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Chapter 7Sales and Collection CycleSales and Collection Cycle

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Business Process

• Making a sale and accounting for sale - related

• Decisions - what to sell, how, much to sell for

• Ie. Sales discount

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Accounts Receivable

• Largest current asset• Managing size and

conversion to cash• Credit policies• Collection efforts• Selling A/R - factoring

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Sales Cycle

• Firm sells to customers that pay• Goods and services are delivered• Customers billed correctly• Money received and deposited• Recording to sale• Collecting payment

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Timing of Revenue Recognition

• Recognized and reported on income statement

• Accrual accounting - not concerned about cash collection

• GAAP - accrual accounting• Recognized - earnings process is

virtually complete, collection reasonably

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Study Break 7-1

Cash 100,000Unearned Rev 100,000

Unearned Rev 50,000Ticket Rev Earned

50,000Unearned Rev 33,333

Ticket Rev Earned33,333

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Sales Discounts• If pay bills promptly• 2/10, n/30• Deducted from sales - income

statement• Contra-revenue account

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Study Break 7-2

Accounts Receivable 3,500Sales 3,500

Cash 3,395Sales Discount 105

Accounts Receivable 3,500

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Sales Returns

• Return merchandise• Refund - full or partial cash, credit• Separate from sales• Contra-revenue account - see both numbers• Deducted from sales

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Payment for Goods and Services

• Customers - Two choices - cash or credit• Analyze risks• Controls

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Accounting For Cash:Reconciling The Bank Statement• An important part of internal control,

segregation of duties• Need for calculating a true cash balance• Two “sides” to be reconciled - SAME

• balance per bank• balance per books

• Locate errors and make adjustments

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Accounting For Cash:Examples

• Company books know• Outstanding check• Deposit in transit

• Bank knows• Service charge• NSF - nonsufficient funds check• Interest earned• Miscellaneous charges• Miscellaneous credits• Notes collected

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Cash (Bank) Reconciliation Has Two “Independent” Parts

++ deposits in transit-- outstanding checks

True cash balance

++ collections for us made by the bank

-- NSF checks (from customers)

-- Service charges

True cash balance

Balance per bankBalance per bank Balance per booksBalance per books

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Study Break 7-3Balance per book $2,400Interest 100Collection 300 Service Charge (100)True cash balance $2,700

Cash 300Misc Oper Exp 100

Accounts Receivable 300Interest Revenue 100

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Account Receivables• Do not expect to collect 100%• Balance Sheet - business expects to collect• Accounting for uncollectible accounts

• Direct write-off method• Not GAAP• Write off when identified

• Allowanced method• Estimated and matched• Recorded at end of period• GAAP

• Bad debt expense

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Used only when bad debts Used only when bad debts are a very small item or are a very small item or when credit sales are when credit sales are insignificant.insignificant.

GAAP Not GAAP

Two Methods

Allowance Method Direct Write-Off Method

A/R Method

Sales Method

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Study Break 7-4• Accounts identified and written off - bad debt

expense• 2005 - no journal entries required• 2006Bad debt expense 35

Accounts receivable 35

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Allowance method• GAAP - matching principle - with related sale• Estimated - recognize expense• Allowance for uncollectible accounts - deducted

from Accounts receivable - contra asset account• Net realizable value - amount expected to be

collected - book value or carrying value• Expense - don’t wait until bad debt identified

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Allowance Method, continued• Two allowance methods - estimating with

• Sales - Income Statement MethodEstimate based upon credit sales or total sales

• Accounts Receivable - Balance Sheet MethodAccounts receivable - starting pointAging schedule - length of time outstanding

• Problem• Reduction of both accounts receivable and

allowance - no effect in net accounts receivable

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Bad debt expense 400Allowance for uncollectible accounts 400

• 500 - 100 = 400• Estimate - prior year overestimate = current

estimate• 9,500 = 10,000 - 500 - net realizable value

Study Break 7-5

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Credit Card Sales•Credit card company is responsible for evaluating a persons credit worthiness and collecting payments

•Cost compared to benefits

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Accounts Receivable 4,850Credit card expense 150

Sales revenue5,000

5,000 * .97 = 4,850

Study Break 7-6

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Other Accounting Issues Related to Sales: Warranty

Costs• Why give warranties?

• Sales and marketing tool• Strategic decision

• When should expense be recognized?• Time of sale - matching principle• Estimated future costs

WarrantyWarranty

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Study Break 7-7

• No warranty expense recorded - previously recorded with sale

Estimated warranty liability 500Cash 500

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Finding and using information• Revenue recognized when earned, often

before collected• Analysis

• Current ratio - quick ratio, acid test ratio• Accounts receivable turnover ratio - measures

ability to collect cash from credit customers• # of days to collect

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Business risks

• Policies and procedures• Preventive controls• Detective controls• Corrective controls