Chapter 6: Reporting & Interpreting Sales Revenue, Receivables, and Cash

Chapter 6:

• Revenues Recognition Principle:

  • When a company transfers promised goods/services to a customer

  • In the amount expected to receive

  • Transferred: When titles & risks of ownership transfer to the buyer

  • Options:

    • When the goods are shipped → FOB Shipping Point

    • When the goods reach their destination → FOB Destination

• Revenue on Income Statement:

  • Gross Revenues → Revenue Acct (R)

  • Contra-Rev Acct (XR)

    • Credit Card “Discounts”

    • Sales Discounts

    • Returns & Allowances

  • Net Sales Revenue → Where the income statement starts

• Credit Card Sales (Customers):

  • Companies often accept Credit card payments from customers

  • Credit card companies charge a fee for this service (credit card discount)

  • Since the company will never collect this cash, revenue should be reduced

  • Some Companies report credit card discounts in other operating expense line items, ie Selling, General, & Administrative Expenses

• Sales Discounts to Businesses:

  • Companies often provide direct credit to business customers

  • Credit sales occur on an “open account” with no formal written promissory note

  • Credit sale terms are printed on a sales document & invoice

    

  • Sales Discounts encourage prompt payment from customers, reducing the need for the company to borrow money to meet operating needs

  • Customers often pay bills by providing discounts first

• Sales Returns & Allowances:

  • Customers have a right to return unsatisfactory or damaged merchandise and receive a refund or adjustment to their bill (allowance)

  • Sales (& associated receivables) must be reduced when returns occur or when allowances are offered

• Revenue for Bundled Goods & Services:

  • Bundling of goods & services within one sales contract is common in a variety of industries

  • When a seller promises multiple goods or services in a single sales contract, they must:

    • Determining the value of each good & service

    • Recognize revenue when the performance obligation is satisfied

• Receivables:

  • When companies generate credit sales, companies record receivables

  • Because receivables represent a right to collect cash in the future

    • A certain portion may become uncollectible

  • GAAP requires companies to record Bad Debt Expense (E) to reflect the estimated uncollectible amount

  • Since collectability is often uncertain, companies use an allowance account, Allowance for Doubtful Accounts (XA), to record aggregated bad debt expense

• Writing off Specific Accounts:

  • Occasionally, it becomes known that a specific account is uncollectible (ie bankruptcy)

  • Receivable needs to be removed (credited) since it is no longer expected to provide a future economic benefit

  • Allowance also needs to be reduced (debited) since a reserved portion of the estimated uncollectible amount has been realized

• Calculating Bad Debt/Allowance:

  • Two main methods to estimate Bad Debt in the period of the sale

  • Percentage of Credit Sales:

    • Focus on changes

    • Calculate Bad Debt Expense as a present of total credit sales for the period

      • Use historical % of credit sales resulting in bad debts

      • Bad Debt Expense = Total Credit Sales x Bad Debt 5

    • Debit calculated Bad Debt Expense

    •  As a debit & credit Allowance for Doubtful Accounts for the same amount

  • Aging of The Accounts Receivable:

    • Focus on the Balance

    • Calculate the uncollectible portion of A/R (allowance) based on the age of existing receivables

    • As receivable gets older & more overdue, it is less likely to be collected

    • Record Bad Debt Expenses to update the Allowance balance to the desired amount