Chapter 5: Sales and Receivables

Cash-basis accounting

Recognizes revenue in the period payment is received (as on your tax return)

Accrual-basis accounting

Recognizes revenue when the company’s performance obligation is satisfied by transferring control of the promised good or service to the customer

FASB

Provides detail to when the revenue should be recognized: service companies when they provide the service to customer or sellers of goods, which title passes to owner

GAAP

Requires accrual-basis accounting, which recognizes revenue when a performance obligation or promise under a contract is satisfied

GAAP 5 STEP MODEL for Accounting for Revenue

1. Identify the contract(s) with the customer

2. Identify the performance obligation in the contract

3. Determine the transaction price

4. Allocate the transaction prices to the performance obligations in the contract

5. Record revenue or sales when, or as, the entity satisfies the performance obligation

Sales Discount

A price reduction (usually expressed as a percentage of the selling price) the companies may offer to encourage prompt payment

NET Method

All customers take the discount

GROSS Method

• Assumes no one will take the discount

• Simplifies communication with the customer

Sales Return

When a customer returns goods as unsatisfactory or unneeded

Sales Allowance

A reduction in the price charged by a seller dure to a problem with the product or service

Receivable

Money due from another business or individual

Types of Receivables

• Accounts or Notes Receivable

• Current or Non-current Receivable

• Trade or Non-trade Receivable

Accounts Receivable

Money due from another business or individual as payment for services performed or goods delivered. Payment is typically due in 30 to 60 days and does not involve a formal note between parties, nor does it include interest

Note(s) Receivable

A receivable that generally specifies an interest rate and a maturity date at which any interest and principal must be repaid

Trade Recievable

An account receivable that is due from a customer purchasing inventory in the ordinary course of the business

Nontrade recievable

A receivable that arises from transactions not involving inventory (e.g., interest receivable or cash advances to employees)

Two Method to Record Bad Debt

Direct write-off method and Allowance method

Direct Write-off Method

Waits until an account is deemed uncollectible before reducing accounts receivable and recording bad debt expense

Allowance Method

Recognized in the period of sale, which allows it to be properly matched with revenues

Allowance for Doubtful Accounts

A contra-asset account that is established to “store” the estimate of uncollectible accounts until specific accounts are identified as uncollectible

Percentage of Credit Sales Method

A method of determining bad debt expense whereby past experience and management’s view of how the future may differ drom the past are used to estimate the percentage of the current period’s credit sales that will eventually become uncollectible.

Estimated Bad Debit Expense

Total Credit Sales x Percentage of Credit Sales Estimated by Default

Aging Method

A method in bad debt expense is estimated indirectly by determining the ending balance desired in the allowance for doubtful accounts and then computing the necessary adjusting the entry to achieve this balance

Factor

A method of handling receivables in which the seller receives an immediate cash payment reduced by the factor’s fees. The factor, the buyer of the receivable, acquires the right to collect the receivables and the risk of uncollectibility.

Securitization

A process in which large businesses and financial institutions frequently package factored receivables as financial instruments or securities and sell them to investors.

Profitability Ratio

Ratios that measure two aspects of a corporation’s profits (1) those elements of operations and that they contribute to profit and (2) the relationship of profit of total investment and investment by stockholders

Accounts Receivable Turnover

Net sales/average net accounts receivable