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chapter 7. The Revenue/ Receivable/Cash Cycle. An electronic presentation by Douglas Cloud Pepperdine University. Learning Objectives. 1. Explain the normal operating cycle of a business.

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slide1

chapter7

The Revenue/Receivable/Cash Cycle

An electronic presentation

by Douglas Cloud

Pepperdine University

learning objectives
Learning Objectives

1. Explain the normal operating cycle of a business.

2. Prepare journal entries to record sales revenue, including the accounting for bad debts and warranties for service or replacement.

3. Analyze accounts receivable to measure how efficiently a firm is using this operating asset.

Continued

slide3

Learning Objectives

4. Discuss the composition, management, and control of cash, including the use of a bank reconciliation.

5. Recognize appropriate disclosures for presenting sales and receivables in the financial statements.

Continued

learning objectives1
Learning Objectives

EXPANDED LEARNING OBEJCTIVES:

6. Explain how receivables may be used as a source of cash through secured borrowing or sale.

7. Describe proper accounting and valuation of notes receivable

8. Understand the impact of uncollectible accounts on the statement of cash flows.

slide5

Revenue/Receivables/Cash Timeline

RETURNS

PROVIDE

continuing services

STRUGGLE

with nonpaying customers

DELIVER a product or service

COLLECT cash (includes discounts)

ACCEPT returned products

the operating cycle of a business
The Operating Cycle of a Business

Inventory

Accounts

Receivables

Cash

the operating cycle of a business1
The Operating Cycle of a Business

Assume that Acme Manufacturing sold merchandise to Harper Company on account.

When the inventory is sold on account:

Accounts Receivable 1,000

Sales 1,000

Sold merchandise to Harper

Company on account.

When the collection takes place:

Cash 1,000

Accounts Receivable 1,000

Payment received on account.

the operating cycle of a business2
The Operating Cycle of a Business

Receivables are all claims against other entities. They are usually settled in cash.

  • Trade receivables: Receivables arising from normal operating activities.
  • Notes receivable: Trade receivables evidenced by a formal written promise to pay.
  • Nontrade receivables: All receivables arising from activities other than normal operations.
slide9

The Operating Cycle of a Business

Nontrade receivables arise from a variety of transactions, such as—

(1) The sale of securities or property other than inventory

(2) Deposits to guarantee contract performance or expense payments

(3) Claims for rebates and tax refunds

(4) Dividends and interest receivable

slide10

Accounting for Sales Revenues

A trade discount may vary by customer, depending on the volume of business or size or order.

slide11

Accounting for Sales Revenues

A cash (sales) discount is offered to customers to encourage prompt payment of bills.

slide12

Accounting for Sales Revenues

Gross Method

Assume on March 15, $1,000 of merchandise is sold on account. The terms of the agreement are 2/10, n/30. The firm uses the gross method for record sales on account.

Entry on date of sale:

Accounts Receivable 1,000

Sales 1,000

slide13

Accounting for Sales Revenues

Gross Method

If paid within the discount period:

Cash 980

Sales Discounts 20

Accounts Receivable 1,000

If not paid within the discount period:

Cash 1,000

Accounts Receivable 1,000

slide14

Accounting for Sales Revenues

Net Method

This time, assume that all sales on account are recording using the net method. Again, the terms of the agreement are 2/10, n/30.

At the point of sale (March 15):

Accounts Receivable 980

Sales 980

slide15

Accounting for Sales Revenues

Net Method

If paid within the discount period:

Cash 980

Accounts Receivable 980

If not paid within the discount period:

Cash 1,000

Sales Discounts Not Taken 20 Accounts Receivable 980

slide16

Sales Returns and Allowances

Red sweaters costing $600 are sold for $1,000. When delivered, it was determined that the sweaters should have been green. The customer agrees to keep the merchandise for a $200 reduction in price.

Sales entry:

Accounts Receivable 1,000

Sales 1,000

Cost of Goods Sold 600

Inventory 600

Sales allowance entry:

Sales Returns and Allowances 200

Accounts Receivable 200

slide17

Sales Returns and Allowances

Suppose that instead of the allowance, the customer elects to return the sweaters.

Sales return entries:

Sales Returns and Allowances 1,000

Accounts Receivable 1,000

Inventory 600

Cost of Goods Sold 600

sales discounts and sales returns and allowances
Sales Discounts and Sales Returns and Allowances

Income Statement

Sales $15,000

Less: Sales discounts $250

Sales returns and allowances 400 (650) Net sales $14,350

accounting for bad debts
Accounting for Bad Debts
  • Occur when customers do not pay for items or services purchased on credit.
  • Bad debts are uncollectible accounts receivable.
  • Bad Debt Expense is reported as a selling or general and administrative expense.
  • Accounts receivable are reported on the balance sheet at their net realizable value.
slide20

Accounting for Uncollectible Receivables (Direct Method)

Write Off:

Bad Debts Expense 400

Accounts Receivable 400

To write off an

uncollectible account.

Since this determination was made after the period in which the sale takes place, the matching principle is violated. This method is not accepted under GAAP.

This entry is made when the account has been determined uncollectible. The direct write-off method is used by small businesses because of its simplicity.

slide21

Accounting for Uncollectible Receivables (Allowance Method)

In this method, an estimate of the total uncollectible accounts is made at the end of the period, and an expense is recognized.

Bad Debts Expense 2,000

Allowance for Bad Debts 2,000

To record estimated

uncollectible accounts.

GAAP requires the use of the allowance method.

slide22

Accounting for Uncollectible Receivables (Allowance Method)

When the account is then determined to be uncollectible, the write-off entry is:

Allowance for Bad Debts 400 Accounts Receivable 400 To write off an uncollectible

account.

Note: Bad Debt Expense is not debited.

slide23

Accounting for Uncollectible Receivables (Allowance Method)

What happens if the written off receivable is later collected? Assume that the customer from Slide 22 pays the $400 written-off debt a month after the write-off.

Accounts Receivable 400 Allowance for Bad Debts 400 To reverse the entry made to

write off the account.

Note: Before the payment entry, the debt must be restored.

slide24

Accounting for Uncollectible Receivables (Allowance Method)

What happens if the written off receivable is later collected? Assume that the customer from Slide 22 pays the $400 written-off debt a month after the write-off.

Cash 400 Accounts Receivable 400 To record collection of the

account.

slide25

Accounting for Uncollectible Receivables (Allowance Method)

2) The actual write-off entry for $400 does not reduce net receivables, as shown below:

Accts. Receivable $100,000 Accts. Receivable $99,600

Less Allowance for Less Allowance for

Doubtful Accounts 2,000 Doubtful Accounts 1,600

Net Receivables $ 98,000 Net Receivables $98,000

(1) Allowance for Doubtful Accounts is a contra-asset account which is subtracted from Accounts Receivable on the balance sheet.

estimating the allowance for uncollectible accounts
Estimating the Allowance for Uncollectible Accounts
  • Percentage of credit sales
  • Percentage of accounts receivable
  • Aging receivables
slide27

Percentage of Credit Sales

Example: Doubtful Accounts Expense

The ABC company had credit sales of $100,000. The current accounts receivable balance is $30,500. The allowance for doubtful accounts balance is $350. Historically, 2 percent of the credit sales are not collected.

What is the entry to record estimated bad debts?

slide28

Percentage of Credit Sales

Example: Doubtful Accounts Expense

The ABC company had credit sales of $100,000. The current accounts receivable balance is $30,500. The allowance for doubtful accounts balance is $350. Historically, 2 percent of the credit sales are not collected.

Bad Debt Expense 2,000

Allowance for Doubtful Accounts 2,000

To record estimated uncollectible

accounts for the year.

slide29

Percentage of Credit Sales

Allowance for Doubtful Accounts

Balance 350

Adjusting 2,000

Dec. 31, Bal. 2,350

slide30

Percentage of Accounts Receivable

Example: Doubtful Accounts Expense

The XYZ company had credit sales of $693,000. The current accounts receivable balance is $50,000. The allowance account balance is $600. Historically, 3 percent of accounts receivable are not collectible.

What is the required adjusting entry to record estimated bad debts?

slide31

Percentage of Accounts Receivable

($50,000 x .03) – $600

Bad Debt Expense 900

Allowance for Doubtful Accounts 900

To record estimated uncollectible

accounts for the year.

slide32

Percentage of Accounts Receivable

Allowance for Doubtful Accounts

Balance 600

Adjusting 900

Dec. 31, Bal. 1,500

That’s the desired ending balance.

slide33

Percentage of Accounts Receivable

What if the allowance account had a debit balance of $350?

I see! The ending balance must be “forced” to be the calculated amount.

Allowance for Doubtful Accounts

Adjusting 1,850

Dec. 31, Bal. 1,500

Balance 350

slide34

Aging Receivables

The ABC company had credit sales of $100,000. The current accounts receivable balance is $47,550. The allowance for doubtful accounts balance is $620. The firm ages the accounts to determine the expected uncollectibles.

Remember, because receivables are involved, the amount derived from aging provides the desired balance of the allowance account.

slide35

Aging Receivables

Uncollectible Estimated

Accounts Amount of

Classification Experience Uncollectible

(in days) Balance Percentage Accounts

Not yet due $40,000 2% $ 800

1-30 past due 3,000 5 150

31-60 past due 1,200 10 120

61-90 past due 650 20 130

91-180 past due 500 30 150

181-365 past due 800 50 400

+365 past due 1,400 1,120

$47,550 $2,870

slide36

Aging Receivables

Bad Debt Expense 2,250

Allowance for Doubtful Accounts 2,250

To record estimated uncollectible

accounts for the year.

Required balance $2,870

Current balance (620)

Adjusting entry $2,250

slide37

Aging Receivables

Allowance for Doubtful Accounts

Balance 620

Adjusting 2,250

Dec. 31, Bal. 2,870

slide38

Accounting for Warranties

MJW Video & Sound sells compact stereo systems with a two-year warranty. Past experience indicates that 10% of all systems will need repairs in the first year and 20% will need repairs in the second year. The average repair cost is $50 per system.

slide39

Accounting for Warranties

The number of systems sold in 2004 and 2005 was 5,000 and 6,000, respectively. Actual repair costs were $12,500 in 2004 and $55,000 in 2005.

slide40

Accounting for Warranties

To record estimated warranty expense:

2004

Warranty Expense 75,000

Estimated Liability Under Warranties 75,000

To record estimated warranty

expense based on systems sold.

(5,000 x 0.30) x $50

slide41

Accounting for Warranties

To record the actual cost of doing repairs:

2004

Estimated Liability Under Warranties 12,500 Cash 12,500

To record cost of actual repair

work in 2004.

slide42

Accounting for Warranties

To record estimated warranty expense:

2005

Warranty Expense 90,000

Estimated Liability Under Warranties 90,000

To record estimated warranty

expense based on systems sold.

(6000 x 0.30) x $50

monitoring accounts receivable
Monitoring Accounts Receivable

Average Collection Period:The average number of days that lapse between the time that a sale is made and the time that cash is collected. It is calculated by dividing the average daily sales by the average receivables outstanding.

monitoring accounts receivable1
Monitoring Accounts Receivable

WS Corporation had average receivables of $354,250 and average daily sales of $1,650,000. The average collection period can be calculated as follows:

Average Collection Period:

Average receivable $354,250

Average daily sales ($1,650,000/365)

=

Average collection period = 78 days

slide45

Monitoring Accounts Receivable

Accounts receivable turnover is determined by dividing net sales by the average trade accounts receivable outstanding during the year. For WS Corporation, the 2005 turnover is:

Accounts Receivable Turnover:

Net sales $1,650,000

Average net receivables $354.250

=

Receivables turnover for year = 4.7 times

cash management and control
Cash Management and Control

What items are classified as “cash”?

  • Undeposited Coins and currency (change funds)
  • Demand deposits
  • Petty cash funds
  • Cashier’s checks
  • Personal checks
slide47

Composition of Cash

Many companies report investments in very short-term, interest-earning securities as cash equivalents in the balance sheet.

slide48

Composition of Cash

A credit balance in the cash account is known as a cash overdraft and should be reported as a current liability.

management and control of cash
Management and Control of Cash

1) Specifically assigned responsibilities for handling cash receipts

2) Separation of handling and recording receipts

3) Daily deposits of all cash received

4) Voucher system to control cash payments

5) Internal audits at irregular intervals

6) Double record of cash—bank and books, with reconciliation performed by someone outside the accounting function

slide50

Bank Reconciliation

A comparison of the bank balance with the book’s balance by means of a summary is a bank reconciliation.

bank reconciliation
Bank Reconciliation

Common causes of differences:

  • Deposits in transit.
  • Outstanding checks.
  • Bank debits for items such as service charges and NSF checks.
  • Bank credits for items such as the bank collecting a note for the depositor.
  • Accounting errors.
slide52

Svendsen, Inc.

Bank Reconciliation

November 30, 2005

Balance per bank.... $2,979.72

Additions to bank

balance:

Deposits in transit.... 658.50

Error by bank 12.50

Total................... $3,650.72

Deductions from bank

balance:

Outstanding checks:

Listed individually (703.83)

Corrected bank bal. $2,946.89

Balance per books............. $2,952.49

Additions to bank

balance:

Interest earned...............…. 98.50

Error by depositor.........…. 18.00

Total............................ $3,068.99

Deductions from book

balance:

Service charge.............. $ ( 3.16 )

NSF check.................... (118.94 )

Corrected book bal. $2,946.89

slide53

Bank Reconciliation

All adjustments made to the Balance per Books need to be recorded:

Cash 98.50

Interest Revenue 98.50

To record interest earned.

Cash 18.00

Advertising Expense 18.00

To record correction for check in

payment of advertising recorded

as $64 instead of the actual amount,

$46.

Continued

slide54

Bank Reconciliation

Accounts Receivable 118.94

Miscellaneous General Expense 3.16

Cash 122.10

To record customer’s

uncollectible check and bank

charges for November.

Note: When the item is a plus under “Balance per books,” Cash is debited. When it is a minus, Cash is credited.

slide55

Presentation of Sales and Receivables in the Financial Statements

Receivables qualifying as current items may be grouped for presentation on the balance sheet in the following classes:

1) Notes receivable—trade debtors

2) Accounts receivable—trade debtors

3) Other receivables

accounts receivable as a source of cash
Accounts Receivable as aSource of Cash
  • As a sale (either with or without recourse.
  • As a secured borrowing.
accounts receivable as a source of cash1
Accounts Receivable as aSource of Cash

SFAS 140 specified conditions that must be met if a transfer of receivables is to be accounted for as a sale:

1. The transferred assets have been isolated from the transferor and its creditors cannot access the assets.

2.The transferee has the right to pledge or exchange the transferred assets.

3. The transferor does not maintain effective control over the assets through either (a) an agreement to repurchase them before their maturity or (b) the ability to cause the transferee to return specific assets.

factoring accounts receivable
Factoring Accounts Receivable

Cash from Factoring Accounts Receivable

Payment of Accounts Receivable

Sale of Accounts Receivable

Goods and Services Provided

Customers

Company

Accounts Receivable Established

Factor

accounting for factoring accounts receivable
Accounting for Factoring Accounts Receivable
  • Close sold receivables
  • Close accompanying Allowance for Bad Debts
  • Expense any factoring charges
  • Establish a receivable for any sales price withheld by the factor
  • Debit Cash for net proceeds of the sale
  • Recognize a gain or loss from factoring
example factoring accounts receivable
Example: FactoringAccounts Receivable

Assume:

Factored Receivables $10,000

Allowance for Bad Debts 300

Factor Withholding 5 %

Sales Price $ 8,500

Let’s journalize this transaction

example factoring accounts receivable1
Example: FactoringAccounts Receivable

Cash 8,075

Receivable from Factor 425

Allowance for Bad Debts 300

Loss from Factoring Receivables 1,200

Accounts Receivable 10,000

Computations

Cash: $8,500 – 425 = $8,075

Factor Receivable: $8,500 x 5% = $425

Factoring Loss: ($10,000 – 300) – $8,500 = $1,200

slide62

Sale of Receivableswith Recourse

Sale of receivables with recourse is different from factoring, since factoring is normally sold on a nonrecourse basis.

slide63

Sale of Receivableswith Recourse

When receivables are sold with recourse, a purchaser of receivables retains the right to collect from the seller when the seller’s customers fail to make payments when due.

slide64

Sale of Receivableswith Recourse

A firm raises funds by selling $5,000 of its receivables for $4,300. The receivables have a net realizable value of $4,700. The receivables are sold with recourse and the seller estimates (as required by SFAS No. 140) that the recourse obligation has a fair value of $250. Assume in this illustration that the factor does not withhold a percentage of the purchase price.

slide65

Sale of Receivableswith Recourse

Cash received $4,300

Estimated value of recourse obligation (250)

Net proceeds $4,050

Book value of the receivables $4,700

Net proceeds to be received (4,050)

Loss on sale of receivables $ 650

slide66

Sale of Receivableswith Recourse

The entry to record the sale:

Cash 4,300

Allowance for Bad Debts 300

Loss on Sale of Receivables 650

Accounts Receivable 5,000

Recourse Obligation 250

secured borrowing
Secured Borrowing
  • Assignment of Accounts Receivable
    • There are no special accounting problems involved.
    • Simply record the loan.
  • Specific Assignment:
    • Specified accounts receivable pledged.
    • Accounts receivable reclassified on balance sheet.
    • Footnote disclosure of loan provisions required.
slide68

Notes Receivable

A promissory note is an unconditional written promise to pay a certain sum of money at a specified time.

notes receivable
Notes Receivable
  • Initially recorded at present value.
  • Two types:
    • Interest-bearing: Interest rate is stated on the note.
    • Noninterest-bearing: Interest is implied in the face amount of the note.
example notes receivable
Example: Notes Receivable

Assume:

Note Receivable $1,000

Interest Rate 10%

Time to Maturity 2 years

Journalize this note as:

1. An interest-bearing note.

2. A noninterest-bearing note.

slide71

Example: Notes Receivable

Interest-Bearing Note:

Notes Receivable 1,000

Sales 1,000

Noninterest-Bearing Note:

Notes Receivable 1,210

Sales 1,000

Discount on Notes Receivable 210

(PV of $1,000 @ 10% for

2 years = $1,210)

slide72

Discounting Notes Receivables

  • Discount Rate: The interest rate charged by the financial institution for buying a note receivable.
  • Discount Period: The time between the date a note is sold to a financial institution and its maturity date.
formulas for discounting notes
Formulas for Discounting Notes

Interest = Face amount x Interest rate x Interest period

Maturity value= Face amount + Interest

Discount = Maturity value x Discount period x Discount rate

Proceeds = Maturity value - Discount

slide74

chapter 7

The End

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