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Financial Accounting_ Second Canadian Edition

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Financial Accounting_ Second Canadian Edition Powered By Docstoc
					             Chapter 7
       Reporting and Interpreting
       Sales Revenue, Receivables,
                and Cash
They’re all inter-related. Whenever you
       sell you get cash, or A/R.


 7-1                      Financial Accounting, Second Canadian Edition
      Accounting for Sales Revenue

The revenue recognition principle requires
  that revenues be recorded when earned:
  1) An exchange has taken place
between yourself and third party & is
measurable (doesn‟t have to be exact).

               2) The earnings process is nearly
                  complete. Upon delivery, or
             substantially/nearly complete criteria.
             Ex: Dec 2nd, ordered. Dec 5th order is
                 delivered. Count it for the 5th.

                              3) Collection is probable. Reasonably
                                   certain that we will be paid.
7-2                                             Financial Accounting, Second Canadian Edition
                 Reporting Net Sales
        Companies record sales          Sales revenue
       discounts, sales returns and
        allowances, and credit card
       discounts separately to allow    Less:   Credit card discounts (contra-revenue)
      management to monitor these
               transactions.
      Returns decrease our sales.               Sales discounts (contra-revenue)
        That‟s not an expense. We
         reduce sales not increase              Sales returns and allowances (contra-
       expenses. These are “Contra                  revenue)
       Revenues”. This is also true
      for sales discounts, ex “If you
          pay quickly, you can pay      Net sales

       less”. We record gross sale,
         and discount on that sale.



7-3                                                     Financial Accounting, Second Canadian Edition
      Credit Card Sales to Consumers
Companies accept credit cards for several reasons:
 To increase sales.
 Credit is such a big thing in the retail world. People don‟t carry cash or
  cheque.
 To avoid providing credit directly to customers.
 To avoid losses due to bad cheques.
 To receive payment quicker. They get the money right away.
 No effect on merchandiser if you don‟t pay your credit card bill. Don‟t have to
  worry about bad debts.



       When credit card sales are made, the company must pay
       the credit card company a fee or the service it provides.



7-4                                                  Financial Accounting, Second Canadian Edition
        Credit Card Sales to Consumers
  On January 2, a store had credit card sales of
 $3,000. The credit card company charges a 3%
                   service fee.
Prepare the journal entry to record these sales.
Credit Card Discounts are reported as a contra-revenue account.




  7-5                                   Financial Accounting, Second Canadian Edition
      Sales to Businesses on Account

       When companies allow customers to
         purchase merchandise on an open
       account, the customer promises to pay
          the company in the future for the
                     purchase.
      Available in most business-business or
          wholesaler-retailer relationships.


7-6                            Financial Accounting, Second Canadian Edition
        Sales to Businesses on Account
 When customers purchase on open account, they may
be offered a sales discount to encourage early payment.



   2/10, n/30
 Percentage of   Number of     Otherwise,             Number of
   Discount         Days        the Full              Days When
                 Discount Is   Amount Is               the Full
                  Available       Due                Amount Is Due

  Read as: “Two ten, net thirty”
  7-7                                 Financial Accounting, Second Canadian Edition
       Sales to Businesses on Account
On January 6, Gildan sold $1,000 of merchandise on credit
   with terms of 2/10, n/30.
Prepare the journal entry to record the sale.
We initially record the sale of the full amount (Gross Recording Method
   assumes that the consumer doesn‟t take discount)
Net Recording method assumes the do take it, but we don‟t use this
   secondary method.




 7-8                                              Financial Accounting, Second Canadian Edition
       Sales to Businesses on Account
      On January 14, Gildan receives the appropriate payment from
                   the customer for the January 6 sale.
                  Prepare the required journal entry.



             $1,000 × 2% = $20 sales discount (XR)
             $1,000 - $20 = $980 cash receipt




7-9                                          Financial Accounting, Second Canadian Edition
         Sales to Businesses on Account
If the customer remits the appropriate amount on January 20 instead
              of January 14, what entry would Gildan record?
     14 days after sale date = no discount. Because we‟re using the
           Gross method, we reduce the amount oweing on A/R.
      Generally A/R will be split up into A/R for each „borrower‟. All
        together they create the „main general A/R control account‟

         Since the customer paid after the discount period,
                  a sales discount is not granted.




7 - 10                                      Financial Accounting, Second Canadian Edition
           Sales Returns and Allowances

                      Debited for damaged merchandise.
    They record original Gross amount. Upon return they record it as
      a reduction of sales (XR). Typically this account is in a debit
       position, because credit is typically in the credit position.

         Debited for returned merchandise. We want to show that it was
          originally sold. There‟s information value in that (increased
                              handling costs, etc).




                           Contra revenue account.



7 - 11                                               Financial Accounting, Second Canadian Edition
           Sales Returns and Allowances
             On July 8, The T-Shirt Store returns $500 of shirts originally
                              purchased on account from Gildan.
         Originally Gildan would have had a sale recorded. Now a customer
          has a return. They debit the contra-revenue account, and decrease
            the A/R (they don‟t have to pay any more assuming they haven‟t
             paid for it. If they had payed for it, you still decrease A/R. IT IS
                    POSSIBLE TO HAVE A NEGATIVE A/R account.).
                            Prepare the required journal entry.




7 - 12                                                  Financial Accounting, Second Canadian Edition
                                Exercise 7-4
•      We are trying to make the net-sales             Nov 25th – A/R Clara – Debit 4000
•      section of the income statement                 Nov 28th – A/R David – Debit 6000
                                                       Nov 30th – A/R David – Credit 600
       Sales                                           Dec 6th – A/R David – Credit 5400
-      Sales Returns and Allowances
-      Sales Discounts
                                                       Each of these have resultant
-      Credit Card Discounts
                                                          transactions
       Net Sales

Sale                           400
                               + 4000
                               + 6000
Credit Card Discount           400 * .02
Sales Returns                  6000 * .1
Sales Discounts                6000 * .03 * .9 = 162
Credit Card Fees               6000 * .03 * .9
NET SALES                      9,630
    7 - 13                                                   Financial Accounting, Second Canadian Edition
           Gross Profit Percentage

            Gross Profit          Gross Profit
                            =
            Percentage             Net Sales

          In 2004, Gildan reported gross profit of
          $154,671,718 on sales of $533,367,537.

All other things equal, a higher gross profit results in
       higher net income. Higher Gross profit is better,
       more money to pay for these other expenses that
       you‟ve encured.
If we use our Gross sales then it skews the results.
Gross Profit is our net sales – cost of goods sold
 7 - 14                                Financial Accounting, Second Canadian Edition
         Gross Profit Percentage
         Gross Profit          Gross Profit
                          =
         Percentage             Net Sales

          Gross Profit         $154,671,718
                          =                                = 29.0%
          Percentage           $533,367,537

         All other things equal, a higher gross
          profit results in higher net income.




7 - 15                              Financial Accounting, Second Canadian Edition
       Measuring and Reporting
            Receivables
                 Accounts
                 Receivable

 Amounts owed by         Open accounts
    other companies       owed to the
       or persons for   business by trade
      cash, goods, or      customers.
          services.
        Wholesale                  Retail
7 - 16                    Financial Accounting, Second Canadian Edition
           Measuring and Reporting
         Receivables (Note Recievable)
                Term
  $1,200                Montreal, Quebec             January 5, 2006
                                       Payee
         Sixty days           after date I promise to pay to
  the order of
        Principal         First Canadian Bank
  One thousand two hundred ---------------------------------Dollars
                       Interest Rate
  Payable at        First City Bank                     Maker
  Value received with interest at   12%       per annum
                                                  Pat Rogers
  No. 10242 Due        March 6, 2006
                                          Gildan Activewear

                               Due Date
7 - 17                                      Financial Accounting, Second Canadian Edition
               Accounting for Bad Debts

         Bad debts result from credit customers who will not pay the
         business the amount they owe, regardless of collection efforts.
Notes recievable come about because of the bad debts. Bad debts
   have just decided not to pay for the charges. Merchandise has
  been sold, and given to customer, but customer refuses to pay.
    If they had known this in the beginning they would have never
                        shown this to begin with.
    Historically there is a statistical average of customers you can
    expect to create bad debts. You can estimate your bad debts for
    the year based on previous periods. We can set up an entry to be
       pro-active on this, so that we follow the matching principal


7 - 18                                           Financial Accounting, Second Canadian Edition
         Accounting for Bad Debts

                          Bad Debt
                          Expense
                        Record in same
    Matching
                          accounting
    Principle               period.
                            Sales
                           Revenue
7 - 19                    Financial Accounting, Second Canadian Edition
         Accounting for Bad Debts


Most businesses record an estimate of the
 bad debt expense by an adjusting entry
   at the end of the accounting period.




7 - 20                    Financial Accounting, Second Canadian Edition
          Recording Bad Debt Expense
                  Estimates
           Assume Gildan estimated bad debt expense for 2005 to be
                                     $2,383,000.
                          Prepare the adjusting entry.
         NOTE: we haven‟t identified customers, and we haven‟t forgiven
                          them. This is a global estimate.

           Bad Debt Expense is normally classified as a
            selling expense and is closed at year-end.




7 - 21                                             Financial Accounting, Second Canadian Edition
    Allowance for Doubtful Accounts

           Balance Sheet Disclosure




                        Amount the business
                expects to collect. We‟re saying we
            can‟t record the full A/R because historically
                     We have some bad debts.
         (Conservatism Principal: don‟t overstate our assets)
7 - 22                                        Financial Accounting, Second Canadian Edition
          Writing Off Uncollectible
                  Accounts
      When it is clear that a specific customer‟s
     account receivable will be uncollectible, the
         amount should be removed from the
     Accounts Receivable account and charged
       to the Allowance for Doubtful Accounts.

Debit AFDA
Credit A/R
= no effect on income statement accounts


7 - 23                             Financial Accounting, Second Canadian Edition
            Writing Off Uncollectible
                    Accounts
         Assume on May 6, Gildan wrote off a
            specific account receivable with
                  a balance of $2,500.
          Prepare the required journal entry.




7 - 24                           Financial Accounting, Second Canadian Edition
             Writing Off Uncollectible
                     Accounts
         Assume that before the write-off entry, Gildan‟s
          Accounts Receivable balance was $81,000,000
         and the Allowance for Doubtful Accounts balance
                          was $2,000,000.
               (Net realizable value = 79,000,000)

         Let‟s see what effect the write-off had on these
                             accounts.




7 - 25                                   Financial Accounting, Second Canadian Edition
               Writing Off Uncollectible
                       Accounts




         Notice that the write-off did not change the net realizable value nor
                     did it affect any income statement accounts.
           We still have a net realizable value of 79,000,000 = no effect on
                                     balance sheet.
         We should make a note of this though, as the customer may return
                    and pay you, or try the same thing again.
7 - 26                                                Financial Accounting, Second Canadian Edition
           Methods for Estimating Bad
                     Debts
                Percentage of credit sales
                   (income statement method)
                           or
              Aging of accounts receivable
                     (balance sheet method)

         We choose one method and stick with it year over
              year. If we do change, notify investors.


7 - 27                                   Financial Accounting, Second Canadian Edition
              Percentage of Credit Sales
            (Income Statement Method)
          Bad debt percentage is based on actual uncollectible
                accounts from prior years‟ credit sales.
          In the past, X% of our sales have been uncollectable.


         The focus is on determining the amount to
            record on the income statement as
                     Bad Debt Expense.




7 - 28                                         Financial Accounting, Second Canadian Edition
          Percentage of Credit Sales
     In 2005, Kid‟s Clothes had credit sales
           of $60,000. Past experience
           indicates that bad debts are
               one percent of sales.
         What is the estimate of bad debts
                  expense for 2005?
                   = ___600___

7 - 29                           Financial Accounting, Second Canadian Edition
          Percentage of Credit Sales

Now, prepare the adjusting journal entry.




 7 - 30                     Financial Accounting, Second Canadian Edition
          Aging of Accounts Receivable
                (balance sheet method)

              The focus is on determining
               the desired balance in the
           Allowance for Doubtful Accounts
                 on the balance sheet.
         We are not trying to achieve matching
          concept. Instead we look at existing
           balance of A/R and make analysis
            based on that (if we‟ve already
           collected, then it‟s not bad debt).
7 - 31                            Financial Accounting, Second Canadian Edition
         Aging of Accounts Receivable




7 - 32                      Financial Accounting, Second Canadian Edition
                       Aging Schedule
          Each customer‟s account is aged by breaking down the
           balance by showing the age (in number of days) of each
                             part of the balance.
     If an account isn‟t yet due, it‟s more likely that it will be payed
         than a customer who‟s balance has been due for > 90 days.

         An aging of accounts receivable for Kid‟s Clothes in 2005
                          might look like this . . .

    The % uncollectable gets higher as the age of A/R gets higher




7 - 33                                           Financial Accounting, Second Canadian Edition
                  Aging Schedule




  Based on past experience, the business estimates the
percentage of uncollectible accounts in each time category.
          These percentages are then multiplied
             by the appropriate column totals.
 7 - 34                              Financial Accounting, Second Canadian Edition
                Aging Schedule

         The column totals are then added to
             arrive at the total estimate of
           uncollectible accounts of $1,201.

                Not our journal entry




7 - 35                            Financial Accounting, Second Canadian Edition
         Aging of Accounts Receivable

           Record the Dec. 31, 2005 adjusting
            entry assuming that the Allowance
          for Doubtful Accounts currently has a
                    $50 credit balance.
                So we subtract the 50




7 - 36                           Financial Accounting, Second Canadian Edition
         Aging of Accounts Receivable




                              After posting, the
                                   Allowance
                                account would
                               look like this . . .
7 - 37                      Financial Accounting, Second Canadian Edition
          Aging of Accounts Receivable
              Allowance for Doubtful Accounts




 Notice that the balance
after adjustment is equal
to the estimate of $1,201
   based on the aging
   analysis performed
          earlier.


 7 - 38                             Financial Accounting, Second Canadian Edition
                Receivable Turnover

  Receivable                       Net Sales
                    =
   Turnover               Average Net Trade Receivables

Gildan reported 2004 net sales of $533,367. The receivables were $64,260
at September 29, 2003 (beg. of year) and $85,317 at October 5, 2004 (end
                                 of year).

                       (All amounts in thousands.)
  The quicker they collect their A/R the less bad debt they have. It also
             allows them to use that cash in their business

          This ratio measures how quickly a company
                collects its accounts receivable.
 7 - 39                                         Financial Accounting, Second Canadian Edition
              Receivable Turnover
 Receivable                    Net Sales
                 =
  Turnover            Average Net Trade Receivables

 Receivable                 $533,367
                 =                                    = 7.13 times
  Turnover           ($64,260 + $85,317) ÷ 2

         This ratio measures how quickly a company
               collects its accounts receivable.




7 - 40                                 Financial Accounting, Second Canadian Edition
              Focus on Cash Flows
                   A = L + SE
                     Add Decrease in
                   Accounts Receivable
                   AR down -> Cash up


                                                  Cash Collected
     Sales
                                                      from
    Revenue
                                                    Customers
                   Subtract Increase in
                   Accounts Receivable

                   A/R up -> Cash down




7 - 41                               Financial Accounting, Second Canadian Edition
                Internal Controls

     Internal Controls are the processes by
     which the company’s board of directors,
     management, and other personnel provide
     reasonable assurance regarding the
     reliability of the company’s financial
     reporting, the effectiveness and efficiency of
     its operations, and its compliance with
     applicable laws and regulations.


7 - 42                             Financial Accounting, Second Canadian Edition
         Controls Over Accounts Receivable

         To guard against the extending credit to non-
            worthy customers, the following practices can
            help minimize bad debts:
         1. Require approval of customer’s credit history by a
            person independent of the sales and collection
            functions.
         2. Monitor the age of accounts receivable periodically
            and contact customers with overdue payments.
         3. Reward both sales and collection personnel for
            speedy collections so that they work as a team.

7 - 43                                       Financial Accounting, Second Canadian Edition
         Cash and Cash Equivalents
  Cheques                                      Money
                                               Orders
                 Cash and
                   Cash
                Equivalents

Certificates                           Bank Drafts
of Deposit
                   T-Bills
7 - 44                       Financial Accounting, Second Canadian Edition
            Internal Control of Cash

         Internal control refers to policies and
           procedures that are designed to:


     properly            safeguard                 ensure the
    account for           assets.                  accuracy of
      assets.                                       financial
                                                    records.

     Cash is the asset most susceptible to theft and fraud.
7 - 45                                 Financial Accounting, Second Canadian Edition
           Internal Control of Cash

                                         Custody


         Separation
                                       Recording
          of Duties

                                  Authorization

7 - 46                      Financial Accounting, Second Canadian Edition
         Internal Control of Cash
                   Bank
               Reconciliations
    Daily                               Prenumbered
   Deposits                               Cheques
                  Cash
                 Controls
  Payment                                            Verify
  Approval
                                              Signatures
                 Purchase
                 Approval
7 - 47                       Financial Accounting, Second Canadian Edition
                   Bank Reconciliation
           Explains the difference between cash reported on bank
             statement and cash balance on company‟s books.
         A way to safeguard our entries. Whatever goes through the
         bank is recorded. We compare our entries to those that go
                              through the bank.




                Provides information for
               reconciling journal entries.


7 - 48                                         Financial Accounting, Second Canadian Edition
               Bank Reconciliation
         Bank Balance      Book Balance
         Balance per Bank    Balance per Book


                            + Deposits by Bank
   + Deposits in Transit
                               (credit memos)

                            - Service Charge
   - Outstanding
                            - NSF Cheques
   Cheques

   ± Bank Errors            ± Book Errors


   = Adjusted Balance       = Adjusted Balance
7 - 49                       Financial Accounting, Second Canadian Edition
                  Bank Reconciliation
             All per Bank
         Balance reconciling    Balance per Book
       items on the book
         side require an
                               + Deposits by Bank
       adjusting entry
   + Deposits in Transit to
                                  (credit memos)
       the cash account.
                               - Service Charge
   - Outstanding
                               - NSF Cheques
         We
   Cheques need   bank
        statement and
   ± Bank Errors
      accounting record        ± Book Errors
              match
   = Adjusted Balance          = Adjusted Balance
7 - 50                           Financial Accounting, Second Canadian Edition
                Bank Reconciliation
           Prepare a July 31 bank reconciliation
         statement and the resulting journal entries
          for the Simmons Company. The July 31
         bank statement indicated a cash balance of
          $9,610, while the cash ledger account on
            that date shows a balance of $7,430.

         Additional information necessary for the
         reconciliation is shown on the next page.

7 - 51                              Financial Accounting, Second Canadian Edition
                    Bank Reconciliation
• Outstanding cheques totaled $2,417.
     Cheques that we‟ve written, but bank doesn‟t know about yet.
• A $500 cheque mailed to the bank for deposit had not reached
  the bank at the statement date.
     Deposit in our books, not at bank yet (Dep. In transit)
• The bank returned a customer‟s NSF cheque for $225 received
  as payment of an account receivable.
     Bank knows customer gave a bad cheque, not recorded on our side yet
• The bank statement showed $30 interest earned on the bank
  balance for the month of July.
• Cheque 781 for supplies cleared the bank for $268 but was
  erroneously recorded in our books as $240.
     Incorrectly reported on our books. EX: Typing error
• A $486 deposit by Acme Company was erroneously credited to
  our account by the bank.
     Deposited into wrong bank account – nothing to record here… just on the
       bank side
 7 - 52                                                Financial Accounting, Second Canadian Edition
         Bank Reconciliation




7 - 53                 Financial Accounting, Second Canadian Edition
              Bank Reconciliation
         (one for each book side event)




7 - 54                       Financial Accounting, Second Canadian Edition
                        E7-23
                            Company                          Bank
Ending Blance                   7,400                        6,050
Additions
  Deposit in Transit                                         2,000
Deductions
  Outstanding Cheques                                           700
  Service Charges                   50
                                 7,350                       7,350

ONLY MAKE JOURNAL ENTRIES FOR THINGS WE
  HAVEN‟T REPORTED YET (COMPANY SIDE ONLY)
7 - 55                          Financial Accounting, Second Canadian Edition
                                        E7-13
Allowance for doubtful accounts

         AFDA (XA)
           | 1166 opening/last year closing
1591 losses |      (debit AFDA, Credit A/R by same amount)
           | 2261 bad debt expense (DR bad debt exp, CR AFDA)
           | 1836 Ending balance



Working Capital = current assets – current liabilities

How is it affected by a DR AFDA of 1,591? No delta in asset accounts total. A write off in A/R
   we have no change in net realizable value.

What impact of recording bad debt expense have? It affects current assets. AFDA is a contra
  asset, so net realizable value decreases, so current assets decreases, so working capital
  decreases.

How is net income affected by the 1591 writeoff?
 7 - 56                                                     Financial Accounting, Second Canadian Edition
               Midterm

   • 35 multi choice
   • 8 short answer Qs
   • Material from lectures




7 - 57                        Financial Accounting, Second Canadian Edition

				
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