Accounts Receivable

Which income statement accounts are affected by the sale of a product?

Sales revenue, COGS

Which balance sheet accounts are affected by the sale of a product?

Accounts receivable, inventory

The Realization Principle

The earnings process is considered complete when goods are sold or when services are performed, even if cash is not collected at the time the good is sold or service performed

Record revenue when…

The earnings process is complete or virtually complete AND there is reasonable certainty as to the collectability of the asset to be received (usually cash)

If the sale of goods or performance of services occurs prior to the receipt of cash, it is an…

Accrued revenue (and an account receivable is recorded!)

Sales Revenue

Represents revenue earned from selling inventory

The 2 adjustments to sales revenue:

1) Sales Returns & Allowances

2) Sales Discounts

Sales returns

Result when customers are dissatisfied with merchandise and are allowed to return the goods to the seller for a credit or refund

Sales Allowances

Result when customers are dissatisfied with merchandise and the seller allows a reduction from the selling price. Goods are NOT returned in this case

Sales Discounts

Offer a cash discount to a credit customer for the prompt payment of a balance due

Example of discount

• 3/10, n/30

• Read as “three (percent discount), (for) ten (days), net, thirty”

• In this case, after 10 days there is no discount available and the remaining balance is due in 30 days

Characteristics of Sales Returns & Allowances and Sales Discounts

• Both accounts are classified as a contra-revenue

• Result in a decrease to revenues (specifically sales rev) on the income statement

• Normal balance is DEBIT

• Both accounts are subtracted from sales revenue on the income statement to calculate the net sales revenue

Since not all customers pay their bills, companies must record a…

Bad Debt Expense

Bad debt expense must be recorded in…

The same year as the credit sale is made

T or F: Bad Debt Expense is an ESTIMATE

True! We can’t predict who won’t pay

To record a bad debt expense…

Debit: bad debt expense (BDE)

Credit: allowance for doubtful accounts (ADA)

• THIS IS AN ADJUSTING ENTRY BC IT IS MADE AT END OF EVERY YEAR

Characteristics of BDE

• Expense account

• Found on income statement

• REDUCES NET INCOME

Characteristics of ADA

• Contra-asset account

• Decreases assets

• Normal balance is a CREDIT

• Found on balance sheet as a decrease to the accounts receivable

• Represents the amount of accoutns receivable the company estimates it will not collect

What happens when the company makes the determination that a specific customer will not pay?

They must write-off the customer’s account receivable

Note: write-offs can occur at any point during the year and represent…

the actual bad debts of the company

Two key points about the write-off entry

1. It does NOT effect bad debt expense: BDE is estimated at end of each year. Thus, when a specific account is written off, we do not record BDE again—this would be double-counting. Instead, we eliminate the account receivable and reduce ADA to match

2. The write-off of an accunt receivable has no effect on the Net Realizable Value

Net Realizable Value (NRV)

NRV = Accts Rec - ADA

BDE is an estimate and _______ are an actual amount

Write-offs

2 methods in estimating BDE

1. Percentage of sales (net credit sales method)

2. Percentage of receivables (aging method)

Net credit sales method

BDE = net credit sales * % expected uncollectible

Aging method

• Put accounts receivable into categories by age, and assign a % expected to be uncollectible to each category (this is an aging schedule)

Um yay

Financial Statement ratios relating to accounts receivable

1. Accoutns receivable turnover

2. Average collection period

Accounts receivable turnover ratio

• An indication of how many times during a year a company is ‘turning over’ or collecting its receivables

• Higher is better!!!! Means we’re collecting cash quicker

• net sales rev / avg accts rec

Average Collection Period

• Measures # of days, on average, between making a sale on credit and collecting cash

• avg collection period = 365/accts rec turnover