CHAPTER 6 REPORTING AND INTERPRETING SALES REVENUE REVEIBABLES AND CASH UNDERSTANDING THE BUSINESS Gross profit Net sales revenue Cost of sales ACCOUNTING FOR SALES REVENUE The revenue principle requires that revenues be recorded when they are The point at which title changes hands is determined by the shipping terms earned in the sales contract o FOB Shipping Point when goods are shipped title changes hands at shipment and the buyer normally pays for shipping o FOB destination when items are shipped title changes hands on delivery and the seller normally pays for the shipping Revenues from goods shipped FOB shipping point are normally recognized at shipment Revenues from goods shipped FOB delivery are normally recognized at delivery The appropriate amount of revenue to record is the cash equivalent sales price The principal method includes o 1 allowing consumers to use credit cards to pay for purchase o 2 providing business customers direct credit and discounts for early payment o 3 allowing returns from all customer under certain circumstances Credit Card Sales to Consumers Credit card discount the free charged by the credit company for its services Sales Discounts to Businesses Sales discount is a cash discount offered to encourage prompt payment of an account receivable CHAPTER 6 REPORTING AND INTERPRETING SALES REVENUE REVEIBABLES AND CASH o Provides two benefits Prompt receipt of cash from customers reduces the necessity to borrow money to meet operating needs Since customers tend to pay bills providing discounts first a sales discount also decreases the chances that the customer will run out of funds before the bill is paid Sales Returns and Allowances Sales Returns and Allowances a reduction of sales revenue for return of or allowances for unsatisfactory goods o Must be deducted from gross sales revenue in determining net sales Reporting Net Sales On the company s books credit card discounts sales discounts and sales returns and allowances are accounted for separately to allow managers to monitor the costs of credit card use sales discounts and returns Analysts often examine gross profit as a percentage of sales o A higher profit results in a higher net income o Gross Profit Percentage Gross profit Net Sales MEASURING AND REPORTING RECEIVABLES Classifying Receivables Receivables may be classified in three common ways o 1 They may be classified as either an account receivable or a note receivable account Accounts receivable created by a credit sale on an open Note receivable a promise in writing to pay a specified amount of money called the principle at a definite future dates known as the maturity date and a specified amount of interest at one or more future dates o 2 Receivables may be classified as trade or nontrade receivables A trade receivable is created in the normal course of business when a sale of merchandise or services on credit occurs A nontrade receivable arises from transactions other than the normal sale of merchandise or services o 3 In a classified balance sheet receivables also are classified as either current or noncurrent Allowance method bases bad debt expense one an estimate of uncollectible accounts debt expense o 1 making the end of period adjusting entry to record estimated bad CHAPTER 6 REPORTING AND INTERPRETING SALES REVENUE REVEIBABLES AND CASH o 2 writing off specific accounts determined to be uncollectible during the period Recording Bad Debt Expense Estimates Bad debt expense the expense associated with estimated uncollectible accounts receivable Allowance for doubtful accounts a contra asset account containing the estimated uncollectible accounts receivable When a customer makes a payment on an account that has already been written off the journal entry to written off the account is reversed to put the receivable back on the books and the collection of cash is recorded Summary of the Accounting Process Recording Accounts Receivable and Bad Debts CHAPTER 6 REPORTING AND INTERPRETING SALES REVENUE REVEIBABLES AND CASH Estimating Bad Debts The bad debt expense amount recorded in the end of period adjusting entry often is estimated based on either percentage of total credit sales for the period or an aging of accounts receivable Percentage of Credit Sales Method Percentage of credit sales method bases bad debt expense on the historical percentage of credit sales that result in bad debts Aging of Accounts Receivable Aging of accounts receivable method estimates uncollectible accounts based on the age of each account receivable o Relies on the fact that as accounts receivable become older and more overdue it is less likely that they will be collectible Comparison of the Two Methods Percentage of credit sales Directly compute the amount to be recorded as bad debt expense on the income statement for the period in the adjusting journal entry Aging Compute the estimated ending balance we would like to have in the allowance for doubtful accounts on the balance sheet after we make the necessary adjusting entry The difference between the current balance in the account and the estimated balance is recorded as the adjusting entry for bad debt expense for the period Actual Write Offs Compared with Estimates If uncollectible accounts actually written off differ from the estimated amount preciously recorded a higher or lower amount is recorded in the next period to make up for the previous period s error in estimate When estimates are found to be incorrect financial statement sales for prior annual accounting periods are not corrected Control Over Accounts Receivable Receivables Turnover Net Sales Average Net Trade Ac Receivable REPORTING AND SAFEGUARDING CASH Cash and Cash Equivalents Defined Cash money or any instrument that banks will accept for deposit and immediate credit to a company s account such as a check money order or bank draft Cash equivalent are short term investments with original maturities of three months or less that are readily convertible to cash and whose value is unlikely to change CHAPTER 6 REPORTING AND INTERPRETING SALES REVENUE REVEIBABLES AND CASH Cash Management 1 Accurate accounting so that reports of cash flows and balance may be prepared 2 Controls to ensure that enough cash is available to meet current operating needs maturing liabilities and unexpected emergencies 3 Prevention of the accumulation of excess amounts of idle cash Internal Control of Cash Internal control the process by which a company safeguard its assets
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