Accounting For Sales (Selling products or services)
A. Sales
Recognition of Revenue:
1. Revenue recognition principle
Revenue should be recognized when earned and realized
Earned: The work (providing goods or services) has been substantially completed.
Realized:Cash, or a valid promise of future payment, has been received.
2. 5 steps for revenue recognition
Identify contract with customer
Identify its separate performance obligations
Determine the transaction price
Allocate transaction price to the separate performance obligations
Recognize revenue when entity satisfies a performance obligation
3. Revenue Recognition Method
a. Percentage of completion method
Recognizing revenue on long-term contracts as production occurs
Does not require waiting until the final product is delivered
Associated expenses must be recognized by the company
Used when:
There is surety of receiving payment
Progress measures are dependable
Contract obligations are explicit
b. Completed contract method
Recognizing revenue on long-term contracts that delays recognition of both revenue and related expenses until completion of the contract
Used when:
there is uncertainty about customers paying at end of contract (U.S. GAAP)
the outcome of a contract cannot be estimated reliably (IRFS)
4. Typical Line of business about sale
Negotiation -> Contract -> Collect Cash -> Deliver Product -> Continuing Service
OR
Deliver Product -> Collect Cash (Cash Discount?) -> Customer Return -> Bad Debt -> Continuing Service
Measurement of Sales
1. Gross Sales and Net Sales
Gross Sales: initial revenues or asset inflows based on the initial sales price
Net sales: Total amount of sales after deducting returns, allowances, and discounts
2. Sales Return and Allowances
A sales return occurs when a customer returns previously purchased merchandise
A sales allowance is a reduction of the original selling price
A contra account (Sales Returns and Allowances) combines both returns and allowances in a single account
Contra revenue account
• Used instead of reducing the revenue account directly
• Combines both returns and allowances
• Helps monitor changes in the level of returns and allowances
• Helps in forecasting demand and managing inventory
Dr. Sales Returns and Allowances
Cr. Accounts Receivable (or Cash)
3. Sales Discount
Sale discounts are rewards for prompt payment
Credit Terms:
p/n, x/m
p=discount percentage
n= # of days in discount period
x=otherwise, the full amount is due
m=maximum days in credit period
Discount is a reduction in the full price due to either a sale, promotion or prompt payment
Trade discounts offer one or more reductions to the gross selling price for a particular class of customers
The Gross sales is the price received after deducting the trade discount
There is no contra account for trade discount
Dr. Cash
Cash discounts on sales
Cr. Accounts Receivable
4. Credit Card Discount
Credit Card Fees: typically 1% 4% of gross sales
• An alternative to sales discount
• Deduct from gross sales directly
• Or Record as credit card discount
Dr. Cash
Credit Card Discount
Cr. Sales
5. Reporting for Net Sales Revenue
B. Bad Debts
Record:
1. Classification of Receivables
Accounts Receivable, Notes Receivable, Interest Receivable, Dividends receivable, Other Receivables
2. Uncollectible Accounts of A/Rs
Occur when customers do not pay for items or services purchased on credit
When an account receivable becomes uncollectible, a firm incurs a bad-debt expense
3. The Direct Write-off Method
journal entries:
when credit sales are made:
Dr. Accounts Receivable
Cr. Sales Revenue
when an A/R becomes uncollectible:
Dr. Bad Debt Expense
Cr. Accounts Receivable
when cash received on the previously bad account:
Dr. Accounts Receivable
Cr. Bad Debt Expense
Dr. Cash
Cr. Accounts Receivable
Method is objective because bad debt expense is written off at the time it proves to be uncollectible.
This method is not consistent with the matching principle(All costs and expenses in generating revenues must be identified with those revenues period by period).
4. The Allowance Method
The firm estimates the amount of sales that will ultimately be uncollectible in the same period in which those credit sales are made.
A contra asset account(allowance for bad debts, or, Allowance for doubtful accounts坏帐准备) is set up and deducted from the A/R account on the BS.
journal entries:
when credit sales are made:
Dr. Accounts Receivable
Cr. Sales Revenue
Bad debts are estimated and recognized in the same period as credit sales are made:
Dr. Bad Debt Expense
Cr. Allowance for Bad Debts
when actually write off a bad account:
Dr. Allowance for Bad Debts
Cr. Accounts Receivable
when credit customers eventually pay:
The Allowance Method: Reversing Written-off Receivables
Dr. Accounts Receivable
Cr. Allowance for Bad Debts
Dr. Cash
Cr. Accounts Receivable
Estimate:
1. As a Percentage of Credit Sales (matching+IS focus)
Amount of uncollectibles=a straight percentage of the current year’s credit sales.
Based on experience of prior years, modified for changes expected in current year.
Any existing balance in Allowance for Bad Debts is not considered
2. As a Percentage of Total Receivables (realizable+BS focus)
Amount of uncollectibles = a percentage of total receivables balance at period’s end.
Focus is on estimating total bad debts existing at the end of the period.
The ending balance in Allowance for Bad Debts is the amount of total receivables estimated to be uncollectible.
3. Aging Accounts Receivable (realizable+BS focus)
A more refined version of % of total receivable method.
Based on how long receivables have been outstanding to estimate the ending balance in the Allowance for Bad Debts.
Each receivable is categorized according to age, such as
Current
1-30 days past due
31-60 days past due, etc.
The total amount in each classification is multiplied by an appropriate uncollectible percentage
C. Analyze and management of Accounts Receivable
Assessing Management of Receivables
1. Accounts Receivable Turnover 应收帐款周转率
Accounts Receivable Turnover=Credit Sales/Average Accounts Receivable
Credit Sales=Net Sales on Account
Average Accounts Receivable=(Beginning of the year+End of the year)/2
为什么这是一个有效的衡量指标？
Determines the number of times during a year a company is “turning over” or collecting its receivables.
Measure of how many times old receivables are collected and replaced by new receivables.
2. The Days to Collect A/Rs (Average collection period, 应收账款平均收账期)
Average Collection Period=365 days/Accounts Receivable Turnover
Converts A/Rs turnover into the number of days it takes to collect receivables.
For each dollar revenue, how long it takes the firm to collect the cash.
Balancing the desire to extend credit in order to increase sales with the need to collect cash quickly to pay the company’s bills.
3. Earning Manipulation through Bad Debt Expense
Overestimate:
Years incurring huge loss
CEO turnover - big bath
Merger & Acquisition
Outside Negative forces
Underestimate:
Loss Aversion
Earnings growth
D. Cash Management & Internal Control
1. What is Internal Control?
a. Internal Control is an organizational plan and the designed to accomplish the following:
Safeguard assets
Encourage employees to follow company policies
Promote operational efficiency related measures
Ensure accurate, reliable accounting records
b. Checklist of internal control:
Reliable personnel with clear responsibilities
Separation of duties makes it harder to collude
Adequate documentation (source documents)
Proper authorization for normal/abnormal transactions
Well-documented policies and procedures
Physical safeguards over items of value
Vacations and rotation of duties
Independent review of all systems
Cost-benefit considerations should apply
2. Internal Control of Cash
Bank Reconciliations Daily Deposits Purchase Approval Payment Approval
Check Signatures Pre-numbered Checks
Internal Control of Cash Receipts:
A mail room employee opens all mail and records the checks on a remittance advice.
The Treasurer is responsible for depositing the checks, documented with a deposit receipt.
The remittance advice goes the Accounting Department where is it recorded.
The Controller’s office matches the remittance advice and the deposit receipt.
Controls Over Cash Payments:
Bills are only approved for payment by the accounting department when all the documents related to the transaction are matched together.
A payment voucher authorizes a check to be sent to the vendor.
Bank Reconciliation:
A mathematical explanation of the difference between two numbers.
With a bank reconciliation, there is often a difference between the bank statement balance and the general ledger cash balance.
Process A:
Start with the Bank Balance at the end of the period
+ Add Deposits-in-Transit (DIT)
Cash you have collected from customers, but which has not yet been deposited
- Deduct Outstanding Checks (O/S Checks)
Include ALL uncleared checks, even from previous periods
Adjust for bank errors
= Adjusted Bank Balance
Process B:
Start with the Book Balance at the end of the period
+ Add Bank Collections, Interest Revenue, and EFT Receipts
(Cash receipts not already on the books)
-Deduct Services Charges, NSF Checks, and EFT Payments
(Cash payments not already on the books)
Adjust for book errors
= Adjusted Book Balance