Chapter 6

Reporting and Interpreting Sales

Revenue, Receivables, and Cash
Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001
 Accounting for Sales Revenue
The revenue principle requires that
revenues be recorded when earned:

An
An exchange
exchange has
has taken
taken
place.
place.
The
The earnings
earnings process
process is
is
nearly
nearly complete.
complete.

Collection
Collection is
is probable.
probable.
Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001
 Reporting Net Sales

Companies
Companies record
record sales
sales discounts,
discounts, sales
sales
returns
returns and
and allowances,
allowances, and and credit
credit card
card
discounts
discounts separately
separately toto allow
allow management
management
monitoring
monitoring of
of these
these transactions.
transactions.

Sales revenue
Less: Sales returns and allowances
Sales discounts
Credit card discounts
Net sales
Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001
 Credit Card Sales to Consumers
Companies accept credit
cards for several reasons:
To increase sales.
To avoid providing credit
directly to customers.
To avoid losses due to bad
checks.
To receive payment quicker.

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001

 Credit Card Sales to Consumers
When credit card sales are made,
the company must pay the credit
card company a fee for the service it
provides.

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001

 Credit Card Sales to Consumers
On January 2, a Timberland factory store’s
credit card sales were $3,000. The credit
card company charges a 3% service fee.
Prepare the Timberland journal entry.

GENERAL JOURNAL Page 34

Date Description Debit Credit
Jan. 2

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001

 Credit Card Sales to Consumers
On January 2, a Timberland factory store’s
credit card sales were $3,000. The credit
card company charges a 3% service fee.
Credit
Prepare Card
the Discounts are
Timberland reported
journal entry.
as a contra revenue account.
GENERAL JOURNAL Page 34
Date Description Debit Credit
Jan. 2 Accounts Receivable 2,910
Credit Card Discounts 90
Sales Revenue 3,000
$3,000 × 3% = $90 Credit Card Fee

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001

 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.

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001

 Sales to Businesses on Account

2/10, n/30
Read as: “Two ten, net thirty”
When customers purchase on open
account, they may be offered a sales
discount to encourage early payment.
Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001
 Sales to Businesses on Account

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

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001

 Sales to Businesses on Account

On January 6, Timberland sold $1,000

of merchandise on credit with terms
of 2/10, n/30.
Prepare the Timberland journal entry.

GENERAL JOURNAL Page 34

Date Description Debit Credit
Jan. 6

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001

 Sales to Businesses on Account

On January 6, Timberland sold $1,000

of merchandise on credit with terms
of 2/10, n/30.
Prepare the Timberland journal entry.

GENERAL JOURNAL Page 34

Date Description Debit Credit
Jan. 6 Accounts Receivable 1,000
Sales Revenue 1,000

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001

 Sales to Businesses on Account
On January 14, Timberland receives
the appropriate payment from the
customer for the January 6 sale.
Prepare the Timberland journal entry.

GENERAL JOURNAL Page 34

Date Description Debit Credit
Jan. 14

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001

 Sales to Businesses on Account
On January 14, Timberland receives
the appropriate payment from the
customer for the January 6 sale.
Prepare the Timberland journal entry.
$1,000 × 2% = $20 sales discount
GENERAL JOURNAL Page 34
Date $1,000 - Description
$20 = $980 cash receipt
Debit Credit
Jan. 14 Cash 980
Sales Discounts 20
Accounts Receivable 1,000

Irwin/McGraw-Hill Contra-revenue account © The McGraw-Hill Companies, Inc., 2001

 Sales to Businesses on Account
If the customer remits the appropriate
amount on January 20 instead of
January 14, what entry would
Timberland make?

GENERAL JOURNAL Page 34

Date Description Debit Credit
Jan. 20

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001

 Sales to Businesses on Account
If the customer remits the appropriate
amount on January 20 instead of
January 14, what entry would
Timberland make?
Since the customer paid outside of the discount
period, a sales JOURNAL
GENERAL discount is not granted.Page 34
Date Description Debit Credit
Jan. 20 Cash 1,000
Accounts Receivable 1,000

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001

 Sales Returns and Allowances

Debited for damaged

merchandise.

Debited for returned

merchandise.

Contra revenue
account.

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001

 Sales Returns and Allowances
On July 8, Fontana Shoes returns $500
of hiking boots originally purchased
on account from Timberland.
Prepare the Timberland journal entry.

GENERAL JOURNAL Page 40

Date Description Debit Credit
July 8

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001

 Sales Returns and Allowances
On July 8, Fontana Shoes returns $500
of hiking boots originally purchased
on account from Timberland.
Prepare the Timberland journal entry.

GENERAL JOURNAL Page 40

Date Description Debit Credit
July 8 Sales Returns and Allowances 500
Accounts Receivable 500

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001

 Gross Profit Percentage
Gross Profit Gross Profit
=
Percentage Net Sales
In
In1998,
1998,Timberland
Timberlandreported
reportedgross
grossprofit
profit
of
of$342,839,000
$342,839,000on
onsales
salesof
of$862,168,000.
$862,168,000.

All
Allother
otherthings
thingsequal,
equal,aahigher
highergross
gross
profit
profitresults
resultsin
inhigher
highernet
netincome.
income.

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001

 Gross Profit Percentage
Gross Profit Gross Profit
=
Percentage Net Sales

Gross Profit $342,839,000

= = 39.8%
Percentage $862,168,000

All
Allother
otherthings
thingsequal,
equal,aahigher
highergross
gross
profit
profitresults
resultsin
inhigher
highernet
netincome.
income.

1998 Gross Profit Comparisons

Timberland Skechers U.S.A. Wolverine
39.8% 41.5% 31.8%
Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001
 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.
Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001
 Measuring and Reporting
Receivables
Term
$1,200 Wheaton, Ohio Payee January 5, 2000

Sixty days after date I promise to pay to

the order of
Principal Wheaton Mountain Bank
One thousand two hundred --------------------------------- Dollars
Payable at InterestMountain
Wheaton Rate Bank
Maker
Value received with interest at 12% per annum
No. 10242 Due March 6, 2000 Pat
Timberland Company
Rogers
Due Date
Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001
 Accounting for Bad Debts

Bad
Bad debts
debts result
result from
from credit
credit customers
customers
who
who will
will not
not pay
pay the
the business
business the
the
amount
amount they
they owe,
owe, regardless
regardless of
of
collection
collection efforts.
efforts.

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001

 Accounting for Bad Debts

Bad Debt
Expense
Record in same
Matching accounting
Principle period.
Sales
Revenue
Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001
 Accounting for Bad Debts

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

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001

 Recording Bad Debt Expense
Estimates
Timberland estimated bad debt
expense for 1998 to be $2,383,000.
Prepare the adjusting entry.

GENERAL JOURNAL Page 78

Date Description Debit Credit
Dec. 31

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001

 Recording Bad Debt Expense
Estimates
Timberland estimated bad debt
expense for 1998 to be $2,383,000.
Prepare the adjusting entry.
Bad Debt Expense is
GENERAL normally classified as aPage 78
JOURNAL
Date selling expense and is closed at year-end.
Description Debit Credit
Dec. 31 Bad Debt Expense 2,383,000
Allowance for Doubtful Accounts 2,383,000

Contra asset account

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001
 Allowance for Doubtful
Accounts
Balance Sheet Disclosure

Accounts receivable
Less: Allowance for doubtful accounts
Ne t re aliz able value o f ac c o unts re c e ivable

Amount the business

expects to collect.
Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001
 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.

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001

 Writing Off Uncollectible
Accounts
On May 6, Timberland wrote off a
specific account receivable with
a balance of $2,500.
Prepare the Timberland journal entry.

GENERAL JOURNAL Page 37

Date Description Debit Credit
May 6

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001

 Writing Off Uncollectible
Accounts
On May 6, Timberland wrote off a
specific account receivable with
a balance of $2,500.
Prepare the Timberland journal entry.

GENERAL JOURNAL Page 37

Date Description Debit Credit
May 6 Allowance for Doubtful Accounts 2,500
Accounts Receivable 2,500

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001

 Writing Off Uncollectible
Accounts
Assume
Assume that
that before
before the
the write-off
write-off entry,
entry,
Timberland’s
Timberland’s Accounts
Accounts Receivable
Receivable
balance
balance was
was $81,000,000
$81,000,000 and
and the
the
Allowance
Allowance for
for Doubtful
Doubtful Accounts
Accounts
balance
balance was
was $2,000,000.
$2,000,000.

Let’s
Let’s see
see what
what effect
effect the
the write-off
write-off had
had
on
on these
these accounts.
accounts.
Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001
 Writing Off Uncollectible
Accounts

Before Write- After Write-

Off Off
Accounts receivable $ 81,000,000 $ 80,997,500
Less: Allow. for doubtful accts. 2,000,000 1,997,500
Net realizable value $ 79,000,000 $ 79,000,000

Notice
Noticethat
thatthe
thewrite-off
write-offdid
didnotnotchange
changethe
thenet
net
realizable
realizablevalue
valuenor
nordid
didititaffect
affectany
anyincome
income
statement
statementaccounts.
accounts.

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001

 Methods for Estimating Bad
Debts
Percentage of credit sales
or
Aging of accounts receivable

????

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001

 Percentage of Credit Sales

Bad debt percentage is based

on actual uncollectible accounts
from prior years’ credit sales.

Focus is on determining the amount to

record on the income statement as
Bad Debt Expense.

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001

 Percentage of Credit Sales

Net
Net Credit
Credit Sales
Sales
×× %
% Estimated
Estimated Uncollectible
Uncollectible
Amount
Amount of
of Journal
Journal Entry
Entry

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001

 Percentage of Credit Sales
In 2000, 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 2000?

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001

 Percentage of Credit Sales
In 2000, 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 2000?
$60,000 × .01 = $600
Now, prepare the adjusting entry.
Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001
 Percentage of Credit Sales

GENERAL JOURNAL Page 76

Date Description Debit Credit
Dec. 31 Bad Debt Expense 600
Allowance for Doubtful Accounts 600

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001

 Now let’s discuss
another method that is
used to account for
uncollectible accounts.

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001

 Aging of Accounts Receivable

Focus is on determining the desired

balance in the Allowance for Doubtful
Accounts on the balance sheet.

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001

 Aging of Accounts Receivable
Accounts
Accounts Receivable
Receivable
×× %% Estimated
Estimated Uncollectible
Uncollectible
Desired
Desired Balance
Balance in
in Allowance
Allowance Account
Account
-- Allowance
Allowance Account
AccountCredit
Credit Balance
Balance
Amount
Amount of
of Journal
Journal Entry
Entry
Accounts
Accounts Receivable
Receivable
×× %
% Estimated
Estimated Uncollectible
Uncollectible
Desired
Desired Balance
Balance in
in Allowance
Allowance Account
Account
++ Allowance
Allowance Account
Account Debit
Debit Balance
Balance
Amount
Amount of
of Journal
Journal Entry
Entry
Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001
 Aging Schedule

Each
Each customer’s
customer’s account
account is is aged
aged by
by
breaking
breaking down
down the
the balance
balance byby
showing
showing the
the age
age (in
(in number
number ofof days)
days)
of
of each
each part
part of
of the
the balance.
balance.
An
An aging
aging of
of accounts
accounts receivable
receivable for
for
Kid’s
Kid’s Clothes
Clothes in
in 2000
2000 might might look
look like
like
this
this .. .. ..

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001

 Aging Schedule
Days Pa st Due
Total
Not Yet A/R
Customer Due 1-30 31-60 61-90 Over 90 Balance
Aa ron, R. $ 235 $ 235
Ba xter, T. $ 1,200 300 1,500
Cla rk, J. $ 50 $ 200 $ 500 750

Zak, R. 325 325

Tota l $ 3,500 $ 2,550 $ 1,830 $ 1,540 $ 1,240 $10,660

Based on past experience, the business

estimates the percentage of uncollectible
accounts in each time category.
Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001
 Aging Schedule
Days Pa st Due
Total
Not Yet A/R
Customer Due 1-30 31-60 61-90 Over 90 Balance
Aa ron, R. $ 235 $ 235
Ba xter, T. $ 1,200 300 1,500
Cla rk, J. $ 50 $ 200 $ 500 750

Zak, R. 325 325

Tota l $ 3,500 $ 2,550 $ 1,830 $ 1,540 $ 1,240 $10,660
% Uncollectible 0.01 0.04 0.10 0.25 0.40

These percentages are then multiplied

by the appropriate column totals.
Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001
 Aging Schedule
Days Pa st Due
Total
The column
Not Yet totals are then added to A/R
Customer arrive
Due at 1-30
the total estimate
31-60 of 90 Balance
61-90 Over
Aa ron, R. $ 235
uncollectible accounts of $1,201. $ 235
Ba xter, T. $ 1,200 300 1,500
Cla rk, J. $ 50 $ 200 $ 500 750

Zak, R. 325 325

Tota l $ 3,500 $ 2,550 $ 1,830 $ 1,540 $ 1,240 $10,660
% Uncollectible 0.01 0.04 0.10 0.25 0.40
Estima ted
Uncoll. Amount $ 35 $ 102 $ 183 $ 385 $ 496 $ 1,201

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001

 Aging of Accounts Receivable
Days Pa st Due
Total
Record the Dec. 31, 2000 adjusting
Not Yet A/R
Customer entry
Dueassuming
1-30 that
31-60 the61-90
Allowance
Over 90 Balance
Aa ron, R. $ 235 $ 235
Ba xter, T.
for Doubtful
$ 1,200
Accounts
300
currently has 1,500
Cla rk, J. a $50 credit
$ balance.
50 $ 200 $ 500 750

Zak, R. 325 325

Tota l $ 3,500 $ 2,550 $ 1,830 $ 1,540 $ 1,240 $10,660
% Uncollectible 0.01 0.04 0.10 0.25 0.40
Estima ted
Uncoll. Amount $ 35 $ 102 $ 183 $ 385 $ 496 $ 1,201

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001

 Aging of Accounts Receivable
GENERAL JOURNAL Page 76
Post.
Date Description Ref. Debit Credit
Dec. 31 Bad Debt Expense 1,151
Allow ance for Doubtful Accounts 1,151

1,201
1,201 Desired Balance After posting, the
Desired Balance
-- 50 Credit Balance Allowance
50 Credit Balance
$$ 1,151 Adjusting account would
1,151 Adjusting Entry
Entry look like this . . .

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001

 Aging of Accounts Receivable
Allowance for Doubtful Accounts
50 Balance at
12/31/2000
before adj.
1,151 2000 adjustment
Notice that the balance
after adjustment is equal 1,201 Balance at
to the estimate of $1,201 12/31/2000
based on the aging after adj.
analysis performed
earlier.

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001

 Now let’s
start our
discussion
of cash.

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001

 Cash and Cash Equivalents
Money
Checks
Orders
Cash and
Cash
Equivalents

Certificates Bank
of Deposit Drafts
T-Bills
Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001
 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
Cashis
isthe
theasset
assetmost
mostsusceptible
susceptibleto
totheft
theftand
andfraud.
fraud.
Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001
 Internal Control of Cash

Custody

Separation
Recording
of Duties

Authorization

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001

 Internal Control of Cash
Bank
Reconciliations
Daily Prenumbered
Deposits Checks
Cash
Controls
Payment Check
Approval Signatures
Purchase
Approval
Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001
 Bank Reconciliation

Explains the difference between cash

reported on bank statement and cash
balance on company’s books.

Provides
Provides information
information for
for
reconciling
reconciling journal
journal entries.
entries.

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001

 Bank Reconciliation
Balance per Bank Balance per Book

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

- Service Charge
- Outstanding Checks
- NSF Checks

± Bank Errors ± Book Errors

= Adjusted Balance = Adjusted Balance

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001

 Bank Reconciliation
All
Balance per Bank Balance per Book

reconciling
+ Deposits by Bank
+items
Deposits on the
in Transit
(credit memos)
book side
- Service Charge
requireChecks
- Outstanding an - NSF Checks
adjusting
± entry to the
Bank Errors ± Book Errors

cash
= Adjusted Balance = Adjusted Balance
account.
Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001
 Bank Reconciliation
Prepare
Prepare aa July
July 3131 bank
bank reconciliation
reconciliation
statement
statement and and the
the resulting
resulting journal
journal entries
entries
for
for the
the Simmons
Simmons Company.
Company. The The July
July 31
31
bank
bank statement
statement indicated
indicated aa cash
cash balance
balance of
of
$9,610,
$9,610, while
while the
the cash
cash ledger
ledger account
account on on
that
that date
date shows
shows aa balance
balance ofof $7,430.
$7,430.

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

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001

 Bank Reconciliation
•• Outstanding
Outstanding checks
checks totaled
totaled $2,417.
$2,417.
•• AA $500
$500 check
check mailed
mailed toto the
the bank
bank for
for deposit
deposit had
had
not
not reached
reached thethe bank
bank atat the
the statement
statement date.
date.
•• The
The bank
bank returned
returned aa customer’s
customer’s NSF NSF check
check for
for
$225
$225 received
received asas payment
payment of of an
an account
account receivable.
receivable.
•• The
The bank
bank statement
statement showed
showed $30 $30 interest
interest earned
earned on
on
the
the bank
bank balance
balance for
for the
the month
month ofof July.
July.
•• Check
Check 781781 for
for supplies
supplies cleared
cleared the
the bank
bank for
for $268
$268
but
but was
was erroneously
erroneouslyrecorded
recorded in in our
our books
books asas
$240.
$240.
•• AA $486
$486 deposit
deposit by byAcme
Acme Company
Companywas was erroneously
erroneously
credited
credited toto our
our account
account by by the
the bank.
bank.
Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001
 Bank Reconciliation
Ending bank balance, July 31 $ 9,610
Additions:
Deposit in transit 500
Deductions:
Bank error $ 486
Outstanding checks 2,417 2,903
Correct cash balance $ 7,207

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001

 Bank Reconciliation
Ending bank balance, July 31 $ 9,610
Additions:
Deposit in transit 500
Deductions:
Bank error $ 486
Outstanding checks 2,417 2,903
Correct cash balance $ 7,207

Ending book balance, July 31 $ 7,430

Additions:
Interest 30
Deductions:
Recording error $ 28
NSF check 225 253
Correct cash balance $ 7,207
Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001
 Bank Reconciliation

GENERAL JOURNAL Page 56

Post.
Date Description Ref. Debit Credit
Jul 31 Cash 30
Interest Revenue 30

31 Supplies Inventory 28
Accounts Receivable 225
Cash 253

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001

 End of Chapter 6

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001