BU8101_Week3

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Week 3

Sales Revenue, Receivables and Cash

BU8101

Accounting: A User Perspective

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Learning Outcomes

Once you have completed this lesson, you should be able

to:

1. Explain how companies measure and report sales

revenue.2. Explain how companies measure, report and manage

receivables.

3. Apply internal control principles to cash and explain

reporting of cash.

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1. Explain how companies measure and report sales

revenue.

2. Explain how companies measure and report

receivables and impairment of accounts receivableexpenses.

3. Explain how companies manage accounts receivables.

4. Explain and apply internal control principles to cash.

5. Prepare a bank reconciliation and explain its purpose.

6. Explain the reporting of cash.

Learning Objectives

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EXPLAIN HOW COMPANIESMEASURE AND REPORT SALESREVENUE

Learning Objective 1

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The Effect of Sales of Goods andServices on the Financial Statements

LO 1

Activity

Sales ofgoods andservices to

customers

Income

Statement

Sales revenue

Balance

SheetCash

AccountsReceivable

Statement of

Cash FlowsCash receivedfrom customers

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Sales revenue is recorded when the performanceobligation is satisfied.

Performance obligation is satisfied when the goods aretransferred from the seller to the buyer or when serviceobligation is performed.

Sales revenues are reported in the income statement asNet sales as shown in Procter & Gambles

consolidated statement of earnings.

Sales Revenue

LO 1

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Sales Revenue

LO 1

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Deductions from Sales Revenue

LO 1

Three types of transactions are recorded in contra-revenue accounts

Contra-revenue means theyll have a debit balance.

Why are they recorded in separate accounts and notdeducted directly from sales revenue?

Sales revenue

Less: Sales discountsSales returns and allowancesCredit card discounts

Net Sales

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Sales Discounts

When selling on credit, companies may offer customers asales discount to encourage early payment.

Read as two ten, net thirty.

Terms

Time

Due

Discount Period Credit Period

Full amount dueFull amountless discount

Purchase or Sale

2/10,n/30

DiscountPeriod

Otherwise, Net(or All) is Due

Credit

Period

Discount

Percent

Read as: Two ten, net thirty

LO 1

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On 25th June 2015, Barry Best sells biscuits priced at$5,000 to a customer on terms 2/10, n/30.

The customer pays within the discount period on 2nd

July 2015.

The entries would be:

Example: Sales Discounts

Date Description Debit CreditJun 25 Accounts receivable (A+) 5,000

Sales Revenue (R+) 5,000

Jul 2 Cash (A+) 4,900Sales Discount[5,000x2%] (R-)(OE-) 100

Accounts Receivable (A-) 5,000

LO 1

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Sales Returns and Allowances

Debited fordamaged

merchandise.

Debited forreturned

merchandise.

Contra revenueaccount.

LO 1

Customer Service

Reason forthe return?

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Credit Card Discounts

On 1stAugust 2015, Mary uses her Visa card to buy$200 worth of biscuits from Barry Best Biscuit Company.

DBS Visa charges a 2% fee.

Barry Best would record (ignore COGS):

Date Description Debit Credit

Aug 1 Cash DBS Bank (A+) 196

Credit Card Discount (R-)(OE-) 4

Sales Revenue (R+)(OE+) 200

LO 1

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End of Learning Objective

You have come to the end of this LearningObjective!

Try the review questions that follow.

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EXPLAIN HOW COMPANIESMEASURE AND REPORT

RECEIVABLES AND IMPAIRMENTOF ACCOUNTS RECEIVABLEEXPENSES


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Amounts due from individuals and other companies thatare expected to be collected in cash.

Amounts owed to

the business for

credit sales of

goods, or services.

AccountsReceivable

Amounts owed to

the business for

which formal

instruments of credit

are issued as proof

of debt.

Nontrade amounts

owed to the

business for other

than business

transactions.

NotesReceivable

OtherReceivables

LO 2

Types of Receivables

AccountsReceivable

NotesReceivable

OtherReceivables

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When companies allow customers to purchasemerchandise on credit, and customers promise to pay inthe future, it is inevitable that some of these receivablesmight not be collectible.

Example:

Bank loans are receivables.

During the subprime mortgage crisis, borrowers of bank loansdefaulted in their mortgage payments (receivables for banks) due

to increased interest rate.Banks had to foreclose their homes and write off a portion of thecredit losses .

hence the term bad debts or Impairment of Accountsreceivable

Impairment of Accounts Receivable

LO 2

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LO 2

We sell biscuits oncredit. It is likely

that somecustomers may

not pay.

Accounting rulesrequire you to

estimate the amount

of doubtful accountsfor each fiscalperiod.

The estimated amounts ofdoubtful accounts are known as

impairments of accountsreceivable expense and they

should be matched with revenuesin the same fiscal period that

created those accounts.

Why cant we justwrite off accounts

after they turnbad?

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Theoretically undesirable:

No matching.

Receivable not stated atcash realizable value.

Not acceptable forfinancial reporting.

Methods of Accounting for Impairment of AccountsReceivable (AR)

Direct Write-Off


LO 2

Not GAAP

Losses are estimated:

Matched with sales revenuein the same accounting

period.

Receivable stated at cashrealizable value.

Required by GAAP.

Allowance MethodDirect Write-Off Allowance Method

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30th June

Assume that up to 30th June 2015, Barry Best BiscuitCompany have unrealistically assumed that all of theaccounts receivable will be collectible.

At 30th June, accounts receivable amounted to $10,000.

Barry Best makesmost sales on credit

Accounts receivable $10,000

LO 2

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Jun 30 Impairment of Accounts Receivable (E+)(OE-) 1,500

Allowance for Impairment of AccountsReceivable (A-) 1,500

Barry and Best reviews the list of accounts receivable at 30thJune 2015 and estimates that approximately $1,500 of theseaccounts will prove to be uncollectible or impaired

Selling expenseContra-asset account

Also known as Uncollectible Account Expense, Doubtful Debts or

Bad debts

LO 2

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Current Assets:

Cash XXX

Accounts receivable 10,000$

Less: Allowance for impairment of accounts receivable (1,500) 8,500

Inventory XXPrepaid expense XX

Total current assets XXXX

Balance Sheet at 30 June (partial)

Barry Best Biscuit Company

Reporting Accounts Receivable andImpairment of Accounts Receivable Expenses

Net sales revenue XXX

Less: Expenses XXX

Impairment of accounts receivable expense 1,500

Utlities XX

Salaries XX

Income Statement for June 2015 (partial)


Also called Allowance for Doubtful Debts

Net realizable value

LO 2

W iti Off

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Writing Off anUncollectible Account Receivable


Jul 15 Allowance for Impairment of AccountsReceivable (A+) 500

Accounts Receivable (Chill Cafe)(A-) 500

Assume in July 2015, Barry Best Biscuit Company learnsthat Chill Caf has gone out of business and that the $500account receivable from this customer is now worthless.

When an account is determined to be completely impaired,

it no longer qualifies as an asset and should be written off.

LO 2

Current Assets:

Cash XXX



Inventory XXPrepaid expense XX

Total current assets XXXX

Balance Sheet at 30 June (partial)


W iti OffLO 2

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Writing Off anUncollectible Account Receivable

Notice that the $500 write-off did not changethe net realizable value nor did it affect anyincome statement accounts.

LO 2

Before write-Off After Write-Off

Accounts receivable 10000 -500 9500

Less: Allow. for impairment of AR 1500 -500 1000

Net realizable value 8500 8500

LO 2

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Chill Caf comes out of bankruptcy and on 1st November2015 and sends a cheque to Barry Best for $500.

When there is recovery of a customers account that has

previously been written off, the entry to write off theaccount is first reversed and

Recovery of Accounts


Nov 1Accounts Receivable (Chill Cafe)(A+) 500

Allowance for Impairment ofAccounts Receivable (A-) 500

LO 2

LO 2

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Recovery of Accounts

Then the collection of the account is recorded in the usualmanner:


Nov 1 Cash (A+) 500

Accounts Receivable (A-) 500

LO 2

E ti ti I i t fLO 2

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Estimating Impairment ofAccounts Receivable

LO 2

At the end of each accounting period, management estimatethe probable amount of impaired accounts and adjust the

Allowance for Impairment of Accounts Receivable to this newestimate.

Example:

Sunny Company assess its accounts receivable for impairment onthe following basis:

Customers E, G & H are considered individually significant.

Other customers are collectively assessed and aged. Each agegrouping has a different likelihood of being uncollectible.

Estimate of impairment is based on past collection experience,the customers financial status

Sunny Company

LO 2

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Sunny CompanySchedule of Accounts Receivable

at 31 December 2014Days

Past Due

Total

EstimatedImpairmentCustomer Total AR Current 1-30 31-60 > 60

Individually

significant

E $130,000 $120,000 $10,000 $ 10,000

G 150,000 145,000 $3,000 2,000 5,000

H 100,000 80,000 $10,000 5,000 5,000 10,000Sub-total 380,000 345,000 10,000 8,000 17,000 25,000

Age analysis

A 4,000 3,500 500

B 12,000 10,000 1,000 1,000

C 5,000 5,000D 20,000 8,000 5,000 4,000 3,000

F 35,000 30,000 3,000 1,500 500

Sub-total 76,000 56,500 9,500 6,500 3,500

x % impairment 1% 3% 5% 10%

Est impairment 565 285 325 350 1,525

Total 456,000 26,525

LO 2

Reporting Accounts ReceivableLO 2

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Current Assets:

Cash 33,000$



Inventory 8,120Prepaid expense 40

Total current assets 470,635

Balance Sheet at 31 December 2014(partial)

Sunny Company

Reporting Accounts Receivableat Net realizable Value

Current Assets:Cash 33,000$

Accounts receivable, net of $26,525 allowance 429,475

Inventory 8,120

Prepaid expense 40

Total current assets 470,635

Balance Sheet at 31 December 2014(partial)

Sunny Company

Method 1

Method 2

LO 2

Adjustments for Impairment ofLO 2

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Adjustments for Impairment ofAccounts Receivable

LO 2

Compare the current balance in the Allowance forImpairment of AR before any adjustments with the desiredbalance in the account.

Assume that Allowance for Impairment of AR before any

adjustment:

Case 1: $ 10,000 credit balance

Case 2: $ 2,000 debit balance

At 31 December 2014, how much impairment of accountsreceivable expense should be recognized in Case 1 and Case 2respectively?

Adjustments for Impairment ofLO 2

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Adjustments for Impairment ofAccounts Receivable

Allowance for

Impairment of ARCase 1

Balance before adjustment

Adjustment needed

Desired balance

Allowance for

Impairment of ARCase 2

2,00010,000

26,525 26,525

16,525 28,525

Date (Case 1) Description Dr Cr

Impairment of Accounts Receivable 16,525

Allowance for Impairment of AR 16,525Date (Case 2) Description Dr Cr

Impairment of Accounts Receivable 28,525

Allowance for Impairment of AR 28,525

LO 2

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EXPLAIN HOW COMPANIESMANAGE ACCOUNTSRECEIVABLES


LO 3

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Tight or relax credit policies? Tight reduces risk of uncollectible accounts.

Relax increases volume of credit sales but higher

Managing Accounts Receivable

LO 3

FactoringAccounts

Receivable

Credit CardSales

LO 3

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A higher turnover ratio suggests: the company is managing its credit-granting and

collection activities effectively.

=

This ratio measures how many times a company converts itsreceivables into cash each year and is used as an indication

of the liquidity of the company.

LO 3

Net SalesAverage Net Acc. Receivable

AccountsReceivableTurnover

LO 3

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This ratio measures, on average, how many days ittakes to collect an account receivable.

AverageCollection

Period=

365 DaysAccounts Receivable Turnover

= 13.50 daysAverage

CollectionPeriod

=365 Days

27.03 Times

LO 3

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EXPLAIN AND APPLY INTERNALCONTROL TO CASH


LO 4

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Barry and Best are celebrating their first six months inbusiness with their accounting professor. Net sales for thefirst six months to 30 June was $400,000, more than fourtimes the original projection. Customers love their biscuits

and orders are streaming in from all over Singapore. Theyexpect to hit the million dollar mark for sales by end of 2015.

Internal Control System

We are now worriedthat we may not be

able to be in controlof our business.

Implement an internalcontrol system in yourbusiness. It will help toprevent fraud and

safeguard assets and yourinterests in the business.

LO 4

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Opportunity

A fraud occurs when an employee act dishonestly forpersonal benefit at the cost of the employer.

Fraud and Internal Control

Financial Pressure Rationalization

Three factors contribute to fraudulent activities as depicted bythe fraud triangle below.

LO 4

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Internal Control System

Policies and procedures adopted to: Safeguard assets.

Ensure the accuracy and reliability of accounting

records.

Increase operational efficiency.

Ensure adherence to companys policies and

compliance with laws and regulations.

All transactions affect cash and Cash is the asset

most susceptible to theft and fraud.

LO 4

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Establish Responsibility Assign responsibility and identify specific individual for a

given task at a time.

Cash receipts: only cashiers are authorised to handle

cash receipts Cash payments: only authorised persons can sign

cheques and authorise payments.

Segregation of Duties

Responsibility for record keeping, custody of assets andauthorization should be separate.

Related activities should be assigned to differentindividual.

Internal Control Principles

LO 4

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Documentation Procedures Use prenumbered documents to account for all

documents. Source documents should be promptlygiven to accounting department for timely recording.

Physical Controls Relate to safeguarding of assets and enhance the

accuracy and reliability of the accounting records.

Cash and cheques to be deposited in bank account on a

daily basis.

Internal control Procedures

LO 4

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Independent Internal Verification Periodic check by an individual or department on the

work of another.

For example, Supervisors count cash receipts daily;

assistant treasurer compares total receipts to bankdeposits daily.

Human Resource Controls

Conduct background check.

Require employees to take vacations and rotateemployees duties.

Bond employees who handle cash.

Internal Control Procedures

LO 4

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Costs should not exceed benefit.

Human element.

Ineffective internal control could be caused byemployees indifference, fatigue or negligence.

Employees in collusion can override the best controls.

Size of the business.

Small companies find it difficult to segregate duties.

Limitations of Internal Control

LO 4

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Used for minorexpenditures.

Petty Cash Funds

Has onecustodian.

Replenishedperiodically.

Petty CashFunds

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PREPARE A BANKRECONCILIATION AND EXPLAINITS PURPOSE


LO 5

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Safeguard cash by using abank as a depository.

Bank minimizes the amountof cash on hand.

Bank creates a doublerecord for all banktransactions.

Bank reconciliation.

Bank As A Control Over Cash

LO 5

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Bank Reconciliation

+ Deposits in Transit (latedeposits not yet reflected inthe bank statement)

Outstanding Cheques

(Issued but not yetpresented to the bank)

Bank Errors

= Adjusted Balance

+ Deposits by Bank(electronic transfers)

-Service Charge-Giro payments,

-NSF or Cancelled Cheques

Interest Revenue/ Expenses Book Errors

= Adjusted Balance

Explains the difference between cash reported on bankstatement and cash balance on companys books and provides

information for reconciling journal entries.

Balance per Bank Balance per Book

LO 5

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STEP 1: Deposits in transit: Deposit received by bank

on 1stAugust. $500STEP 2: Outstanding cheques: Totaled $2,417

STEP 3: Bank memoranda:

Debit: A customers NSF cheque $225

Credit: Interest on bank balance for July $30STEP 4: Errors: Cheque 781 for supplies cleared the bank

for $268 but was erroneously recorded as $240. $28

A $486 deposit by Acme Company was

erroneously credited to our account by the bank. $486

Bank Reconciliation

The bank statement for Simmons Company indicated a cash

balance of $9,610 on 31st July. On this date, the cash ledger accountshows a balance of $7,430. Using 4 reconciling steps, Simmonsdetermine the following reconciling items:

LO 5

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Bank Reconciliation

Balance per bank statement, 31stJuly 9,610$

Additions:

Deposit in transit (Step 1) 500

Deductions:

Outstanding cheques (Step 2) 2,417$

Bank error (Step 4) 486 (2,903)Adjusted cash balance 7,207$

Balance per depositor's records, 31stJuly 7,430$

Additions:

Interest (Step 3) 30Deductions:

NSF cheque (Step 3) 225$

Recording error (Step 4) 28 (253)

Adjusted cash balance 7,207$

LO 5

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Reconciling Journal Entries

GENERAL JOURNAL

Date Account Titles and Explanation Debit Credit

31 July Cash (A+) 30

Interest Revenue (R+)(OE+) 30

31 July Supplies (A+) 28

Accounts Receivable (A+) 225

Cash (A-) 253

Reconciling journal entries for items in the bank statementnot yet recorded in the ledger and for errors in recording.

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EXPLAIN THE REPORTING OFCASH


LO 6

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Cash and Cash Equivalents

Deposits in bank accounts - current accounts, savingsaccounts, fixed deposits accounts etc.

Cash equivalents - short-term investments, usually with amaturity date of less than three months, that have little risk ofmarket value changes.

Bank credit

card sales

Bank drafts Cheques

Treasury Bills

Coins and

paper moneyCash & Cash

Equivalents aredisclosed together in

the balance sheet

For example:

Reporting Other CashLO 6

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Reporting Other Cashon the Balance Sheet

Restricted Cash

Including compensatingbalance must be disclosed

Line of Credit

Unused line of credit mustbe disclosed as a note tothe accounts

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Documents

BU8101_Week3