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Accounting Fundamentals Dr. Yan Xiong Department of Accountancy CSU Sacramento The lecture notes are primarily based on Reimers (2003). 7/11/03 Chapter 7: Sales and Collection Cycle Agenda Control Procedures for Cash Bank Reconciliations Accounts Receivables and Bad Debts

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accounting fundamentals

Accounting Fundamentals

Dr. Yan Xiong

Department of Accountancy

CSU Sacramento

The lecture notes are primarily based on Reimers (2003).

7/11/03

chapter 7 sales and collection cycle
Chapter 7: Sales and Collection Cycle

Agenda

  • Control Procedures for Cash
  • Bank Reconciliations
  • Accounts Receivables and Bad Debts
  • Other Accounting Issues
agenda
Agenda
  • Control Procedures for Cash
controlling cash
Controlling CASH
  • Cash has universal appeal and ownership is difficult to prove.
  • Both cash receipts and cash payments should be recorded immediately when received and made.
  • Checks should be prenumbered and kept secure.
safeguarding cash
Safeguarding Cash
  • Separation of duties
    • Different people receive and disburse the cash.
    • Procedures for the record keeping of cash receipts and disbursements are separate.
    • Handling the cash and record keeping are completely separate.
procedures to have in place
Procedures To Have In Place
  • Both cash receipts and cash payments should be recorded immediately when received and made.
  • Keep cash under strict physical control, and deposit cash receipts daily.
  • Have separate approvals for purchases and the payment for those purchases.
procedures
Procedures
  • Use pre-numbered checks, and keep a log of electronic transfers.
  • Payment approval, check signing, and electronic funds transfer should be assigned to different individuals.
  • Bank accounts and cash balances should be reconciled monthly.
accounting for cash reconciling the bank statement
Accounting For Cash:Reconciling The Bank Statement
  • An important part of internal control
  • Need for calculating a true cash balance
  • Two “sides” to be reconciled
    • balance per bank
    • balance per books
  • If there are any mistakes or transactions that have not been recorded in the company’s books, the company’s records should be updated.
agenda9
Agenda
  • Bank Reconciliations
terminology
Terminology

Bank statement

Monthly report prepared by bank that contains details of a company’s deposits, disbursements, and bank charges.

Bank reconciliation

Report prepared by the company after receiving the bank statement that compares the bank statement with the company’s records to verify the accuracy of both.

more terminology
More Terminology

Outstanding check

A check written by the company that has been recorded on the company’s records but has not yet cleared the bank

Deposit in transit

A deposit that the company has made and recorded, but it has not reached the bank’s record keeping system yet.

more terminology12
More Terminology

NSF check

A “bad” check written by a customer that must be deducted from the company’s records. The company recorded the check as a cash receipt (and then deposited it), but the check writer didn’t have the money in his or her account to cover it. The bank will have already deducted it from the company’s balance (in the bank’s records), but the company will have to make an adjustment to their records.

more terminology13
More Terminology

Credit memo

An addition to the company’s balance in the bank’s records for a reason such as the bank having collected a note for the company (from a third party who owed the company).

Debit memo

A deduction from the company’s balance in the bank’s records for a reason such as a bank service charge.

an example of a reconciliation
An Example Of A Reconciliation

Given the following information:

Balance per bank at 4/30 $8,750

Balance per books at 4/30 6,900

Outstanding checks at 4/30 1,380

Bank service charge for April 30

Deposit in transit at 4/30 400

Customer’s NSF check 100

(returned with bank statement)

Bank collected note receivable 1,000 for company

balance per bank section of the reconciliation
Balance Per Bank Section Of The Reconciliation

Balance per bank $8,750

Plus: Deposit in transit 400

Less: Outstanding checks (1,380)

Cash Balance at 4/30 $7,770

balance per books section of the reconciliation
Balance Per Books Section Of The Reconciliation

Balance per books $6,900

Plus: Note collected by bank 1,000

Less: NSF check returned (100)

Service charge ( 30)

Cash balance at 4/30 $7,770

bank reconciliation necessary entries to correct account balances
Bank Reconciliation: Necessary Entries to Correct Account Balances
  • How would the collection of the note receivable be recorded in the journal?

Date Transaction Debit Credit

Apr 30 Cash 1,000

Note receivable 1,000

bank reconciliation necessary entries to correct account balances18
Bank Reconciliation: Necessary Entries to Correct Account Balances
  • How would the NSF check and the bank service charge be recorded in the journal?

Date Transaction Debit Credit

Apr 30 Accounts receivable 100

Operating expenses 30

Cash 130

there is one true cash balance
There Is One True Cash Balance
  • Bank balance per statement is reconciled to the TRUE cash balance
  • Book balance (company’s records) is reconciled to the TRUE cash balance
cash bank reconciliation has two independent parts
++ deposits in transit

++

-- outstanding checks

--

True cash balance

++ collections for us made by the bank

++

-- NSF checks (from customers)

-- Service charges

True cash balance

Cash (Bank) Reconciliation Has Two “Independent” Parts

Balance per bank

Balance per books

agenda21
Agenda
  • Accounts Receivables and Bad Debts
slide22

Accounts And Notes Receivable

  • A/R are the expected future cash receipts of a company. They are typically small and are expected to be received within 30 days.
  • N/R are used when longer credit terms are necessary. The note specifies the maturity date, the rate of interest, and other credit terms.
value of receivables
Value Of Receivables
  • Receivables are reported at their face value less an allowance for accounts which are likely to be uncollectible.
  • The amount which is actually expected to be collected is called the net realizable value (NRV).
  • GAAP requires that A/R be reported at NRV.
two methods
Two Methods

GAAP

Not GAAP

Allowance Method

Direct Write-Off Method

Used only when bad debts are a very small item or when credit sales are insignificant.

A/R Method

Sales Method

the most common method
Allowance method

Estimate the bad debt expense as an adjustment when it is time to prepare the financial statements.

Record the amount as a reduction in ACCOUNTS RECEIVABLE, even though you don’t know whose accounts will be “bad.”

The Most Common Method
allowance method continued
Allowance Method, continued
  • We will base the estimate on:
    • Sales, or
    • Accounts Receivable
  • This method attempts to match the expense (bad debt) with the revenue (sale) by recording the expense in the same period as the sale even though the company has not specifically identified which accounts will go unpaid.
the other method
The Other Method

Direct Write-Off

  • No estimates of bad debts are made.
  • Only when a specific account is known to be uncollectible (customer files bankruptcy, for example) is bad debt expense recorded.
  • This doesn’t do a very good job of matching the revenue (sale) with the expense (bad debt), because a company often discovers an account is uncollectible in a period subsequent to the one in which the sale was made.
how do we report a r on the balance sheet
How Do We Report A/R On The Balance Sheet?

Net Realizable Value of AR = what we expect to collect

On the balance sheet:

Accounts Receivable $3,000

less allowance for

uncollectible accounts (200)

Net AR $2,800

1 on april 1 provided 5 000 services on account
1. On April 1, provided $5,000 Services On Account.
  • How would providing services on account be recorded in the journal?

Date Transaction Debit Credit

Apr 1 Accounts receivable 5,000

Service revenue 5,000

2 on april 15 collected 4 000 cash from accounts receivable
2. On April 15, Collected $4,000 Cash From Accounts Receivable.
  • How would the collection on account be recorded in the journal?

Date Transaction Debit Credit

Apr 15 Cash 4,000

Accounts receivable 4,000

3 adjusting entry booked to reflect the estimate of 5 of ending a r to be uncollectible
3. Adjusting Entry Booked To Reflect The Estimate Of 5% Of Ending A/R To Be Uncollectible.
  • How would the adjusting entry be recorded in the journal?

Date Transaction Debit Credit

Dec 31 Bad debt expense 50

Allowance for uncollect. accts. 50

financial statements at the end of year 19x4

Statement of Cash Flows

For the year 19X4

Income Statement

For the year 19X4

Cash from operations $4,000

Cash from investing -0-

Cash from financing -0-

Sales $5,000

Bad debt expense 50

Net Income $4,950

Total change in cash $4,000

Financial Statements At The End Of Year 19X4:
slide33

Balance Sheet

At 12/31/X4

Assets:

Cash $4000

AR 1,000

Allowance (50)

Net A/R 950

Liab. + Equity:

RE $4,950

Total Assets $4,950 $4,950

1 b on feb 5 wrote off a 40 a r that was determined to be uncollectible
1-b. On Feb 5, wrote Off A $40 A/R That Was Determined To Be Uncollectible.
  • How would the actual write-off of accounts receivable be recorded in the journal?

Date Transaction Debit Credit

Feb 5 Allowance for uncollect. accts. 40

Accounts receivable 40

1 on march 8 provided 6 000 services on account
1. On March 8, Provided $6,000 Services On Account.
  • How would providing services on account be recorded in the journal?

Date Transaction Debit Credit

Mar 8 Accounts receivable 6,000

Service revenue 6,000

2 on march 23 collected 4 500 cash from accounts receivable
2. On March 23, Collected $4,500 Cash From Accounts Receivable.
  • How would the collection on account be recorded in the journal?

Date Transaction Debit Credit

Mar 23 Cash 4,500

Accounts receivable 4,500

where do we stand
Where Do We Stand?

We overestimated bad debts by $10--we estimated $50

but we only wrote off $40 in the subsequent year.

This year our estimate is 5% of $2460 (BB 1,000 + 6,000

credit sales - $4,500 collections -$40 accounts written off)=

$123. But since we overestimated last year, we only need

to record $113 this year.

3 adjusting entry booked to reflect the estimate of 5 of ending a r to be uncollectible38
3. Adjusting Entry Booked To Reflect The Estimate Of 5% Of Ending A/R To Be Uncollectible.
  • How would the adjusting entry be recorded in the journal?

Date Transaction Debit Credit

Dec 31 Bad debt expense 113

Allowance for uncollect. accts. 113

to summarize
To summarize:
  • Two methods:
    • the allowance method
    • the direct write-off method
  • Which one involves estimating future uncollectibles?
summary of the allowance method continued
Summary Of The Allowance Method Continued
  • One way to estimate bad debt expense is to use a percentage of ending A/R (or an aging schedule)
  • When an actual account is written off as uncollectible, it is credited out of A/R and debited out of the Allowance. THERE IS NO NET EFFECT ON ASSETS and NO EXPENSE at the time of the write-off.
agenda41
Agenda
  • Other Accounting Issues
other accounting issues related to sales warranty costs
Other Accounting Issues Related to Sales: Warranty Costs
  • Why give warranties?
  • When should expense be recognized?

We will

repair or

replace this

item...

Warranty

warranties
Warranties
  • How is the warranty obligation met and subsequently removed from the balance sheet?
  • How do all of the above affect financial statements?
  • What other issues are similar to warranties?
transaction analysis
Transaction Analysis
  • Assume the following selected events occurred at Cell-It. For each event:
    • Determine how the accounting equation was affected.
    • Determine the effect on the financial statements.
    • Record the event in t-accounts.
slide45
1. On Jan 1, Sold Merchandise For $5,000 Cash That Had Originally Cost $4,000. These Goods Were Sold With A Two-year Warranty.
  • How would the sale of merchandise be recorded in the journal?

Date Transaction Debit Credit

Jan 1 Cash 5,000

Sales revenue 5,000

Cost of goods sold 4,000

Inventory 4,000

slide46
2. Estimated That $100 Of Warranty Cost Will Be Incurred Over The Next Two Years On The Goods Sold In Transaction 1.
  • How would the adjusting entry be recorded in the journal?

Date Transaction Debit Credit

Dec 31 Warranty expense 100

Estimated warranty liability 100

slide47
3. On February 7, A Customer Returned Goods Under Warranty For Repair. The Cost Of The Repair Was $30 Cash.
  • How would the cost of the repair be recorded in the journal?

Date Transaction Debit Credit

Feb 7 Estimated warranty liability 30

Cash 30