Chapter 6 Reporting and Interpreting Sales Revenue Receivables and Cash Credit Card Sales to Consumers Companies accept credit cards for several reasons 1 To increase sales 2 To avoid providing credit directly to customers 3 To avoid losses due to bad checks 4 To avoid losses due to fraudulent credit card sales 5 To receive payment quicker When credit card sales are made the company must pay the credit card company a fee for the service it provides Sales Discounts When customers purchase on open account they may be offered a sales discount to encourage early payment Discount 2 10 n 30 Maximum Days in Credit Period of Days in Discount Period Full Amount A customer saves 2 on a 100 purchase by paying on the 10th day instead of the 30th day Interest Rate for 20 Days Amount Saved Interest Rate for 20 Days 2 2 04 Amount Paid 98 Annual Interest Rate 365 Days 2 04 37 23 20 Days Sales Returns and Allowances Debited for damaged merchandise Debited for returned merchandise Contra revenue account Sales revenue Less Credit card discounts Sales discounts Sales returns and allowances Net sales Accounting for Bad Debts Bad debts result from credit customers who will not pay the business the amount they owe regardless of collection efforts Most businesses record an estimate of the bad debt expense with an adjusting entry at the end of the accounting period Most businesses record an estimate of the bad debt expense with an adjusting entry at the end of the accounting period Deckers estimated bad debt expense for 2006 to be 4 685 000 Prepare the adjusting entry GENERAL JOURNAL Date Description Debit Credit Dec 31 Bad Debt Expense E SE 4 685 000 Allowance for Doubtful Accounts XA 4 685 000 Accounts receivable Less Allowance for doubtful accounts Net realizable value of accounts receivable Writing Off Uncollectible Accounts When it is clear that a specific customer s account receivable will be uncollectible the amount should be removed from the Accounts Receivable account and charged to the Allowance for Doubtful Accounts Deckers total write offs for 2006 were 6 969 000 Prepare a summary journal entry for these write offs GENERAL JOURNAL Date Description Debit Credit Allowance for Doubtful Accounts XA 6 969 000 Accounts Receivable A 6 969 000 Assume that before the write off Deckers Accounts Receivable balance was 62 640 000 and the Allowance for Doubtful Accounts balance was 13 069 000 Let s see what effect the total write offs of 6 969 000 had on these accounts Before Write Off Accounts receivable Less Allow for doubtful accts Net realizable value 62 640 000 13 069 000 49 571 000 After Write Off 55 671 000 6 100 000 49 571 000 The total write offs of 6 969 000 did not change the net realizable value nor did it affect any income statement accounts Summary of the Accounting Process Accounting for bad debts is a two step process Step Timing Accounts affected 1 Record estimated bad debts adjustment End of period which sales are made Bad debt expense E Allowance for bad debt expense XA 2 Identify and write off actual bad debts Throughout period as bad debts become known Accounts receivable A Allowance for doubtful accounts XA Estimating Bad Debts Percentage of Credit Sales Income Statement Approach Bad debt percentage is based on actual uncollectible accounts from prior years credit sales Ignores the current balance in allowance for doubtful accounts Financial Statement Effects Net income Assets Accounts receivable net No effect Net credit sales Bad debt loss rate Amount of journal entry Percentage of Credit Sales In 2008 Kid s Clothes had credit sales of 600 000 Past experience indicates that bad debts are one percent of sales What is the estimate of bad debts expense for 2008 600 000 01 6 000 GENERAL JOURNAL Date Description Debit Credit Dec 31 Bad Debt Expense E SE 6 000 Allowance for Doubtful Accounts XA 6 000 Net credit sales Bad debt loss rate Amount of journal entry Estimating Bad Debts Aging of Accounts Receivable Balance Sheet Approach 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 uncollectible Total Estimated uncollectable amount for each column Add row for total An aging of accounts receivable for Kid s Clothes in 2008 might look like this Aging Schedule Days Past Due Not Yet Due 1 200 235 300 1 30 31 60 61 90 Over 90 50 200 500 3 500 0 01 2 550 0 04 1 540 0 25 1 240 0 40 325 1 830 0 10 Total A R Balance 235 1 500 750 325 10 660 35 102 183 385 496 1 201 Customer Aaron R Baxter T Clark J Zak R Total Uncollectible Estimated Uncoll Amount Record the Dec 31 2008 adjusting entry assuming that the Allowance for Doubtful Accounts currently has a 50 credit balance GENERAL JOURNAL Date Description Debit Credit Dec 31 Bad Debt Expense E SE 1 151 Allowance for Doubtful Accounts XA 1 151 1 201 1 201 50 50 1 151 1 151 Desired Balance Desired Balance Credit Balance Credit Balance Adjusting Entry Adjusting Entry Estimating Bad Debts aging of accounts receivable Receivables Turnover Net sales Average Net trade receivables Deckers reported 2008 net sales of 689 445 000 December 31 2007 receivables were 72 209 000 and December 31 2008 receivables were 108 129 000 Receivables Turnover 689 445 000 7 6 72 209 000 108 129 000 2 This ratio measures how many times average receivables are recorded and collected for the year Average Collection Period 365 Receivables Turnover The average collection period indicates the average time it takes a customer to pay its accounts Cash and Cash Equivalents can be converted into cash with 90 days checks money orders bank drafts T bills certificates of deposit Internal Control of Cash policies and procedures designed to properly account for assets safeguard assets and ensure the accuracy of financial records Cash is the asset most susceptible to theft and fraud Separation of Duties recording custody and authorization Need for Reconciliation explains the difference between cash reported on bank statement and cash balance on company s books Reasons 1 Timing Differences a Transactions recorded in the books but not shown on the bank statement b Transactions shown on the bank statement but not recorded in the books 2 Errors in Recording Transactions Balance per Bank Deposits in transit Outstanding Checks Bank errors Correct balance Balance per Book Deposits by Bank credit memos Service charge NSF Checks Book errors Correct balance The bank reconciliation identifies previously unrecorded transactions or
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