Accounting & Financial Reporting

1. Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
Reporting and
Interpreting
Sales Revenue,
Receivables,
and Cash
Chapter 6

2. 6-2
Learning Objectives
Apply the revenue principle to determine the
accepted time to record sales revenue for
typical retailers, wholesalers, manufacturers,
and service companies.

3. 6-3
Accounting for Sales Revenue
The revenue principle requires that
revenues be recorded when earned:
Goods or services
have been delivered.
Collection is
reasonably assured.
Amount of customer
payments known.

4. 6-4
Learning Objectives
Analyze the impact of credit card sales, sales
discounts, and sales returns on the amounts
reported as net sales.

5. 6-5
Reporting Net Sales
Companies record credit card discounts,
sales discounts, and sales returns and
allowances separately to allow management
to monitor these transactions.
Sales revenue
Less: Credit card discounts
Sales discounts
Sales returns and allowances
Net sales

6. 6-6
Credit Card Sales
Companies accept credit cards for
several reasons:
1. To increase sales.
2. To avoid 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.

7. 6-7
When credit card sales are made, the
company must pay the credit card
company a fee for the service it provides.
Credit Card Sales

8. 6-8
When companies allow customers to purchase
merchandise on an open account, the
customer promises to pay the company in the
future for the purchase.
Sales on Account

9. 6-9
2/10, n/30
Sales Discounts
When customers purchase on open account,
they may be offered a sales discount to
encourage early payment.
Read as: “Two ten, net thirty”

10. 6-10
2/10, n/30
Discount
Percentage
# of Days in
Discount
Period
Otherwise,
the Full
Amount Is
Due
Maximum
Days in
Credit
Period
Sales Discounts

11. 6-11
To Take or Not Take the Discount
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.
Annual Interest Rate = 365 Days
20 Days
× 2.04% = 37.23%
$2
$98
= 2.04%
Interest Rate for 20 Days =
Interest Rate for 20 Days =
Amount Saved
Amount Paid

12. 6-12
Sales Returns and Allowances
Debited for damaged
merchandise.
Debited for returned
merchandise.
Contra revenue
account.

13. 6-13
Learning Objectives
Analyze and interpret the gross
profit percentage.

14. 6-14
Gross Profit Percentage
In 2003, Deckers reported gross profit
of $51,345,000 on sales of
$121,055,000.
Gross Profit
Percentage
Gross Profit
Net Sales
=
All other things equal, a higher
gross profit results in higher net
income.

15. 6-15
Deckers Skechers U.S.A. Timberland
42.4% 38.0% 46.5%
2003 Gross Profit Comparisons
Gross Profit
Percentage
$51,345,000
$121,055,000
= = 42.4%
Gross Profit
Percentage
Gross Profit
Net Sales
=
Gross Profit Percentage
All other things equal, a higher gross
profit results in higher net income.

16. 6-16
Measuring and Reporting Receivables
Accounts
Receivable
Trade receivables are
amounts owed to the
business for credit
sales of goods, or
services.
Nontrade receivables
are amounts owed to
the business for
other than business
transactions.

17. 6-17
$1,200 Goleta, CA January 5, 2006
Sixty days after date I promise to pay to
the order of Deckers Outdoor Corporation
One thousand two hundred --------------------------------- Dollars
Payable at First Goleta National Bank
Value received with interest at per annum
No. Due
Goodson Sporting Goods
10242 March 6, 2007
12%
Ivan Goodson
Measuring and Reporting Receivables –
Notes Receivable
Due Date
Maker
Interest Rate
Principal
Term
Payee

18. 6-18
Learning Objectives
Estimate, report, and evaluate the effects of
uncollectible accounts receivable (bad debts)
on financial statements.

19. 6-19
Accounting for Bad Debts
Bad debts result from credit customers
who will not pay the business the amount
they owe, regardless of collection efforts.

20. 6-20
Matching
Principle
Bad Debt
Expense
Sales
Revenue
Record in same
accounting
period.
Accounting for Bad Debts

21. 6-21
Most businesses record an estimate of
the bad debt expense by an adjusting
entry at the end of the accounting period.
Accounting for Bad Debts

22. 6-22
Recording Bad Debt Expense Estimates
Date Description Debit Credit
Dec. 31
GENERAL JOURNAL
Deckers estimated bad debt expense
for 2003 to be $504,000.
Prepare the adjusting entry.

23. 6-23
Date Description Debit Credit
Dec. 31 Bad Debt Expense 504,000
Allowance for Doubtful Accounts 504,000
GENERAL JOURNAL
Bad Debt Expense is normally classified as a
selling expense and is closed at year-end.
Contra asset account
Recording Bad Debt Expense Estimates
Deckers estimated bad debt expense
for 2003 to be $504,000.
Prepare the adjusting entry.

24. 6-24
Allowance for Doubtful Accounts
Accounts receivable
Less: Allowance for doubtful accounts
Net realizable value of accounts receivable
Amount the business
expects to collect.
Balance Sheet Disclosure

25. 6-25
Writing Off 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.

26. 6-26
Date Description Debit Credit
GENERAL JOURNAL
Deckers’ total write-offs for
2003 were $876,000.
Prepare a summary journal
entry for these write-offs.
Writing Off Uncollectible Accounts

27. 6-27
Date Description Debit Credit
Allowance for Doubtful Accounts 876,000
Accounts Receivable 876,000
GENERAL JOURNAL
Writing Off Uncollectible Accounts
Deckers’ total write-offs for
2003 were $876,000.
Prepare a summary journal
entry for these write-offs.

28. 6-28
Assume that before the write-off, Deckers’
Accounts Receivable balance was
$11,000,000 and the Allowance for
Doubtful Accounts
balance was $1,000,000.
Let’s see what effect the total write-offs of
$876,000 had on these accounts.
Writing Off Uncollectible Accounts

29. 6-29
Before Write-
Off
After Write-
Off
Accounts receivable 11,000,000
$ 10,124,000
$
Less: Allow. for doubtful accts. 1,000,000 124,000
Net realizable value 10,000,000
$ 10,000,000
$
Notice that the total write-offs of $876,000 did not
change the net realizable value nor did it affect any
income statement accounts.
Writing Off Uncollectible Accounts

30. 6-30
Methods for Estimating Bad Debts
Percentage of credit sales
or
Aging of accounts receivable
????

31. 6-31
Percentage of Credit Sales
Bad debt percentage is based
on actual uncollectible accounts
from prior years’ credit sales.
Focus is on determining the amount to
record on the income statement as
Bad Debt Expense.

32. 6-32
Net credit sales
 % Bad debt loss rate
Amount of journal entry
Percentage of Credit Sales

33. 6-33
Percentage of Credit Sales
In 2006, Kid’s Clothes had credit sales of
$600,000. Past experience indicates that bad
debts are one percent of sales.
What is the estimate of bad debts expense for
2006?
$600,000 × .01 = $6,000
Now, prepare the adjusting entry.

34. 6-34
Date Description Debit Credit
Dec. 31 Bad Debt Expense 6,000
Allowance for Doubtful Accounts 6,000
GENERAL JOURNAL
Percentage of Credit Sales

35. 6-35
Now let’s discuss
another method that is
used to account for
uncollectible accounts.

36. 6-36
Aging of Accounts Receivable
Focus is on determining the desired
balance in the Allowance for Doubtful
Accounts on the balance sheet.

37. 6-37
Aging Schedule
Each customer’s account is aged by
breaking down the balance by showing the
age (in number of days) of each part of the
balance.
An aging of accounts receivable for Kid’s
Clothes in 2006 might look like this . . .

38. 6-38
Days Past Due
Customer
Not Yet
Due 1-30 31-60 61-90 Over 90
Total
A/R
Balance
Aaron, R. 235
$ 235
$
Baxter, T. 1,200
$ 300 1,500
Clark, J. 50
$ 200
$ 500
$ 750
Zak, R. 325 325
Total 3,500
$ 2,550
$ 1,830
$ 1,540
$ 1,240
$ 10,660
$
Based on past experience, the business
estimates the percentage of uncollectible
accounts in each time category.
Aging Schedule

39. 6-39
Days Past Due
Customer
Not Yet
Due 1-30 31-60 61-90 Over 90
Total
A/R
Balance
Aaron, R. 235
$ 235
$
Baxter, T. 1,200
$ 300 1,500
Clark, J. 50
$ 200
$ 500
$ 750
Zak, R. 325 325
Total 3,500
$ 2,550
$ 1,830
$ 1,540
$ 1,240
$ 10,660
$
% Uncollectible 0.01 0.04 0.10 0.25 0.40
These percentages are then multiplied
by the appropriate column totals.
Aging Schedule

40. 6-40
Days Past Due
Customer
Not Yet
Due 1-30 31-60 61-90 Over 90
Total
A/R
Balance
Aaron, R. 235
$ 235
$
Baxter, T. 1,200
$ 300 1,500
Clark, J. 50
$ 200
$ 500
$ 750
Zak, R. 325 325
Total 3,500
$ 2,550
$ 1,830
$ 1,540
$ 1,240
$ 10,660
$
% Uncollectible 0.01 0.04 0.10 0.25 0.40
Estimated
Uncoll. Amount 35
$ 102
$ 183
$ 385
$ 496
$ 1,201
$
The column totals are then added to
arrive at the total estimate of
uncollectible accounts of $1,201.
Aging Schedule

41. 6-41
Aging of Accounts Receivable
Days Past Due
Customer
Not Yet
Due 1-30 31-60 61-90 Over 90
Total
A/R
Balance
Aaron, R. 235
$ 235
$
Baxter, T. 1,200
$ 300 1,500
Clark, J. 50
$ 200
$ 500
$ 750
Zak, R. 325 325
Total 3,500
$ 2,550
$ 1,830
$ 1,540
$ 1,240
$ 10,660
$
% Uncollectible 0.01 0.04 0.10 0.25 0.40
Estimated
Uncoll. Amount 35
$ 102
$ 183
$ 385
$ 496
$ 1,201
$
Record the Dec. 31, 2006, adjusting entry
assuming that the Allowance for Doubtful
Accounts currently has a $50 credit balance.

42. 6-42
After posting, the
Allowance
account would
look like this . . .
Date Description
Post.
Ref. Debit Credit
Dec. 31 Bad Debt Expense 1,151
Allowance for Doubtful Accounts 1,151
GENERAL JOURNAL
1,201 Desired Balance
- 50 Credit Balance
1,151
$ Adjusting Entry
Aging of Accounts Receivable

43. 6-43
Allowance for Doubtful Accounts
50 Balance at
12/31/2006
before adj.
1,151 2006 adjustment
1,201 Balance at
12/31/2006
after adj.
Notice that the balance
after adjustment is equal
to the estimate of $1,201
based on the aging
analysis performed
earlier.
Aging of Accounts Receivable

44. 6-44
Accounts Receivable
 % Estimated Uncollectible
Desired Balance in Allowance Account
- Allowance Account Credit Balance
Amount of Journal Entry
Accounts Receivable
 % Estimated Uncollectible
Desired Balance in Allowance Account
+ Allowance Account Debit Balance
Amount of Journal Entry
Aging of Accounts Receivable

45. 6-45
Learning Objectives
Analyze and interpret the accounts receivable
turnover ratio and the effects of accounts
receivable on cash flows.

46. 6-46
Deckers reported 2003 net sales of $121,055,000.
December 31, 2002, receivables were $18,745,000
and
December 31, 2003, receivables were $20,851,000.
This ratio measures how many times
average receivables are recorded and
collected for the year.
Receivables Turnover
Net Sales
Average Net Trade Receivables
Receivables
Turnover =

47. 6-47
= 6.1
$121,055,000
($18,745,000 + $20,851,000) ÷ 2
Receivables
Turnover
=
Deckers Skechers Timberland
6.1 8.5 10.4
2003 Receivables Turnover Comparisons
This ratio measures how many times average
receivables are recorded and collected for the year.
Net Sales
Average Net Trade Receivables
Receivables
Turnover =
Receivables Turnover

48. 6-48
Focus on Cash Flows
Sales
Revenue
Add Decrease
in Accounts
Receivable
Subtract
Increase in
Accounts
Receivable
Cash Collected
from
Customers

49. 6-49
Learning Objectives
Report, control, and safeguard cash.

50. 6-50
Cash and Cash Equivalents
Cash and
Cash
Equivalents
Checks Money
Orders
Bank Drafts
Certificates
of Deposit
T-Bills

51. 6-51
Internal Control of Cash
Cash is the asset most susceptible to theft and fraud.
Properly
account
for assets.
Ensure the
accuracy of
financial
records.
Safeguard
assets.
Internal control refers to policies and
procedures that are designed to:

52. 6-52
Separation
of Duties
Custody
Recording
Authorization
Internal Control of Cash

53. 6-53
Daily
Deposits
Purchase
Approval
Prenumbered
Checks
Payment
Approval
Cash
Controls
Check
Signatures
Bank
Reconciliations
Internal Control of Cash

54. 6-54
Bank Reconciliation
Provides information for
reconciling journal entries.
Explains the difference between cash
reported on bank statement and cash
balance on company’s books.

55. 6-55
Balance per Bank
+ Deposits in Transit
- Outstanding Checks
± Bank Errors
= Correct Balance
Balance per Book
+ Deposits by Bank
(credit memos)
- Service Charge
- NSF Checks
± Book Errors
= Correct Balance
Bank Reconciliation

56. 6-56
Balance per Bank
+ Deposits in Transit
- Outstanding Checks
± Bank Errors
= Adjusted Balance
All
reconciling
items on the
book side
require an
adjusting
entry to the
cash account.
Balance per Book
+ Deposits by Bank
(credit memos)
- Service Charge
- NSF Checks
± Book Errors
= Correct Balance
Bank Reconciliation

57. 6-57
Prepare a July 31 bank reconciliation statement
and the resulting journal entries for the
Simmons Company. The July 31 bank
statement indicated a cash balance of $9,610,
while the cash ledger account on that date
shows a balance of $7,430.
Additional information necessary for the
reconciliation is shown on the next page.
Bank Reconciliation

58. 6-58
 Outstanding checks totaled $2,417.
 A $500 check mailed to the bank for deposit had not
reached the bank at the statement date.
 The bank returned a customer’s NSF check for $225
received as payment of an account receivable.
 The bank statement showed $30 interest earned on
the bank balance for the month of July.
 Check 781 for supplies cleared the bank for $268 but
was erroneously recorded in our books as $240.
 A $486 deposit by Acme Company was erroneously
credited to our account by the bank.
Bank Reconciliation

59. 6-59
Ending bank balance, July 31 9,610
$
Additions:
Deposit in transit 500
Deductions:
Bank error 486
$
Outstanding checks 2,417 2,903
Correct cash balance 7,207
$
Bank Reconciliation

60. 6-60
Ending bank balance, July 31 9,610
$
Additions:
Deposit in transit 500
Deductions:
Bank error 486
$
Outstanding checks 2,417 2,903
Correct cash balance 7,207
$
Ending book balance, July 31 7,430
$
Additions:
Interest 30
Deductions:
Recording error 28
$
NSF check 225 253
Correct cash balance 7,207
$
Bank Reconciliation

61. 6-61
Date Description
Post.
Ref. Debit Credit
Jul 31 Cash 30
Interest Revenue 30
31 Supplies Inventory 28
Accounts Receivable 225
Cash 253
GENERAL JOURNAL
Bank Reconciliation

62. 6-62
Recording Discounts and Returns
Chapter Supplement A

63. 6-63
On January 2, a Deckers factory store’s credit
card sales were $3,000. The credit card
company charges a 3% service fee.
Prepare the Deckers journal entry.
Date Description Debit Credit
Jan. 2
GENERAL JOURNAL
Credit Card Sales

64. 6-64
On January 2, a Deckers factory store’s credit
card sales were $3,000. The credit card
company charges a 3% service fee.
Prepare the Deckers journal entry.
Date Description Debit Credit
Jan. 2 Accounts Receivable 2,910
Credit Card Discounts 90
Sales Revenue 3,000
$3,000 × 3% = $90 Credit Card Fee
GENERAL JOURNAL
Credit Card Discounts are reported
as a contra-revenue account.
Credit Card Sales

65. 6-65
On January 6, Deckers sold $1,000 of merchandise
on credit with terms of 2/10, n/30.
Prepare the Deckers journal entry.
Date Description Debit Credit
Jan. 6
GENERAL JOURNAL
Sales Discounts

66. 6-66
Date Description Debit Credit
Jan. 6 Accounts Receivable 1,000
Sales Revenue 1,000
GENERAL JOURNAL
Sales Discounts
On January 6, Deckers sold $1,000 of merchandise
on credit with terms of 2/10, n/30.
Prepare the Deckers journal entry.

67. 6-67
On January 14, Deckers receives the
appropriate payment from the customer for
the January 6 sale.
Prepare the Deckers journal entry.
Date Description Debit Credit
Jan. 14
GENERAL JOURNAL
Sales Discounts

68. 6-68
Date Description Debit Credit
Jan. 14 Cash 980
Sales Discounts 20
Accounts Receivable 1,000
GENERAL JOURNAL
$1,000 × 2% = $20 sales discount
$1,000 - $20 = $980 cash receipt
Contra-revenue account
Sales Discounts
On January 14, Deckers receives the
appropriate payment from the customer for
the January 6 sale.
Prepare the Deckers journal entry.

69. 6-69
Date Description Debit Credit
Jan. 20
GENERAL JOURNAL
Sales Discounts
If the customer remits the appropriate amount
on January 20 instead of January 14, what
entry would Deckers make?

70. 6-70
Date Description Debit Credit
Jan. 20 Cash 1,000
Accounts Receivable 1,000
GENERAL JOURNAL
Since the customer paid outside of the discount
period, a sales discount is not granted.
Sales Discounts
If the customer remits the appropriate amount
on January 20 instead of January 14, what
entry would Deckers make?

71. 6-71
Sales Returns and Allowances
Date Description Debit Credit
GENERAL JOURNAL
On July 8, before paying, a customer returns $500 of
sandals originally purchased on account from
Deckers. The sandals originally cost Deckers $300.
Prepare the Deckers journal entry.

72. 6-72
Date Description Debit Credit
July 8 Sales Returns and Allowances 500
Accounts Receivable 500
July 8 Merchandise Inventory 300
Cost of Goods Sold 300
GENERAL JOURNAL
Sales Returns and Allowances
On July 8, before paying, a customer returns $500 of
sandals originally purchased on account from
Deckers. The sandals originally cost Deckers $300.
Prepare the Deckers journal entry.

73. 6-73
Applying the Revenue Principle in
Special Circumstances
Chapter Supplement B

74. 6-74
Delayed Revenue Recognition: Installment Method
Generally, revenue is recognized when:
 An exchange has taken place.
 The earnings process is nearly complete.
 Collection is probable.
Uncertain collectibles result in delaying
revenue recognition until cash is collected.
Installment method: revenue is recognized as cash
is collected, often over several accounting periods.

75. 6-75
Revenue Recognition Before the Earnings Process
is Complete: Long-Term Construction Contracts
Completed Contract
Method
Percentage-of-
Completion Method
Let’s look at an example of the percentage-of-completion method.
 Revenue and expenses
are recognized in the year
the contract is completed.
 Construction-in progress
years show no revenue
or expenses.
 Revenue and expenses
recognized each year as
work is accomplished.
 Revenues each year are
based on the ratio of costs
incurred to total costs.

76. 6-76
Revenue Recognition Before the Earnings Process
is Complete: Long-Term Construction Contracts
Year 1 Year 2 Year 3
Estimated total cost 40,000,000
Cost incurred in year one 10,000,000
Acme Construction is constructing a building for Jones Foods
over a three-year period for a total price of $50,000,000.
Acme reported the following progress in year one:
How much revenue and expense
should be recognized on the
project in year one using the
percentage of completion method?

77. 6-77
Revenue Recognition Before the Earnings Process
is Complete: Long-Term Construction Contracts
Year 1 Year 2 Year 3
Estimated total cost 40,000,000
Cost incurred in year one 10,000,000
Acme Construction is constructing a building for Jones Foods
over a three-year period for a total price of $50,000,000.
Acme reported the following progress in year one:
Total costs incurred to date
Percent complete =
Estimate of total project cost
$10,000,000
Percent complete =
$40,000,000
= 25%

78. 6-78
Revenue Recognition Before the Earnings Process
is Complete: Long-Term Construction Contracts
Construction revenue (25% of $50,000,000) 12,500,000
$
Construction expense 10,000,000
Construction income 2,500,000
$
Year 1 Year 2 Year 3
Estimated total cost 40,000,000
Cost incurred in year one 10,000,000
Acme Construction is constructing a building for Jones Foods
over a three-year period for a total price of $50,000,000.
Acme reported the following progress in year one:

79. 6-79
End of Chapter 6