Lecture - 2/19/25

Recording Sales Service Revenue

Recording Example:

• Recording revenue from services (e.g., haircuts). It is important to track the actual amount earned or paid to ensure accurate accounting of service-based income.

Trade Discounts:

• Definition: Discounts offered to encourage sales and increase customer acquisition.

• Record the actual earned amount after the trade discount is applied, ensuring revenue reflects the true income from sales, minus any promotional reductions.

Sales Discounts:

• Purpose: Encourage early payment from customers as an incentive for prompt payment, thereby improving cash flow.

• Recorded in a contra revenue account, having an opposite effect on gross revenue reported.

• Example: "2/10, net 30" — meaning a 2% discount if paid within 10 days; otherwise, the net amount is due in 30 days. A sales discount reduces the recorded revenue, highlighting the importance of managing customer relationships and timely collections.

Sales Allowances:

• Occurs when a customer is dissatisfied with a purchase and receives a partial refund after the sale is completed. This is crucial for maintaining customer satisfaction and loyalty.

• Recorded in a contra revenue account similar to sales discounts, reflecting the decreased revenue.

• Example: If a $30 service has a $3 allowance, the revenue recorded is $27. It is vital to showcase net revenue on financial statements to accurately represent income earners.

Balance Sheet Presentation:

• Classified Balance Sheet: Essential for reporting both current and long-term assets and liabilities, providing clarity on a company’s financial position.

• Multi-Step Income Statement: Displays multiple levels of profit including gross revenues, accounting for contra accounts like sales discounts and allowances to determine net revenues accurately.

Contra Revenue Accounts:

• How to Increase? Revenue accounts are increased by crediting whereas contra revenue accounts are increased by debiting (normal balance is debit). Understanding how these accounts function is fundamental for accurate financial reporting.

Allowance for Doubtful Accounts:

• Expectation: Not all customers will pay for their credit sales, highlighting the need for effective accounts receivable management.

• This is achieved through the allowance method which recognizes expenses in the same period as revenue—adhering to the matching principle.

• Methods to Estimate Doubtful Accounts:

  • Credit Sales Method: Estimates uncollectible amounts based on historical data of credit sales (not widely used).

  • Accounts Receivable Method: Most commonly utilized, this method estimates allowances based on the ending balance of accounts receivable. This approach is preferred for its relevance to current assets.

  • Additional methods include the aging method which considers the age of receivables; older receivables are less likely to be collectible.

Bad Debt Expense:

• This is accounted as an expense when estimating uncollectible accounts receivable and is associated with customers who fail to pay.

• Journal Entries: typically involve crediting the Allowance for Doubtful Accounts and debiting Bad Debt Expense. This keeps the financial records in check.

Example Walk-Through with Susie Q Corporation:

• Total Accounts Receivable: $500;

• Estimated uncollectible: 7%.

• Calculation: $500 x 0.07 = $35 (estimated uncollectible).

• Journal Entry:

  • Debit: Bad Debt Expense $35

  • Credit: Allowance for Doubtful Accounts $35.

Adjustments for Differing Beginning Balances:

• Adjust based on the beginning allowance balance to reflect the current estimates accurately, ensuring the company’s financial records are up-to-date.

Aging Method:

• More precise due to the stratification of accounts receivable. This method helps in identifying accounts with varying probabilities of collection.

• Example: Matured accounts may have different percentages of collectibility based on their age (such as current, 1-60 days past due, etc.). Calculate total uncollectibles based on the respective percentages to maintain precision in financial estimations.

Writing Off Accounts Receivable:

• Actions taken when a specific account is deemed uncollectible. It is an essential part of financial prudence and reporting.

• Journal Entry:

  • Debit: Bad Debt Expense

  • Credit: Accounts Receivable.

• Recognizing that the expense was accounted for in the prior period maintains adherence to the matching principle.

Recovering Previous Bad Debts:

• If a previously written-off account makes a payment, it is essential to reverse the original write-off to ensure balanced and accurate accounting. This reflects cash flow health accurately.

• Journal Entry:

  • Debit: Accounts Receivable

  • Credit: Allowance for Doubtful Accounts.

• Only recognize the cash received in the payment journal entry to maintain rigorous accuracy in accounting and cash management techniques.