chapter 6 Reporting and Interpreting Sales

Revenue, Receivables, and Cash

Financial Accounting
9e
Libby • Libby • Hodge

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Learning Objectives
After studying this chapter, you should be able to:

6-1 Analyze the impact of credit card sales, sales discounts, and sales returns
on the amounts reported as net sales.

6-2 Estimate, report, and evaluate the effects of uncollectible accounts

receivable (bad debts) on financial statements.

6-3 Analyze and interpret the receivables turnover ratio and the effects of
accounts receivable on cash flows.

6-4 Report, control, and safeguard cash.

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Accounting for Net Sales Revenue

The revenue recognition principle requires that revenues be recorded

when earned.

Goods and services have been transferred to customers.

The appropriate amount of revenue to record is the

amount the seller expects to receive.

Shipping terms for goods are FOB (free on board):

 Destination - the title of the goods changes

hands on delivery.

 Shipping point - the title of the goods changes

hands at the shipping date.

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Credit Card Sales to Consumers

Companies accept credit cards for several reasons:

1. To increase sales.
2. To avoid the costs of 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 revenue $3,000

Less: Credit card discounts (0.03 × 3,000) 90
Net sales (reported on the income statement) $2,910

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Sales Discounts to Businesses

When customers purchase on open account, they may be offered a sales

discount as an early payment incentive.

Early Payment Incentive

Number of days Net (total sales

In discount period less returns)

Discount Maximum
percentage 2/10, n/30 credit period

Read as: “Two ten, net thirty”

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To Take or Not to Take the Discount, That Is
the Question FINANCIAL ANALYSIS

$$$
With discount terms of 2/10, n/30, a customer
saves $2 on a $100 purchase by paying
on the 10th day instead of the 30th day.

Amount Saved = Interest Rate for 20 Days

Amount Paid

$2 = 2.04% for 20 Days

$98

365 Days × 2.04% = 37.23%

20 Days

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Sales Returns and Allowances

Customers have a right to return unsatisfactory or damaged merchandise

and receive a refund or an adjustment to their bill. Such returns are often
accumulated in a separate account called Sales Returns and Allowances.

Damaged Merchandise

Returned Merchandise

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Reporting Net Sales

Companies record credit card discounts, sales discounts, and sales

returns and allowances separately to allow management to monitor
the magnitude of these transactions.

Sales revenue $6,000

Less: Credit card discounts (a contra-revenue) 90
Sales discounts (a contra-revenue) 20
Sales returns and allowances (a contra-revenue) 500
Net sales (the first line of the income statement) $5,390

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Exhibit 6.1
Net Sales on the Income Statement

DECKERS OUTDOOR CORPORATION AND SUBSIDIARIES

Consolidated Statements of Comprehensive Income
Three Years Ended December 31, 2013, 2012, 2011
(amounts in thousands)
2013 2012 2011
Net sales $1,556,618 $1,414,398 $1,377,283
Cost of sales 820,135 782,244 698,288
Gross profit 736,483 632,154 678,995
Selling, general, and administrative expenses 528,586 445,206 394,157
Income from operations 207,897 186,948 284,838
Other income (expense) (2,340) (2,830) 424
Income before income taxes 205,557 184,118 285,262
Income taxes 59,868 55,104 83,404
Net income $ 145,689 $ 129,014 $ 201,858

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Measuring and Reporting Receivables

Accounts receivable are created Notes receivable are written

when companies have sales to promises from another party to
customers on open accounts. pay with specified terms.

Trade receivables are amounts owed Nontrade receivables are amounts

to the business for credit sales of owed to the business for reasons
goods or services. other than the normal sale of
merchandise or services.

Balance Sheet Classifications

Current (short-term)
Noncurrent (long-term)

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Accounting for Bad Debts

Bad debts result from credit customers who will not pay the amount they
owe, regardless of collection efforts.

Bad Debt Expense

Expense (Matching)
Principle Record in same
accounting period as the
related sales.

Sales Revenue
Most businesses record an estimate of the
Allowance Method bad debt expense with an adjusting entry at
the end of the accounting period.

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Recording Bad Debt Expense Estimates

Deckers estimated bad debt expense for 2013 to be $115,101

and made the following adjusting entry:

Bad debt expense (+E, −SE) ...……..….….….……………………... 115,101

Allowance for doubtful accounts (+XA, −A) ………………… 115,101

Contra-asset account

Bad debt expense is normally classified as a selling expense and is

closed at year-end.

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Writing Off Specific 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’s total write-offs for 2013 were $115,119.

Prepare a summary journal entry for these write-offs.

Allowance for doubtful accounts (−XA, +A) ….….………….... 115,119

Accounts receivable (−A) …………………………………………….. 115,119

Assets = Liabilities + Stockholders’ Equity

Allowance for doubtful accounts +115,119
Accounts receivable −115,119

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Bad Debt Recoveries
FINANCIAL ANALYSIS

When a company receives a payment on account that

has already been written off, the journal entry to write $$$
off the account is reversed to put the receivable back
on the books. Simultaneously, the collection of cash is
recorded.

For example, if the previously written-off amount was

$677, the following two entries need to be made:

Accounts receivable (+A)….….…………...………………........... 677

Allowance for doubtful accounts (+XA, −A)…………….... 677
Cash (+A) ….….…………...……………….................................. 677
Accounts receivable (−A) ……………............................... 677

Note - The effect of these two entries is to increase cash and increase
the Allowance for doubtful accounts.

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Summary of the Accounting Process

Accounting for bad debts is a two-step process.

Financial
Step Timing Accounts Affected Statement Effects
1. Record End of period in Bad Debt Expense (E) Net Income
estimated which sales are
bad debts made Allowance for Assets (Accounts
adjustment Doubtful Accounts Receivable, Net)
(XA)

2. Identify and Throughout Accounts Receivable Net Income

write off period as bad (A)
No
actual bad debts become effect
debts known Allowance for Assets (Accounts
Doubtful Accounts Receivable, Net)
(XA)

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Summary of the Accounting Process

Accounts Receivable (Gross)(A)

Beginning balance 215,842 Collections on account 1,448,260
Sales on account 1,556,618 Write-offs 115,119

Ending balance 209,081

Allowance for Doubtful Accounts (XA)

Beginning balance 25,086
Bad debt expense
Write-offs 115,119 adjustment 115,101
Ending balance 25,068

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Exhibit 6.2
Accounts Receivable on the Partial Balance Sheet

DECKERS OUTDOOR CORPORATION AND SUBSIDIARIES

Consolidated Balance Sheets
December 31, 2013 and 2012
(amounts in thousands)
2013 2012
ASSETS
Current assets:
Cash and cash equivalents $237,125 $110,247
Trade accounts receivable, net of allowances
of $25,068 and $25,086 as of December 31, 2013,
and December 31, 2012, respectively 184,013 190,756
Inventories 260,791 300,173
Prepaid expenses 14,980 14,092
Other current assets 112,514 59,028
Deferred tax assets 19,881 17,290
Total current assets $829,304 $691,586

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Exhibit 6.3
Accounts Receivable Valuation Schedule (Form 10-K)

DECKERS OUTDOOR CORPORATION AND SUBSIDIARIES

Valuation and Qualifying Accounts
Three Years Ended December 31, 2013, 2012, 2011
(amounts in thousands)
Balance at Balance
Beginning at End
of Year Additions Deductions of Year
December 31, 2013 $25,086 $115,101 $115,119 $25,068
December 31, 2012 21,692 96,931 93,537 25,086
December 31, 2011 13,772 75,995 68,075 21,692

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Two Methods of Estimating Bad Debt Expense

The bad debt expense amount recorded in the end-of-period

adjusting entry often is estimated based on either:
(1) A percentage of total credit sales for the period or
(2) An aging of accounts receivable.

Both methods are acceptable under GAAP and are widely used.

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Estimating Bad Debts—Percentage of Credit Sales Method

The percentage of credit sales method bases bad debt expense on the
historical percentage of credit sales that ultimately result in bad debts.

Credit sales $1,500,000

× Bad debt loss rate (1.0%) × 0.01
Bad debt expense $ 15,000

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Estimating Bad Debts—Percentage of Credit Sales Method

The focus of the percentage of credit sales method is on

determining the amount to record on the income statement
as Bad Debt Expense.

Allowance for Doubtful Accounts (XA)

2014 Beginning balance 25,068
2014 Write-offs 17,068 2014 Bad debt expense
adjustment 15,000
2014 Ending balance ? = 23,000

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Estimating Bad Debts—Aging of Accounts Receivable

The focus of the aging of accounts receivable method is on determining

the desired balance in the Allowance for Doubtful Accounts on the balance
sheet.

Aging Schedule 2014

Estimated Estimated
Percentage Amount
Aged Accounts Receivable Uncollectible Uncollectible
Not yet due $115,000 × 2% = $2,300
Up to 90 days past due 69,000 × 10% = 6,900
Over 90 days past due 46,000 × 30% = 13,800
Estimated ending balance in Allowance for Doubtful Accounts $23,000
Less: Balance in Allowance for Doubtful Accounts
before adjustment (25,068 — 17,068) 8,000
Bad Debt Expense for the year $15,000

Allowance for Doubtful Accounts (XA)

2014 Beginning balance 25,068
2014 Bad debt expense
= 15,000
2014 Write-offs 17,068 adjustment ? Total estimated
2014 Ending balance 23,000 uncollectible
accounts

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Control over Accounts Receivable

Practices That Can Help Minimize Bad Debts

Require approval of
customers’ credit history
by a person independent Age accounts
of the sales and receivable periodically
collections functions. and contact customers
with overdue
payments.

Reward both sales and

collections personnel
for speedy collections.

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Receivables Turnover Ratio

The receivables turnover ratio measures how many KEY RATIO

times average trade receivables are recorded and ANALYSIS
collected for the year.

Deckers 2013 COMPARISONS OVER TIME

Deckers 2013
2011 2012 2013
8.9 7.4 8.3

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 Accounts Receivable
FOCUS ON CASH FLOWS

$$$
Add any decrease in
Accounts Receivable

Cash collections
Sales
from customers
Revenue
Subtract any increase in
Accounts Receivable

Effect on Cash Flows

Operating activities (indirect method)
Net income $ xxx
Adjusted for
Add accounts receivable decrease +
or
Subtract accounts receivable increase −

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Cash and Cash Equivalents

Money
Checks

Cash
Money Orders

Bank Drafts

Certificates of Deposit
Cash Equivalents

T-Bills

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Cash Management

Cash Management Procedures

Accurate accounting so
that reports of cash flows Controls to ensure
and balances may be that enough cash is
prepared. available to meet current
operating needs, maturing
liabilities, and unexpected
emergencies.

Prevention of the
accumulation of excess
amounts of idle cash.

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Internal Control of Cash

“Internal controls” refers to policies and procedures designed to:

Safeguard Provide reasonable assurance on:

assets
• The reliability of financial records
• The effectiveness and efficiency of operations
• Compliance with laws and regulations

Cash is the asset most vulnerable to theft and fraud.

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Internal Control of Cash

Separate jobs of receiving cash and disbursing cash.

Separation Separate procedures of accounting for cash receipts

of Duties and cash disbursements.

Separate the physical handling of cash and all phases

of the accounting function.

Require that all cash receipts be deposited in a bank

daily.

Require separate approval of the purchases and the

Policies and actual cash payments.
Procedures
Assign responsibilities for cash payment approval and
check-signing to different individuals.

Require monthly reconciliation of bank accounts with

the cash accounts on the company’s books.
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 Exhibit 6.4
Example of a Bank Statement

Interest Earned
(INT)
Screen Shot 2015-11-12 at 5.42.10 PM

Electronic Funds
Transfer (EFT)

Not Sufficient
Funds (NSF)

Service Charge
(SC)
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Need for Reconciliation

A bank reconciliation explains the differences between the

cash reported on the bank statement and the cash balance in
the company’s records. Differences exist for two possible
reasons:
1) Timing differences
2) Errors in recording transactions

Outstanding Errors by the

Checks Bank or the
Company

Bank Service Interest

Charges Earned

Deposits in
NSF Checks
Transit

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Bank Reconciliation Illustrated

General Format of a Bank Reconciliation

Ending cash balance per books $xxx Ending cash balance per bank statement $xxx
+Interest paid by bank xx +Deposits in transit xx
−NSF check/Service charges xx −Outstanding checks xx
±Company errors xx ±Bank errors xx
Ending correct cash balance $xxx Ending correct cash balance $xxx

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Exhibit 6.5
Bank Reconciliation Illustrated

[Link], INC.
Bank Reconcilation
For the Month Ending June 30, 2016
Company’s Books Bank Statement
Ending cash balance Ending cash balance
per books $9,040.00 per bank statement $8,322.20
Additions Additions
Interest paid by the bank 20.00 Deposit in transit 1,800.00
Error in recording payment 9.00
9,069.00 10,122.20
Deductions Deductions
NSF check of R. Smith 18.00 Outstanding checks 1,077.20
Bank service charges 6.00
Ending correct cash balance $9,045.00 Ending correct cash balance $9,045.00

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Bank Reconciliation Illustrated

The bank reconciliation identifies previously unrecorded transactions or

changes that are necessary to cause the company’s Cash account(s) to show
the correct cash balance. Any transactions or changes on the company’s
books side of the bank reconciliation need journal entries.

(a) Cash (+A) ….….………………………………………………………………………… 20

Interest income (+R, +SE) …………………………………………………. 20
To record interest by bank.
(b) Accounts receivable (+A) ….….……………………………………………….. 18
Cash (−A) …………………………………………………………………………… 18
To record NSF check.
(c) Bank service expense (+E, −SE) ….….………………………………………… 6
Cash (−A) …………………………………………………………………………… 6
To record service fees charged by bank.
(d) Cash (+A) ….….………………………………………………………………………… 9
Accounts payable (+L) ……………………………………………………… 9
To correct error made in recording a check payable to a creditor.

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Chapter Supplement: Recording Discounts and Returns

Assume a credit card company is charging a 3 percent fee for its service, and
Deckers's Internet credit card sales are $3,000 for January 2.
Prepare the journal entry.

Cash (+A) ….….………………………………………………………………………… 2,910

Credit card discount (+XR, −R, −SE) ………………………………………… 90
Sales revenue (+R, +SE) ……………………………………………………….. 3,000

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Chapter Supplement: Recording Discounts and Returns

Similarly, assume that credit sales of $1,000 are recorded with terms
2/10, n/30, and payment is made within the discount period.
Prepare the journal entries.

Accounts receivable (+A) ….….………………………………………………. 1,000

Sales revenue (+R, +SE) ……………………………………………………….. 1,000

Cash (+A) ….….………………………………………………………………………... 980

Sales discount (+XR, −R, −SE) …………………………………………………… 20
Accounts receivable (−A) ……………………………………………………… 1,000

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Chapter Supplement: Recording Discounts and Returns

Sales returns and allowances should always be treated as a contra-revenue.

Assume that Fontana’s Shoes of Ithaca, New York, buys 40 pairs of sandals
from Deckers for $2,000 on account. Before paying for the sandals, however,
Fontana discovers that 10 pairs of sandals are not the color ordered and
returns them to Deckers.
Prepare the journal entries.

Accounts receivable (+A) ….….………………………………………………. 2,000

Sales revenue (+R, +SE) ……………………………………………………….. 2,000

Sales returns and allowances (+XR, −R, −SE) ….….……………………. 500

Accounts receivable (−A) ……………………………………………………… 500

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