discount is not granted.

11. Sales Returns and Allowances Debited for damaged merchandise. They record original Gross amount. Upon return they record it as a reduction of sales (XR). Typically this account is in a debit position, because credit is typically in the credit position. Debited for returned merchandise. We want to show that it was originally sold. There’s information value in that (increased handling costs, etc). Contra revenue account.

12. Sales Returns and Allowances On July 8, The T-Shirt Store returns $500 of shirts originally purchased on account from Gildan. Originally Gildan would have had a sale recorded. Now a customer has a return. They debit the contra-revenue account, and decrease the A/R (they don’t have to pay any more assuming they haven’t paid for it. If they had payed for it, you still decrease A/R. IT IS POSSIBLE TO HAVE A NEGATIVE A/R account.). Prepare the required journal entry.

13. Exercise 7-4 Nov 25th – A/R Clara – Debit 4000 Nov 28th – A/R David – Debit 6000 Nov 30th – A/R David – Credit 600 Dec 6th – A/R David – Credit 5400 Each of these have resultant transactions • We are trying to make the net-sales • section of the income statement Sales • Sales Returns and Allowances • Sales Discounts • Credit Card Discounts Net Sales Sale 400 + 4000 + 6000 Credit Card Discount 400 * .02 Sales Returns 6000 * .1 Sales Discounts 6000 * .03 * .9 = 162 Credit Card Fees 6000 * .03 * .9 NET SALES 9,630

14. Gross ProfitPercentage Gross ProfitNet Sales = Gross Profit Percentage In 2004, Gildan reported gross profit of $154,671,718 on sales of $533,367,537. All other things equal, a higher gross profit results in higher net income. Higher Gross profit is better, more money to pay for these other expenses that you’ve encured. If we use our Gross sales then it skews the results. Gross Profit is our net sales – cost of goods sold

15. Gross Profit Percentage Gross ProfitPercentage Gross ProfitNet Sales = Gross ProfitPercentage $154,671,718 $533,367,537 = = 29.0% All other things equal, a higher gross profit results in higher net income.

16. Amounts owed by other companies or persons for cash, goods, or services. Wholesale Open accounts owed to the business by trade customers. Retail Measuring and Reporting Receivables Accounts Receivable

17. Term Montreal, Quebec $1,200 January 5, 2006 Payee after date I promise to pay to Sixty days Principal the order of First Canadian Bank One thousand two hundred --------------------------------- Dollars Interest Rate Payable at First City Bank Maker Value received with interest atper annum 12% Pat Rogers No. Due 10242 March 6, 2006 Gildan Activewear Due Date Measuring and Reporting Receivables (Note Recievable)

18. Accounting for Bad Debts Bad debtsresult from credit customers who will not pay the business the amount they owe, regardless of collection efforts. Notes recievable come about because of the bad debts. Bad debts have just decided not to pay for the charges. Merchandise has been sold, and given to customer, but customer refuses to pay. If they had known this in the beginning they would have never shown this to begin with. Historically there is a statistical average of customers you can expect to create bad debts. You can estimate your bad debts for the year based on previous periods. We can set up an entry to be pro-active on this, so that we follow the matching principal

19. Accounting for Bad Debts Bad Debt Expense Record in same accounting period. Matching Principle Sales Revenue

20. Accounting for Bad Debts Most businesses record anestimateof thebad debt expenseby an adjusting entry at the end of the accounting period.

21. Recording Bad Debt Expense Estimates Assume Gildan estimated bad debt expense for 2005 to be $2,383,000. Prepare the adjusting entry. NOTE: we haven’t identified customers, and we haven’t forgiven them. This is a global estimate. Bad Debt Expenseis normally classified as a selling expense and is closed at year-end.

22. Allowance for Doubtful Accounts Balance Sheet Disclosure Amount the businessexpects to collect. We’re saying we can’t record the full A/R because historically We have some bad debts. (Conservatism Principal: don’t overstate our assets)

23. Writing Off Uncollectible Accounts When it is clear that a specificcustomer’s account receivable will be uncollectible, the amount should beremovedfrom the Accounts Receivable account and charged to the Allowance for Doubtful Accounts. Debit AFDA Credit A/R = no effect on income statement accounts

24. Writing Off Uncollectible Accounts Assume on May 6, Gildan wrote off aspecific account receivable witha balance of $2,500. Prepare the required journal entry.

25. Writing Off Uncollectible Accounts Assume that before the write-off entry, Gildan’s Accounts Receivable balance was $81,000,000 and the Allowance for Doubtful Accounts balance was $2,000,000. (Net realizable value = 79,000,000) Let’s see what effect the write-off had on these accounts.

26. Writing Off Uncollectible Accounts Notice that the write-off did not change the net realizable value nor did it affect any income statement accounts. We still have a net realizable value of 79,000,000 = no effect on balance sheet. We should make a note of this though, as the customer may return and pay you, or try the same thing again.

27. Methods for Estimating Bad Debts Percentage of credit sales (income statement method) or Aging of accounts receivable (balance sheet method) We choose one method and stick with it year over year. If we do change, notify investors.

28. Percentage of Credit Sales(Income Statement Method) Bad debt percentage is based on actual uncollectible accounts from prior years’ credit sales. In the past, X% of our sales have been uncollectable. The focus is on determining the amount to record on the income statement asBad Debt Expense.

29. Percentage of Credit Sales In 2005, Kid’s Clothes had credit sales of $60,000. Past experience indicates that bad debts are one percent of sales. What is the estimate of bad debts expense for 2005? = ___600___

30. Percentage of Credit Sales Now, prepare the adjusting journal entry.

31. Aging of Accounts Receivable(balance sheet method) The focus is on determining the desired balance in the Allowance for Doubtful Accountson the balance sheet. We are not trying to achieve matching concept. Instead we look at existing balance of A/R and make analysis based on that (if we’ve already collected, then it’s not bad debt).

32. Aging of Accounts Receivable

33. Aging Schedule Each customer’s account is aged by breaking down the balance by showing the age (in number of days) of each part of the balance. If an account isn’t yet due, it’s more likely that it will be payed than a customer who’s balance has been due for > 90 days. An aging of accounts receivable for Kid’s Clothes in 2005 might look like this . . . The % uncollectable gets higher as the age of A/R gets higher

34. Aging Schedule Based on past experience, the business estimates the percentage of uncollectible accounts in each time category. These percentages are then multiplied by the appropriate column totals.

35. Aging Schedule The column totals are then added to arrive at the total estimate of uncollectible accounts of $1,201. Not our journal entry

36. Aging of Accounts Receivable Record the Dec. 31, 2005 adjusting entry assuming that the Allowance for Doubtful Accounts currently has a $50 credit balance. So we subtract the 50

37. Aging of Accounts Receivable After posting, the Allowance account would look like this . . .

38. Aging of Accounts Receivable Allowance for Doubtful Accounts Notice that the balance after adjustment is equal to the estimate of $1,201 based on the aging analysis performed earlier.

39. Net Sales Average Net Trade Receivables Receivable Turnover = Receivable Turnover Gildan reported 2004 net sales of $533,367. The receivables were $64,260 at September 29, 2003 (beg. of year) and $85,317 at October 5, 2004 (end of year). (All amounts in thousands.) The quicker they collect their A/R the less bad debt they have. It also allows them to use that cash in their business This ratio measures how quickly a companycollects its accounts receivable.

40. Net Sales Average Net Trade Receivables Receivable Turnover = $533,367 ($64,260 + $85,317) ÷ 2 Receivable Turnover = 7.13 times = Receivable Turnover This ratio measures how quickly a companycollects its accounts receivable.

41. Add Decrease in Accounts Receivable AR down -> Cash up Cash Collected from Customers Subtract Increase in Accounts ReceivableA/R up -> Cash down Focus on Cash FlowsA = L + SE Sales Revenue

42. Internal Controls Internal Controlsare the processes by which the company’s board of directors, management, and other personnel provide reasonable assurance regarding the reliability of the company’s financial reporting, the effectiveness and efficiency of its operations, and its compliance with applicable laws and regulations.

43. Controls Over Accounts Receivable • To guard against the extending credit to non-worthy customers, the following practices can help minimize bad debts: • Require approval of customer’s credit history by a person independent of the sales and collection functions. • Monitor the age of accounts receivable periodically and contact customers with overdue payments. • Reward both sales and collection personnel for speedy collections so that they work as a team.

44. Cash and Cash Equivalents Cash and Cash Equivalents Cheques Money Orders Certificates of Deposit Bank Drafts T-Bills

45. properly account for assets. safeguard assets. ensure the accuracy of financial records. Internal Control of Cash Internal control refers to policies and procedures that are designed to: Cashis the asset most susceptible to theft and fraud.

46. Custody Separationof Duties Recording Authorization Internal Control of Cash

47. Cash Controls Internal Control of Cash Bank Reconciliations Daily Deposits Prenumbered Cheques Payment Approval Verify Signatures Purchase Approval

48. Provides information for reconciling journal entries. Bank Reconciliation Explains the difference between cash reported on bank statement and cash balance on company’s books. A way to safeguard our entries. Whatever goes through the bank is recorded. We compare our entries to those that go through the bank.

49. Balance per Bank Balance per Book + Deposits by Bank (credit memos) + Deposits in Transit - Service Charge - NSF Cheques - Outstanding Cheques ± Bank Errors ± Book Errors = Adjusted Balance = Adjusted Balance Bank ReconciliationBank Balance Book Balance

50. All reconciling items on the book side require an adjusting entry to the cash account. We need bank statement and accounting record match Balance per Bank Balance per Book + Deposits by Bank (credit memos) + Deposits in Transit - Service Charge - NSF Cheques - Outstanding Cheques ± Bank Errors ± Book Errors = Adjusted Balance = Adjusted Balance Bank Reconciliation