Accounting For Managers

Professor ZHOU Ning

SCHOOL OF ECONOMICS AND MANAGEMENT

BEIHANG UNIVERSITY

zning80@buaa.edu.cn
 Chapter 5

Revenue and Monetary Assets

The objectives of chapter 5

 Timing of revenue recognition

 Amount of revenue recognized
 Monetary assets
 Analysis of monetary assets

5-3
 Operating cycle
Receive cash from
customer

Customer acknowledges Purchase materials/services

receipt of the item & pay cash

Ship the product and send

the customer an invoice Convert materials /
services to salable

Receive an order for the

product from a customer Inspect the product

Store the
product

5-4
 Revenue recognition
When? (Timing) & How much? (Amount)
 At one point in revenue cycle (objectivity).

 Criteria:

 When? Earned (Conservatism)

 Normally, goods shipped.

 Service performed.

 How much? Realized or realizable (Realization).

 Already collected or collectible.

 Amount can be measured reliably.

 Next step: matching costs.

5-5
Revenue recognition

5-6
 Revenue recognition

 Revenue can be defined as:

 The gross inflow of economic benefits
during the period arising in the course of
the ordinary activities of an entity when
those inflows result in increase in equity,
other than increases relating to
contributions from equity participants (IAS).

5-7
 Delivery Method
 Recognize revenue when goods or
services are delivered.
 For goods: when title transfers.
 FOB shipping point (when goods are given
to carrier).
 Examples:
 Order is received for $900. Sales entry?
 Goods are produced. Sales entry?
 Goods are shipped. Sales entry? 5-8
 Consignment Method

 Consignor ships goods to consignee.

Dr. Inventory on consignment $1,000
Cr. Merchandise inventory $1,000

 Consignor retains title until goods are

sold to customer. At sale:
Dr. Accounts receivable $1,400
Cr. Sales revenue $1,400
Dr. COGS $1,000
Cr. Inventory on consignment $1,000

5-9
 Franchise Revenue

 Recognize:
 When earned: service has been provided.
 Not necessarily when agreement signed
or fee received.
 Normally, after franchisee commences
operations.

5-10
 Franchise Revenue Example
 Lakers, Inc. receives $600,000 from a
franchisee for the right to use its trademark
and have access to its “know-how” for a
period of 5 years. This know-how includes
training sessions, and some one available to
answer questions. When should the $600,000
be recognized as revenue?

5-11
 Percentage-of-Completion Method

 Design/development and
construction/production projects that extends
over several years.
 Customer pays either fixed price or cost
reimbursement/plus contract.
 Reasonable assurance of profit margin and
ultimate realization.
 Revenue recognized based on total percentage
of project work performed during period.
5-12
 Completed Contract Method

 Percentage of completion method

required unless:
 Amount of income to be earned on contract
cannot reasonably be determined.
 Alternative is completed contract method.
 Costs incurred are an asset/inventory
(Contract Work in Progress) until revenue is
recognized.

5-13
Completed Contract Method

5-14
 Installment Method

 Customer pays a certain amount per

period.
 Installment payment is recognized as
revenue and a proportional part of cost
of sales is recorded.
 Under cost recovery method, cost is
recorded equal to installment payment
until total cost of sales is covered.
5-15
 Installment Method
 Credit risk:
 Customer will default on payments;

 The payment will not be received on time.

 It’s generally accepted that deferring revenue

recognition until completion of the contract,
although reliable, is not appropriate.
 Credit risk is taken into account for receivable
by raising an ‘allowance for doubtful debts’. An
allowance for doubtful debts does not reduce
the gross amount of revenue recognized. 5-16
 Installment Method-example
 A jeweler sells a watch in 2005 for $400, and the
customer agrees to make payments totaling $200 in
2005 and $200 in 2006. The watch cost the jeweler
$220.
Effect on Income Statement

Delivery Method Installment Method

2005 2006 2005 2006

Sales revenue $400 $0 $200 $200

Cost of goods sold 220 0 110 110

Gross margin $180 $90 $90

5-17
 Amount of Revenue Recognized

 Net realizable value (amount reasonably

estimated to be collected).
 2 approaches:
 Direct write-off method.
 Allowance method.
 % of sales.
 % of (analysis of) AR.

5-18
 Bad Debts
Direct Write-Off Method

 Write-off when specific account that is

uncollectible is identified, usually is not
possible.
 Why is this not acceptable under GAAP?

Dr. bad debt expense $200

Cr. Account receivable $200

5-19
 Allowance Method

 Estimate amount of current period credit

sales that will not be collected.
 Historical % of sales tempered by judgment.
 Historical % of aged receivables (+ judgment).
 Adjusting entry at end of period.
 When an uncollectible account is identified,
it is written off.

5-20
 Bad Debt Exercise 1
 Amount of revenue recognized:
 Sales for the year were $2,000 for cash and
$6,000 on credit.
 Historically we don’t collect about 5% of our credit
sales due to customer bankruptcies or unable to
locate customer.
 A customer, The XYZ Company went bankrupt.
They owed us $175.
 Entry for revenue?
 Entry for bad debts - direct write-off (not-GAAP)?
 Entries for bad debts (allowance method)?
5-21
 Bad Debt Exercise 1
 Entry for revenue recognized:
Dr. Cash $2,000
Account receivable $6,000
Cr. Sales $8,000

 Entry for bad debts - direct write-off (not-GAAP)?

Dr. Bad debt expense $175
Cr. Account receivable $175

Accounts receivable net $5,825 ($6,000-$175)

5-22
 Bad Debt Exercise 1
 Entries for bad debts (allowance method)?
 Dr. Bad debt expense $300
Cr. Allowance for doubtful accounts $300
Accounts receivable $6,000
BS will less: Allowance doubtful for accounts $300
show
Accounts receivable, net $5,700
 Dr. Allowance for doubtful accounts $175
Cr. Accounts receivable $175
Accounts receivable $5,825
BS will less: Allowance doubtful for accounts $125
show
Accounts receivable, net $5,700
5-23
 Allowance Method (continued)

Discussion problem 5-3, P130

5-24
 Sales Discounts

 Sales terms are “2/10 net 30”

 Customer gets 2% cash discount if paid within
10 days.
 Otherwise, total amount is due within 30 days.
 What does “1/15 net 45” mean?
 What is the effective annual rate of savings
by taking advantage of terms of “2/10 net
30”?
5-25
 Alternative methods of accounting
for sales discounts
 Record initial sale at gross.
 At collection of net amount record discount
as a reduction from gross sales.
 Record initial sale at gross.
 At collection of net amount record discount
as an expense of the period.
 Record initial sale at net.
 Record amounts not taken as discounts as
additional revenue.
5-26
Sales Discount Exercise

 We sold $10,000 of mdse. Sales terms

are 2/10, n/30. Customers paid us for
$8,000 of the merchandise billed within
10 days. The remaining $2,000 was
paid within 30 days.
 Record at gross.
 Record at net.

5-27
Sales Discount Exercise
 Record at gross:
Dr. Account receivable $9,840
sale discount 160
Cr. Sales revenue $10,000

 Record at net.
Dr. Account receivable $9,840
Cr. Sales revenue $9,840

5-28
 Warranty Costs

 Amounts are estimated (usually as a

percentage of sales).
 Part of Cost of goods sold.
 Record accrual (adjusting entry)
 Record the actual expenditures.
 Allowance… is a liability account.
Estimated warranty expense is part of
costs of sales.
5-29
 Warranty Expenses Exercise
 We estimate that warranty expenses will be
4% of our $10,000 of sales. Entry?
Dr. Estimated warranty expense $400
Cr. provision for warranty $400

 We spent $120 on parts and $250 on labor

for repairs under warranty. Entry?
Dr. provision for warranty $370
Cr. Cash $250
parts inventory 120

5-30
 Monetary& Non-monetary Assets
 Monetary assets are money or claims to
receive fixed sums of money.
 Non-monetary assets are items used in future
production and sales of goods and services.
 Balance sheet distinction
 Current and non-current assets.
 Not monetary and non-monetary.
 Non-monetary assets (except inventory) on
BS at unexpired cost. (Cost less depreciation)
 Monetary assets: Cash reported at face. AR at
NRV. Other at fair value.
5-31
 Cash

 Funds available for disbursement.

 May include liquid short term
investments.
 Highly liquid debt instruments with original
maturities of 90 days or less.

5-32
 Receivables

 Trade receivables
 Accounts receivables from usual sales of
products or services for non-financial
institutions.
 Other receivables are shown separately.
 E.g. due from employees, advances or
loans.

5-33
 Marketable Securities

 Must be marketable.
 E.g. commercial paper, treasury bills,
publicly traded stocks and bonds issued
by companies.
 Also called “Temporary Investments.”

5-34
 Analysis of Monetary Assets

1.

2.

monetary CA=CA - inventories - prepaid items

5-35
 Analysis of Monetary Assets

3.

 Cash expenses  total expenses - depreciation.

4.

Ratios differ by industry.

Discussion problem 5-7, P131

5-36
Analysis of Monetary Assets - Exercise

Answer on page 126-128

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 Summary of Chapter 5

 Timing of revenue recognition

 Amount of revenue recognized
 Monetary assets
 Analysis of monetary assets

5-38
Assignments of Chapter 5

 Problem 5-4
 Problem 5-6
 Case 5-1

5-39
Thank you

5-40
Answer for Discussion problem 5-3
1. To record the write-off:
(1). If Alcon uses the direct write-off method
Dr. Bad debt Expense $3,000
Cr. Accounts Receivable $3,000

(2). If Alcon uses the allowance method:

Dr. Allowance for Doubtful Accounts $3,000
Cr. Accounts Receivable $3,000
2. To record the partial payment:
(1). If Alcon uses the direct write-off method
Dr. Cash $950
Cr. Bad Debts Recovered $950
(or Bad Debt Expense $950)
(2). If Alcon uses the allowance method:
Dr. Cash $950
Cr. Allowance for doubtful accounts $950
5-41
 Answer for Discussion problem 5-7

a. Current ratio = $125,200 / $71,300 = 1.76

Quick ratio = ($23,100 + $32,800) / $71,300 = .78

b. Days’ cash = $23,100 / ($231,000 / 365) = 36.5 days.

c. Days’ receivables = Net receivables / (Credit sales / 365) =

$32,800 / ($323,400 x .77 / 365).
= 48 days.

5-42