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The Revenue/ Receivables/Cash Cycle. Learning Objectives. Explain the normal operating cycle of a business. Prepare journal entries to record sales revenue, including the accounting for bad debts and warranties for service or replacement.

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slide1

The Revenue/

Receivables/Cash Cycle

learning objectives
Learning Objectives
  • Explain the normal operating cycle of a business.
  • Prepare journal entries to record sales revenue, including the accounting for bad debts and warranties for service or replacement.
  • Analyze accounts receivable to measure how efficiently a firm is using this operating asset.
slide3

Learning Objectives

  • Discuss the composition, management, and control of cash, including the use of a bank reconciliation.
  • Recognize appropriate disclosures for presenting sales and receivables in the financial statements.
learning objectives1
Learning Objectives

EXPANDED MATERIAL:

  • Explain how receivables may be used as a source of cash through secured borrowing or sale.
  • Describe proper accounting and valuation of notes receivable.
  • Understand the impact of uncollectible accounts on the statement of cash flows.
  • Use a petty cash fund.
slide5

Revenue/Receivables/Cash Time Line

RETURNS

PROVIDE

continuing service

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

Cash

Accounts Receivable

Inventory

credit sale and collection
Credit Sale and Collection

Assume that John purchased $1,000 of equipment on account. What entries are made?

Assume that John purchased $1,000 of equipment on account. What entries are made?

When the inventory is sold on account:

Accounts Receivable................ 1,000

Sales.................................. 1,000

Sold equipment to John on account.

Assume that John purchased $1,000 of equipment on account. What entries are made?

When the inventory is sold on account:

Accounts Receivable................ 1,000

Sales.................................. 1,000

Sold equipment to John on account.

When the collection takes place:

Cash.......................................... 1,000

Accounts Receivable......... 1,000

Payment from John for equipment

purchased.

receivables
Receivables

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

  • Trade receivables: Receivables arising from normal operating activities.
  • Nontrade receivables: All receivables arising from activities other than normal operations.
slide9

Sales Discounts--Gross Method

Assume $1,000 of equipment is sold on account. The terms of the agreement are 2/10, n/30. What are the collection entries?

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

slide10

Sales Returns and Allowances

Felton Company sold $1,000 of merchandise. When delivered, it was determined that the wrong color had been sent. The customer agrees to keep the merchandise for a reduction in price of $100. What are the journal entries?

Sales entry:

Accounts Receivable (Cash)....… 1,000

Sales..................................…. 1,000

Sales allowance entry:

Sales Returns and Allowances..… 100

Accounts Receivable (Cash).. 100

slide11

Sales Returns and Allowances

Felton Company sold $1,000 of merchandise. One week later, when it was delivered, $100 in merchandise (cost, $60) was the wrong color. With Felton’s approval, it was returned. What are the journal entries?

Sales entry:

Accounts Receivable (Cash)....… 1,000

Sales..................................…. 1,000

Sales return entry:

Sales Returns and Allowances..… 100

Accounts Receivable (Cash).. 100

Inventory………………………… 60

Cost of Goods Sold…………. 60

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

Income Statement

Sales.............................................… $1,000

Less: Sales Discounts...................... $ 20

Sales Returns and Allowances 100 (120)

Net Sales.......................................... $ 880

bad debts
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.
slide14

Accounting for Uncollectible Receivables (Direct Method)

Write Off:

Bad Debts Expense……………. 400

Accounts Receivable………. 400

To write off an uncollectible account.

This entry is made when the account has been determined uncollectible. 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.

slide15

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 Doubtful Accounts.. 2,000

To record estimated uncollectible accounts.

GAAP requires use of the “Allowance Method” for determining bad debts expense.

slide16

Accounting for Uncollectible Receivables (Allowance Method)

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

Allowance for Doubtful Accounts……... 400

Accounts Receivable……………… 400

To write off an uncollectible account.

slide17

Accounting for Uncollectible Receivables (Allowance Method)

2) The actual write-off entry 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) The 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.
slide19

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 (Cr.). Historically, 3 percent of the credit sales are not collected.

What is the entry to record estimated bad debts?

slide20

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 (Cr.). Historically, 3 percent of the credit sales are not collected.

Bad Debt Expense…………………… 3,000

Allowance for Doubtful Accounts .. 3,000

To record estimated uncollectible

accounts for the year.

slide21

Percentage of Credit Sales

Example: Doubtful Accounts Expense

Allowance for Doubtful Accounts

Balance 350

Adjusting 3,000

Dec. 31, Bal. 3,350

slide22

Percentage of Accounts Receivable

($30,500 x .05) - $350

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, 5 percent of accounts receivable are not collectible.

Bad Debt Expense…………………….. 1,175

Allowance for Doubtful Accounts…. 1,175

To record estimated uncollectible

accounts for the year.

What is the entry to record estimated bad debts?

slide23

Percentage of Accounts Receivable

Allowance for Doubtful Accounts

Balance 350

Adjusting 1,175

Dec. 31, Bal. 1,525

slide24

Percentage of Accounts Receivable

Allowance for Doubtful Accounts

What if the allowance account had a debit balance of $300?

Adjusting 1,875

Dec. 31, Bal. 1,525

Balance 350

slide25

Aging Receivables

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. 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.

slide26

Aging Receivables

Percentage

Estimated to be

AgeBalanceUncollectible Amount

Current.............. $21,000 1.5 $ 315

1-30 days.......... 5,000 4.0 200

31-90 days........ 2,800 20.0 560

Over 90 days..... 1,700 40.0 680

$30,500 $1,755

slide27

Aging Receivables

Allowance for Doubtful Accounts

Balance 350

Adjusting 1,405

Dec. 31, Bal. 1,755

slide28

Accounting for Warranties

Edna’s Appliances sells washers and dryers with a one-year warranty. Past experience indicates that 15% of the appliances sold will need repairs before the warranty expires. The average repair cost is $80. In 2001, 500 washers and dryers were sold. Actual repair costs for the year totaled $3,400.

slide29

Accounting for Warranties

To record estimated warranty expense:

Estimated Liability Under Warranties….. 3,400

Cash…………………………………. 3,400

To record cost of actual repairs in 2001.

To record estimated warranty expense:

Warranty Expense……………………….. 4,000

Estimated Liability Under Warranties.. 4,000

To record estimated warranty expense

based on units sold (500 x $80).

assessing management of receivables
Assessing Management of Receivables

Average Collection Period: The average number of days that elapse between the time that a sale is made and the time that cash is collected. It is calculated by dividing the average receivables by the average daily sales. The amount for average daily sales is determined by dividing net sales by 365.

assessing management of receivables1
Assessing Management of Receivables

The Wheeler Company had net sales of $150,000 during 2002. Accounts receivable increased $35,000 to $40,000 during the same time. Calculate the average collection period.

Average Collection Period:

Average Accounts Receivable $37,500

Average Daily Sales ($150,000/365)

Average collection period = 91.25 days

composition of cash
Composition of Cash
  • Undeposited coins and currency (change funds)
  • Demand deposits
  • Petty cash funds
  • Cashiers’ checks
  • Personal checks
slide33

Composition of Cash

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

slide34

Composition of Cash

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

control of cash
Control of Cash
  • Specifically assigned responsibilities for handling cash receipts.
  • Separation of handling and recording receipts.
  • Daily deposit of all cash received.
  • Voucher system to control cash payments
  • Internal audits at irregular intervals.
  • Double record of cash (bank and book) with reconciliation performed by someone outside the accounting function.
slide36

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.
slide38

Lori’s Florist

Bank Reconciliation

March 31, 2002

Balance per bank.... $4,135

Additions to bank

balance:

Deposits in transit.... 500

Total................... $4,635

Deductions from bank

balance:

Outstanding checks:

191....... $251

192....... 125

195....... 75 451

Adj. bank balance $4,184

Balance per books.............. $3,950

Additions to bank

balance:

Direct deposit...................… 450

Interest.............................… 71

Total............................… $4,471

Deductions from book

balance:

Service charge...........… $ 7

NSF check.................… 100

Error in recording check 180 287

Adj. book balance $4,184

slide39

Bank Reconciliation

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

ADDITIONS:

Cash……………………………………. 521

Accounts Receivable………………. 450

Interest Revenue…………………… 71

DEDUCTIONS:

Accounts Receivable (NSF)…………… 100

Miscellaneous General Expense (SC)…. 7

Recording Error, Underwritten check*... 180

Cash……………………………….. 287

* Debited to original account.

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

  • The transferred assets have been isolated from the transferor and its creditors cannot access the assets.
  • The transferee has the right to pledge or exchange the transferred assets.
  • The transferor does not maintain effective control over the assets through an agreement to repurchase them before their maturity.
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

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

slide46

Sale of Receivableswith Recourse

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

slide47

Sale of Receivableswith Recourse

Cash Received $8,500

Estimated Value of Recourse Obligation 500

Net Proceeds $8,000

Book Value of the Receivables $9,700

Net Proceeds to be Received 8,000

Loss on Sale of Receivables $1,700

Continuing the previous example, assume that the receivables were sold with recourse and it is estimated that the recourse obligation has a fair value of $500.

slide48

Sale of Receivableswith Recourse

The entry to record the sale:

Cash………………………………. 8,075

Receivable from Factor…………... 425

Allowance for Bad Debts………… 300

Loss on Sale of Receivables……... 1,700

Accounts Receivable………... 10,000

Recourse Obligation………… 500

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.
    • Notes disclosure of loan provisions required.
slide50

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.
    • Non-interest-bearing: Interest rate is not specified on the note, but the face amount includes the interest charge.
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.

slide53

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)

slide54

Discounting Notes Receivable

  • 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

slide56

Example: Discounting

The original note is a 3-month, $1,000 note at 14% interest. What is the journal entry if the note was discounted after one month at 16%?

Interest = $1,000 x .14 x 3/12 = $ 35.00

Maturity value = $1,000 + $35 = $1,035.00

Discount = $1,035 x .16 x 2/12 = $ 27.60

Proceeds = $1,035 - $27.60 = $1,007.40

Cash……………………………. 1,007.40

Interest Revenue……………... 7.40

Note Receivable……………... 1,000.00