CCOUNTING FOR REVENUE RECOGNITION & ACCOUNTS RECEIVABLES

What is Earnings management

Earnings management works within GAAP to improve stakeholders’ views of the company’s financial position.

What is Earnings manipulation

Earnings manipulation, typically ignores GAAP rules to alter earnings significantly. Carried to an extreme, manipulation can lead to fraudulent behavior by a company.

Revenue recognition principle

Companies must recognize revenue in the period in which it is earned

What is the four step process for Revenue Recognition

1. There is evidence that an arrangement exists.

2. Goods have been delivered or services have been performed.

3. The price is fixed or can be clearly determined.

4. There is reasonable assurance that the amount will be collected

What is Accrual accounting

Record expenses related to revenue generation in the period in which they are incurred.

Special Revenue Recognition Cases

How would revenue be recognized for Long-term construction company projects

Percentage of completion: recognizes revenue based on the

percentage of the work that has been done

Special Revenue Recognition Cases

How would revenue be recognized for Multi-year magazine subscriptions, gym subscriptions, airlines

These are typically paid for in advance, and revenue is recognized as the service is performed.

Special Revenue Recognition Cases

How would revenue be recognized for A combined equipment sale with an accompanying service contract

The sale portion of the contract is recognized immediately, but the revenue allocated to the service portion is recognized over the service period.

What are Bad debts

Bad debts are uncollectible amounts from customer accounts

What account does Bad debt negatively affect

Accounts Receivable

When future collection of receivables cannot materialize, what must companies estimate

Companies must estimate the amount of expected nonpayment

What are methods a company may use to recognize bad debt

The direct write-off method

The allowance method

Aging of accounts receivable method

How does the Direct Write-off Method for calculating Bad Debt work

A bad debt is written off when the company is fairly certain that collection is not possible

What is the problem with the Direct Write-off Method for calculating Bad Debt

This method is not acceptable under GAAP because it violates the

matching principle

Who uses the Direct Write-off Method for calculating Bad Debt

Small to Medium Businesses

How does the Allowance Method (based on Revenue or AR closing balances) for Bad Debt calculation work?

The Allowance or Provision method estimates bad debt during a period, based on past experience and industry standards.

Matches bad debt with related sales during the period

What are two approaches to calculate amount of bad debt expense based on the Allowance Method

Income Statement approach

Balance Sheet approach

How to calculate the Income Statement approach

Average % of yearly revenue, based on past experience

How to calculate the Balance Sheet approach

Average % of closing AR balance, based on past experience

How does the Journal entry look for the Allowance Method

Debit: $ (Bad Debt Allowance)
Credit: $ (Allowance for Doubtful Accounts)

How does the Journal Entry look for the Direct Write-off Method?

Debit: Bad Debt (+L)
Credit: Accounts Receivble (-A)

How does the Balance sheet aging of receivables method work

The balance sheet aging of receivables method estimates bad debt expenses based on the balance in accounts receivable, but it also considers the uncollectible time period for each account. The longer the time passes with a receivable unpaid, the lower the probability that it will get collected

Difference between Accounts Receivable and Notes Receivable

Notes Receivable are more formal with written agreements, for more extended payment periods, and with interest charges.

Notes Receivable Accounting Journal (Example)

A customer buys goods from Acme Co. for $2,000 and signs a note torepay the amount in 24 months, at 10% per year.

Initial:

Debit: 2,000 (Notes Receivable)
Credit: 2,000 (Sales Revenue)

After Interest:

Debit: 200 (Interest Receivable)
Credit: 200 (Interest Revenue)

How to calculate interest

Interest = Annual Interest Rate x Loan Principle x Part of year

eg. 10% x 2,000 x (12/12)

What are Sales discounts

Sales discounts are incentives given to customers to entice them to pay off their accounts early

Sales Discounts (Journal Example)

A customer purchased 10 emergency kits from a retailer at $100 per kit on credit. The retailer offered the customer 2/10, n/30 terms, and the customer paid within the discount window. The retailer recorded the following entry for the initial sale.

COGS = 56 per emergency kit

Before Customer Pays:

Debit: 1,000 (Accounts Receivable)
Credit: 1,000 (Sales Revenue)

Debit: 560 (Cost of Goods Sold)
Credit: 560 (Merchandise Inventory)

After Customer Pays in time:

Debit: 980 (Cash)
Debit: 20 (Sales Discount)
Credit: 1,000 (Accounts Receivable)

If Customer DOESN’T Pay in time:

Debit: 1,000 (Cash)
Debit: 20 (Sales Discount)
Credit: 1,000 (Accounts Receivable)