the revenue/ receivables/cash cycle

The The Revenue/Revenue/

ReceivableReceivables/Cash s/Cash CycleCycle

2

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.

Learning Objectives

3

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 Objectives

4

Learning Objectives

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.

EXPANDED MATERIAL:

5Revenue/Receivables/Cash Time Line

DELIVER a product or

service

COLLECT cash

(includes discounts)

RETURNSRETURNS

ACCEPT returned products

STRUGGLEwith

nonpaying customers

PROVIDEcontinuing

service

6The Operating Cycle of a Business

Accounts Receivable

Cash

Inventory

7

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.

8

Receivables

• Trade receivables: Receivables arising from normal operating activities.

• Nontrade receivables: All receivables arising from activities other than normal operations.

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

9

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

Sales Discounts--Gross Method

If paid within the discount period:Cash............................................ 980Sales Discounts........................... 20

Accounts Receivable.......... 1,000If not paid within the discount period:

Cash........................................… 1,000Accounts Receivable......... 1,000

10

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

11

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).. 100Inventory………………………… 60 Cost of Goods Sold…………. 60

12Sales Discounts and Sales Returns and Allowances

Income Statement

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

Less: Sales Discounts...................... $ 20 Sales Returns and Allowances 100 (120)

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

Income Statement

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

Less: Sales Discounts...................... $ 20 Sales Returns and Allowances 100 (120)

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

13

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.

14Accounting 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.

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.

15Accounting 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.

GAAP requires use of the “Allowance Method” for

determining bad debts expense.

16

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

Accounting for Uncollectible Receivables (Allowance Method)

Allowance for Doubtful Accounts……... 400 Accounts Receivable……………… 400 To write off an uncollectible account.

17Accounting for Uncollectible Receivables (Allowance Method)

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

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

Accts. Receivable $100,000 Accts. Receivable $99,600Less Allowance for Less Allowance for Doubtful Accounts 2,000 Doubtful Accounts 1,600 Net Receivables $ 98,000 Net Receivables $98,000

18Estimating the Allowance for Uncollectible Accounts

Percentage of credit sales.

Percentage of accounts receivable.

Aging receivables.

Percentage of credit sales.

Percentage of accounts receivable.

Aging receivables.

19

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.




Percentage of Credit Sales

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

20

Example: Doubtful Accounts ExpensePercentage of Credit Sales

Bad Debt Expense…………………… 3,000 Allowance for Doubtful Accounts .. 3,000 To record estimated uncollectible accounts for the year.







21

Example: Doubtful Accounts ExpensePercentage of Credit Sales

Allowance for Doubtful Accounts

Balance 350Adjusting 3,000Dec. 31, Bal. 3,350

22

Example: Doubtful Accounts Expense


receivable balance is $30,500. The allowance for doubtful accounts balance is $350. Historically, 5 percent of accounts

receivable are not collectible.


receivable balance is $30,500. The allowance for doubtful accounts balance is $350. Historically, 5 percent of accounts

receivable are not collectible.

Percentage of Accounts Receivable

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?What is the entry to record estimated bad debts?

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

23




24


Adjusting 1,875Dec. 31, Bal. 1,525

Balance 350What if the allowance

account had a debit balance of $300?

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


25

Aging Receivables


receivable balance is $30,500. The allowance for doubtful accounts balance is

$350. The firm ages the accounts to determine the expected uncollectibles.


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 Remember, because receivables are involved, the amount derived from involved, the amount derived from

aging provides the desired balance of aging provides the desired balance of the allowance account.the allowance account.

Remember, because receivables are Remember, because receivables are involved, the amount derived from involved, the amount derived from

aging provides the desired balance of aging provides the desired balance of the allowance account.the allowance account.

26

Percentage Estimated to be

Age Balance Uncollectible 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

Aging Receivables

27



Aging Receivables

28

Accounting for Warranties

Edna’s Appliances sells washers and Edna’s Appliances sells washers and dryers with a one-year warranty. Past dryers with a one-year warranty. Past experience indicates that 15% of the experience indicates that 15% of the

appliances sold will need repairs before appliances sold will need repairs before the warranty expires. The average repair the warranty expires. The average repair

cost is $80. In 2001, 500 washers and cost is $80. In 2001, 500 washers and dryers were sold. Actual repair costs for dryers were sold. Actual repair costs for

the year totaled $3,400.the year totaled $3,400.

Edna’s Appliances sells washers and Edna’s Appliances sells washers and dryers with a one-year warranty. Past dryers with a one-year warranty. Past experience indicates that 15% of the experience indicates that 15% of the

appliances sold will need repairs before appliances sold will need repairs before the warranty expires. The average repair the warranty expires. The average repair

cost is $80. In 2001, 500 washers and cost is $80. In 2001, 500 washers and dryers were sold. Actual repair costs for dryers were sold. Actual repair costs for

the year totaled $3,400.the year totaled $3,400.

29

Accounting for Warranties

Warranty Expense……………………….. 4,000 Estimated Liability Under Warranties.. 4,000 To record estimated warranty expense based on units sold (500 x $80).

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:

30Assessing 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.

31

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)

Assessing Management of Receivables

Average collection period = 91.25 days

32

Composition of Cash

Undeposited coins and currency (change funds)

Demand deposits Petty cash funds Cashiers’ checks Personal checks

33

Composition of Cash

Many companies report investments in very short-

term, interest-earning securities as cash equivalents

in the balance sheet.

Many companies report investments in very short-

term, interest-earning securities as cash equivalents

in the balance sheet.

34

Composition of Cash

A credit balance in the cash account is known as a cash

overdraft and should be reported as a current

liability.

A credit balance in the cash account is known as a cash

overdraft and should be reported as a current

liability.

35

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.

36

Bank Reconciliation

A comparison of the bank balance with the book’s balance by means of a

summary is a bank reconciliation.

A comparison of the bank balance with the book’s balance by means of a

summary is a bank reconciliation.

37

Bank Reconciliation

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.

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.

Common causes of differences:

38

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

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

Lori’s FloristBank Reconciliation

March 31, 2002

39

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

Cash……………………………………. 521 Accounts Receivable………………. 450 Interest Revenue…………………… 71DEDUCTIONS:

Accounts Receivable (NSF)…………… 100 Miscellaneous General Expense (SC)…. 7 Recording Error, Underwritten check*... 180 Cash……………………………….. 287* Debited to original account.

Bank Reconciliation

40Accounts Receivable as aSource of Cash

• As a sale (either with or without recourse).

• As a secured borrowing.

• As a sale (either with or without recourse).

• As a secured borrowing.

41

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.

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:

42

Sal

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Acc

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s R

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vabl

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Accounts Receivable Established

Goods and Services Provided

Factoring Accounts Receivable

CustomersCustomers CompanyCompany

FactorFactorFactorFactor

Cas

h fr

om F

acto

ring

A

ccou

nts

Rec

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Pay

men

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Acc

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43Accounting 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.

44Example: FactoringAccounts Receivable

Assume:

Factored Receivables $10,000

Allowance for Bad Debts $300

Factor Withholding 5%

Sales Price $8,500

Journalize this transaction.

Journalize this transaction.

45Example: FactoringAccounts Receivable

Cash………………………………. 8,075Receivable from Factor…………... 425Allowance for Bad Debts………… 300Loss from Factoring Receivables... 1,200

Accounts Receivable…………. 10,000Computations:

Cash: $8,500 - 425 = $8,075Factor Receivable: $8,500 x 5% = $425Factoring Loss: ($10,000 - 300) - $8,500 = $1,200

46Sale of Receivableswith Recourse

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

nonrecourse basis.

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

nonrecourse basis.


Continuing the previous example, assume Continuing the previous example, assume that the receivables were sold with recourse that the receivables were sold with recourse

and it is estimated that the recourse and it is estimated that the recourse obligation has a fair value of $500.obligation has a fair value of $500.

Continuing the previous example, assume Continuing the previous example, assume that the receivables were sold with recourse that the receivables were sold with recourse

and it is estimated that the recourse and it is estimated that the recourse obligation has a fair value of $500.obligation has a fair value of $500.

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


The entry to record the sale:

Cash………………………………. 8,075Receivable from Factor…………... 425Allowance for Bad Debts………… 300Loss on Sale of Receivables……... 1,700

Accounts Receivable………... 10,000Recourse Obligation………… 500

49

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.

50

Notes Receivable

A promissory note is an unconditional written

promise to pay a certain sum of money at a

specified time.

A promissory note is an unconditional written

promise to pay a certain sum of money at a

specified time.

51

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.

52

Example: Notes Receivable

Assume:Note Receivable $1,000Interest Rate 10%Time to Maturity 2 yearsJournalize this note as:

1. An interest-bearing note.2. A noninterest-bearing note.

53

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)

54

• 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.

Discounting Notes Receivable

55

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

56

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%?

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 = $ 35.00Maturity value = $1,000 + $35 = $1,035.00Discount = $1,035 x .16 x 2/12 = $ 27.60Proceeds = $1,035 - $27.60 = $1,007.40

Cash……………………………. 1,007.40 Interest Revenue……………... 7.40 Note Receivable……………... 1,000.00

57

The EndThe End

the revenue/ receivables/cash cycle

Documents

accounts receivable

sales entry

sales returns

sales discounts

presenting sales

sales revenue

sales allowance entry

sales return entry