Financial Accounting Chapter 6. Reporting and Interpreting Sales Revenue, Receivables, and Cash

Objectives Sales Revenue Sales Discount and Return Account Receivable Bad Debt

Credit Card Sales Credit card sales = credit card discount is the fee charged by the credit card company. Cash 29,400 Credit card discount 600 Sales30,000 When credit card sales are made, the company must pay the credit card company a fee for the service it provides.

Sales Discount Sales Discount – sales can be made either on cash or on accounts. Sellers provide various discounts to promote the sales and prompt payments. The terms used in sales discounts: ◦ n/30: Full billed price is due on the thirtieth day after the invoice date. ◦ 1/5, n/30: A 1% discount can be taken for payment within 5 days of the invoice date; otherwise the full payment is due in thirty days. ◦ 15 E.O.M: The full price is due within 15 days after the end- of-the month of sale.

Sales Return and Allowance Sales return and allowance ◦ Many businesses allow customers to return unsatisfactory merchandise and receive a refund (sales return). ◦ Sometimes, instead of returning merchandise, the customer demands a reduction of the selling price (sales allowance). ◦ These are recorded at a contra account, ‘sales return and allowance’. Contra account ◦ is an account that is an offset to, or reduction of, the primary account. ◦ has a balance in the opposite side of the primary account. ◦ The examples of contra account is sales return & allowances, and sales discount

How to report sales revenue? Illustration Gross salesxxx Less: Credit card discount* XX Sales discount* XX Sales return and allowanceXXxxx Net salesxxx Cost of Goods Soldxxx Gross Profitxxx * Credit card discount and sales discount can be recorded as contra-revenues (as illustrated) or as selling expenses.

Account Receivable and Uncollectible Accounts Account receivable ◦ is amounts owned to a company by customers as a result of delivering goods or services and extending credit in the ordinary course of business. ◦ The claims are supported by a written note and often do not require interest. ◦ Since account receivable produces no interest, maintaining account receivable at a reasonable level is important. Uncollectible account (or Bad debt) ◦ When customers are unable or unwilling to pay account receivable, it becomes uncollectible account. ◦ This is the major cost of granting credit to customers.

Recording Uncollectible A/R There are two ways to record uncollectible A/R. ◦ Direct (or specific) write-off method : This method assumes that all sales are fully collectible until proved otherwise. Once sales turn uncollectible, related account receivable is credited. ◦ Allowance method : The idea is to make adjustment before the actual event of uncollectibility (and reduce earnings at the time of sales!). This assumes that a part of sales inevitably becomes uncollectible and that amount can be reasonably well estimated. Allowance of bad debts ◦ Of course, these assumptions do not mean that accountants can estimate bad debts for each customer or each sale. Instead, this method uses a contra account, ‘Allowance for bad debt’ to record collective amount of estimated bad debts until the company actually experiences it. ‘Allowance for bad debt’ usually has a balance at credit side.

Estimation method of bad debts Percentage of credit sales method Percentage of account receivables method Aging of accounts receivable method

1) Percentage of credit sales method a. Find the % of credit sales expected to be uncollectible from the past experience. b. Additional Allowance = {credit sales during that period} X the % c. Ending balance of Allowance = Beginning balance + Change during the period + Additional Allowance

2) Percentage of account receivables method a. Find the % of A/R expected to be uncollectible from the past experience. b. Target ending balance of Allowance = {ending balance of A/R} X the %. c. If (Ending balance of Allowance > Beginning balance of Allowance)  increase the Allowance by that difference d. If (Ending balance of Allowance < Beginning balance of Allowance)  decrease the Allowance by that difference

3) Aging of accounts receivable method This method is a part of 2) percentage of A/R method. Procedures a. Divide A/R into sub-groups based on its age. b. For each group, find the % of A/R expected to be uncollectible from the past experience. c. For each group, target ending balance of Allowance = ending balance of A/R X the %. d. Target ending balance of Allowance = sum of those target balances for subgroups. e. The same type of adjustment as the percentage of A/R method.