ACCT 701 - M3

Accounts Receivable : Three Accounts for Receivable

-Asset account (balance sheet). -Debit when increasing. -Credit when write off (decrease).

Bad Debt Expense : Three Accounts for Receivable

-Expense Account (Income Statement). -Debit when estimate the uncollectible. Increasing as an expense via the accounting equation.

What costs are included in COGS?

-The cost of products or raw materials, including freight or shipping charges; -The cost of storing products the business sells; -Direct labor costs for workers who produce the products; -Factory overhead expenses.

Two Revenue Recognition Criteria

1) Revenue must be earned. -Risk of ownership has passed. -Seller has executed substantially all the requirements of the agreement. 2) Revenue must be realized or realizable. -Received cash or cash equivalent.

What are the 3 accounts for receivables?

1. Accounts Receivable. 2. Allowances for Uncollectible Receivables. 3. Bad Debt Expense.

What 4 topics did we cover in this module?

1. Accounts Receivable. 2. Inventory. 3. Sales Revenue. 4. Cost of Goods Sold.

When we sell inventory, what happens in the ledger?

1. Asset decreases; Inventory is credited. 2. Expense increases; COGs is debited.

What 2 types of timing difference fraud take place?

1. Companies recognize revenue before a service or product is provided. E.G. Best Buy recognizes revenue before they deliver their products. American Airline recognizes revenue before you take the flight you've paid for. 2. Companies recognize expenses later. Why? This defers expenses to a later year, therefore boosting the revenues of the current year. "Kicking the (expense) can down the road". Following year's revenue will be shrunk.

What are the 2 types of fraud according to Global Fraud Survey?

1. Factious Revenue (37% of fraud cases): Company hasn't sold anything, but is claiming they have done so. 2. Timing Difference (14%): Company recognizes revenue prematurely. For example, is American Airlines recognizes revenue before you've taken the flight, whether you've book it or not. You must have taken the flight for it to be recognizable. Firm may have received money, but did not yet perform the service.

What are the 2 main types of companies which have inventory?

1. Merchandise : Wholesaler, Retailer. 2. Manufacturing Company: Raw materials, Work in progress, Finishing goods.

Two Types of Inventory Systems

1. Perpetual. 2. Periodic.

What're the first two items on an income statement?

1. Revenue. 2. Cost of Goods Sold.

What are the 4 cost flow assumptions?

1. Specific Identification. 2. First-in, First-Out. 3. Last-in, Last-Out. 4. Weighted-Average Cost.

Contra Revenue Account Example

1. We sold 5 car seats for $100 each on Nov. 2. 2. Customer returned 2 of the car seats, because they were the wrong model. 3. We agreed to give $50 back because they were unsatisfied with the quality. What did we do in each step? 1. We credit sales revenue to increase it- This is sales revenue (Revenue). We debit accounts receivable to increase it- they owe us money (Accounts Receivable is an Asset). Contra Revenue - Sales Return 2. We debit Sales Return to reduce our initial $500. We credit Accounts Receivable; this is an asset reduction - We are no longer receiving the fully $500 - Now only $300 because of the returns. Contra Revenue - Sales Allowance 3. We debit Sales Allowance to reduce the initially $500 in revenue even further. We're giving them $50 back for their dissatisfaction. We credit Accounts Receivable - We gave them $50 back on top of the returns. Reduction in asset.

What percentage of fraud cases are timing difference?

14%.

Best Buy : Revenue Recognition

3 Conditions for Revenue to be Recognized: We recognize revenue when the sales price is fixed or determinable, collection is reasonably assured and the customer takes possession of the merchandise, or in the case of services, the service has been provided. For revenue transactions that involve multiple deliverables, we defer the revenue associated with any undelivered elements.

What percentage of fraud cases are factious?

37%.

What is the difference between bad debt expense and allowance for doubtful accounts?

A bad debt is a specifically-identified account receivable that will not be paid and so should be written off at once, while a doubtful debt is one that may become a bad debt in the future and for which it may be necessary to create an allowance for doubtful accounts.

The difference between bad debt and doubtful debt

A bad debt is an account receivable that has been clearly identified as not being collectible. A doubtful debt is an account receivable that might become a bad debt at some point in the future.

Historical Value

The original purchase price of an asset. Recorded on a balance sheet. Historical cost is in line with conservative accounting, as it prevents overstating the value of an asset. Historical cost is one of the basic accounting principles laid out under generally accepted accounting principles (GAAP).

Contra Account : Allowance for Doubtful Accounts

A credit balance that offsets the debit balance of accounts receivable on the balance sheet. Reflects the amount of uncollectable receivables the company expects to write-off from its accounts receivable balance. The net number represents a more reasonable expectation of the true worth of the company's accounts receivable.

What does the contra revenue account do (Sales Allowance)?

A price reduction granted for damaged goods kept by the customer. Reduce the value of the revenue account. Debit when customer returns, to offset revenue.

Sales Allowances

A price reduction granted for damaged goods kept by the customer. •Seller issues a cash refund if original sale was for cash. •Seller reduces balance of accounts receivable if original sale was on account.

Weighted Average Method

A process costing method that blends together units and costs from varying purchased items. Includes costs in beginning inventory and current period costs to establish an average cost per unit. Assumes that the cost of inventory is based on the average cost of the goods available for sale during the period. The average cost is computed by dividing the total cost of goods available for sale by the total units available for sale.

Cost Flow of Inventory

Beginning Inventory (Leftover) + Inventory Bought During Current Period = All Inventory Items Available for Sale = Cost of Goods Sold + Ending Inventory. E.G. Beginning Balance 20,000 Purchase 90,000 80,000 COGs,Sold -------------------------------------------------------------- Ending Balance 30,000

What is the equation for Cost of Goods Sold?

Beginning Inventory + New Purchases - Ending Inventory.

Gift Card Breakage

Breakage is a term used to describe revenue gained by retailers through unredeemed gift cards or other prepaid services that are never claimed.

Merchandising Business

Buy; Resell. Inventory is the goods held by a business that it intends to sell to earn revenue. Merchandising business only hold 1 type of goods.

Cost of Goods Sold (COGs)

COGS only applies to those costs directly related to producing goods intended for sale. E.G. An iPhone is purchased (by Apple) for $500, and is sold on the market for $800. The COGs = $500. The cost of acquiring or manufacturing the products that a company sells during a period, so the only costs included in the measure are those that are directly tied to the production of the products, including the cost of labor, materials, and manufacturing overhead.

Allowances for Uncollectible Receivables : Three Accounts for Receivable

Contra Asset Account (Balance Sheet). This is a subtraction item for receivables. -Reduce value of asset. -Credit when estimate the uncollectible. -Adjusting entry when estimating. -Debit when write off.

On which financial statement does the contra revenue account appear?

Contra revenue accounts appear near the top of the income statement, as a deduction from gross revenue.

Is COGs an expense?

Cost of goods sold is considered an expense in accounting and it can be found on a financial report called an income statement.

When the firm receives notice that a customer will not be able to make payment, the firm decides to write off the accounts receivable. What is the correct journal entry?

Credit- Accounts Receivable. Debit - Allowance for Uncollectible Receivables.

What is accounts receivable?

Current Asset, Company has future benefit attached to this; Customers have made a purchase, but have yet to pay us for it.

What is inventory?

Current Asset. Company has future benefit attached to this; It can be raw materials or half processed products. The things the company purchased, processed, and attempts to sell to customers.

Accounts Receivable : On which financial statement is it found?

Current Asset; Balance Sheet.

Inventory : On which financial statement is it found?

Current Asset; Balance Sheet.

Xerox Case : Fraud

Accelerated the company's recognition of equipment revenue by over $3 billion. The company hadn't delivered the equipment yet, and still recognized its revenue. Increased its pre-tax earnings by approximately $1.5 billion. Why do CFOs, managers, do this? They have incentive to beat Wall Street expectations. They hope to meet or beat expectation of earnings per share (EPS), because that is tied to their compensation/bonuses. What resulted? The SEC investigated, and Xerox was fined $10 million; they also were required to restate the financial statements (redo them).

ASU

Accounting Standards Update

Accounts Payable

Accounts payable is the amount of short-term debt or money owed to suppliers and creditors by a company. Accounts payable is listed on a company's balance sheet. Accounts payable is a liability since it's money owed to creditors and is listed under current liabilities on the balance sheet

Is accounts receivable an asset?

Accounts receivable is the amount owed to a seller by a customer. As such, it is an asset, since it is convertible to cash on a future date. Accounts receivable is listed as a current asset in the balance sheet, since it is usually convertible into cash in less than one year.

What is NRV also equal to on the balance sheet?

Accounts receivable, net.

Uncollectible Receivables

Accounts uncollectible are receivables, loans, or other debts that have virtually no chance of being paid. An account may become uncollectible for many reasons, including the debtor's bankruptcy, an inability to find the debtor, fraud on the part of the debtor, or lack of proper documentation to prove that debt exists.

What are some types of contra accounts?

Accumulated depreciation. Accumulated depletion. Obsolete inventory reserves. Allowance for doubtful accounts. Trade accounts receivable. Discount on notes receivable.

How do we estimate on bad debt?

Aging Method: Older accounts are more likely uncollectible. Specific Clients: The history of the clients can give us information to predict.

At the end of the year, the company estimates that the part of accounts receivables that customers won't pay in the future. What is the journal entry for this kind of estimation?

Debit- Bad Debt Expense, Credit- Allowance for Uncollectible Receivables.

Best Buy : Customer Loyalty Programs

Depending on the customer's membership level within our loyalty program, certificate expirations typically range from 2 to 12 months from the date of issuance. The value of points earned by our loyalty program members is included in accrued liabilities and recorded as a reduction of revenue at the time the points are earned, based on the value of points that are projected to be redeemed.

Misstatement: Error vs. Fraud

Error: Made Accidentally. Fraud: Done Intentionally.

Cost of Goods Sold : On which financial statement is it found?

Expense Account; Income Statement.

What is the Cost of Goods Sold defined as within the accounting equation?

Expense.

Best Buy : Sales Incentives

For sales incentives issued to the customer in conjunction with a sale of merchandise or services, the reduction in revenue is recognized at the time of sale, based on the expected retail value of the incentive expected to be redeemed.

What does 'net' mean in accounting?

Free from all charges or deductions.

On what financial statement does the Contra Revenue Account go?

Income Statement.

What happens to the accounting equation when you purchase inventory with cash? What would happen if you paid on credit?

Inventory, Debit Asset. Cash, Credit Asset. If paid on credit? Inventory, Debit Asset. Accounts Payable, Liability.

Inventory

Items a company intends to sell its customers. An asset; In fact, it is a current asset.

Perpetual Inventory System

Maintains a continual record of inventory. Updates inventory information at any moment; very accurate and timely. More costly. Most companies are choosing this system as technology becomes more advanced.

Manufacturing Business

Make; Sell. Inventory is the raw materials, work-in-progress, and finished goods held by a business that it intends to sell to earn revenue. Manufacturing businesses hold 3 different types of inventory.

Cost Flow Assumptions : Specific Identification

Matches each unit of inventory with its actual cost.

You purchase a coffee machine from Amazon : When Amazon recognize the cost?

Matching principle. The matching principle directs a company to report an expense on its income statement in the period in which the related revenues are earned. The cost is recognized whenever at the time you recognize the revenue. At the same time.

Best Buy : Merchandise Inventories

Merchandise inventories are recorded at the lower of cost or net realizable value and the weighted average method is used to determine the cost of inventory. Inventory valuation reflects adjustments for anticipated physical inventory losses (e.g., theft).

Allowance of Uncollectible Receivables/Doubtful Accounts

Allowance for doubtful accounts is a contra-asset account that nets against the total receivables presented on the balance sheet to reflect only the amounts expected to be paid. The allowance for doubtful accounts is only an estimate of the amount of accounts receivable which are expected to not be collectible. The allowance for doubtful accounts is netted against the full value of the accounts receivable. This gives a more realistic value of a company's receivables. A firm can roughly figure out how many accounts will be doubtful by viewing an accounts receivable aging report.

Accounts Receivable

Amount due by customers to the company.

Contra Account : Depreciation

An account that reduces a related account on a financial statement. A contra account makes it easier for analysts to see the original historical cost of the assets along with the associated accumulated depreciation. For example, a furniture account may have been recorded at historical cost. A contra account credits this asset's accumulated depreciation. A very low net book value indicates that an asset has nearly complete depreciated and may need to be replaced in the near future.

Accounts Receivable Aging Report

An accounts receivable aging report lists unpaid customer invoices and unused credit memos by date ranges. The aging report is the primary tool used by collections personnel to determine which invoices are overdue for payment. Doubtful Accounts are estimated using this report. As the report's numbers change, accountants change their estimates on Doubtful Accounts.

What account is allowance for doubtful accounts?

An allowance for doubtful accounts is a contra-asset account that nets against the total receivables presented on the balance sheet to reflect only the amounts expected to be paid. The allowance for doubtful accounts is only an estimate of the amount of accounts receivable which are expected to not be collectible.

Periodic Inventory System

An inventory system in which a company does not maintain detailed records of goods on hand throughout the period and determines the cost of goods sold only at the end of an accounting period. Update inventory information periodically. Less costly.

LIFO Method

Assuming an ordinary inflationary environment, the last units (those considered sold) are the more expensive ones. Therefore, LIFO generally results in higher COGS, lower net income, lower income taxes, and lower inventory values.

FIFO Method

Assuming an ordinary inflationary environment, the last units (those remaining in inventory) are the more expensive ones. Therefore, FIFO generally results in lower COGS, higher net income, higher income taxes, and higher inventory values.

Cost Flow Assumptions

The term cost flow assumptions refers to the manner in which costs are removed from a company's inventory and are reported as the cost of goods sold. In the U.S. the cost flow assumptions include FIFO, LIFO, and average. (If specific identification is used, there is no need to make an assumption.)

Example of Cost Flow Assumptions

To illustrate, let's assume that a company has four units of the same product in its inventory. The units were purchased at increasing costs and in the following sequence: $40, $41, $43, and $44. If the company physically removes and sells the oldest unit (the unit that had a cost of $40), the cost removed from inventory and reported as the cost of goods sold (COGS) will vary depending on the cost flow assumption: FIFO: Under the FIFO cost flow assumption, the oldest cost of $40 is removed from inventory and charged to COGS LIFO: Under the LIFO cost flow assumption, the most recent cost of $44 is removed from inventory and charged to COGS Weighted Average Cost: Under the average cost flow assumption, the average cost of $42 is removed from inventory and charged to COGS Other than a one-time change to a better cost flow assumption, the company must consistently use the same cost flow assumption.

Is bad debt expense a credit or debit?

To record the bad debt expenses, you must debit bad debt expense and a credit allowance for doubtful accounts.

First-In, First Out Accounting

Under FIFO, the oldest costs will be the first costs to be removed from the balance sheet account Inventory and will be the first costs to be included in the cost of goods sold on the income statement.

Weighted Average Inventory Example

Units: Cost: Total Cost: 20 $100 $2000 10 $500 $5000 ------------------------------------ 30 $7000 The total cost of all the units is $7,000 and there are 30 units. Divide $7,000 by 30 and the weighted average is $233.33.

When is the time for recognizing a cost?

Utilize the matching principle; at the end time you recognize the revenue. This is much easier than deciding when to recognize a purchase.

How do we utilize the lower of cost/market method?

Very simply, we acknowledge the lower of the two numbers, inventory or market price. If the market value is less than the inventory book value -Write down inventory to the market value. If the market value is greater than the inventory book value -Keep the current value of inventory. This prevents inflation of inventory assets. The more conservative, reliable method of analyzing inventory value for investors.

Lower of Cost or Market method : iPhone Example

We have 100 units of an old iPhone. The book value of each iPhone was 780 dollars. As new generation of the new iPhone comes out, the net realizable value of the old iPhone becomes 500 dollars. How do we value this inventory based on loc/market? (780-500)*100= $28,000. $28,000 is a loss. This will be recorded as a COGs, an expense. Simultaneously, we credit inventory, because we lost $28,000 in value from our inventory. Sad!

Best Buy : Credit Card Revenue

We offer promotional financing and credit cards issued by third-party banks that manage and directly extend credit to our customers. The banks are the sole owners of the accounts receivable generated under the program and accordingly, we do not hold any consumer receivables related to these programs. We are eligible to receive a profit-share from our banking partners based on the performance of the programs. We record such profit-share as revenue once the portfolio period to which it relates is complete, and we have sufficient evidence to estimate the amount.

Best Buy : Gift Cards

We sell gift cards to our customers in our retail stores, online and through select third parties. We do not charge administrative fees on unused gift cards and our gift cards do not have an expiration date. We recognize revenue from gift cards when the card is redeemed by the customer.

Sales Return Definition

When a consumer is not satisfied with a product and expects to receive the full amount paid for the product.

What does the contra revenue account do (Sales Return)?

When a consumer is not satisfied with a product and expects to receive the full amount paid for the product. Reduce the value of the revenue account. Debit when customer returns, to offset revenue.

Sales Returns

When a consumer is not satisfied with a product and expects to receive the full amount paid for the product. •Seller issues a cash refund if original sale was for cash. •Seller reduces balance of accounts receivable if original sale was on account.

Receivables

When a customer receives a product or service, but has not paid yet.

Is inventory an expense or an asset?

When you purchase inventory, it is not an expense. Instead you are purchasing an asset. When you sell that inventory THEN it becomes an expense through the Cost of Goods Sold account.

Example of Net Realizable Value (NRV)

You have 100 units of inventory. You expect to sell the inventory at $25/unit. However, you have to pay $7 commission per unit to your sales people. You must also incur $1/unit in packaging cost. Here's the math: 100 units x $25 = $2,500. Commission = $7 x 100 = $700. Packaging = $1 x 100 = $100. ---------------------------------------- $1,700 = NRV.

Matching Principle

You recognize the cost whenever you recognize the revenue.

Process Costing (aka average cost method) - Periodic vs. Perpetual

•For periodic inventory, the unit cost is the weighted average for the entire period. •For perpetual inventory, the unit cost is the weighted average prior to the sale.

Bad Debt Expense

Bad debts expense is related to a company's current asset accounts receivable. Bad debts expense is also referred to as uncollectible accounts expense or doubtful accounts expense. Bad debts expense results because a company delivered goods or services on credit and the customer did not pay the amount owed.

On which financial statement does the allowance of uncollectible receivables/doubtful accounts live?

Balance sheet.

Sales Revenue/Service Revenue

Sales revenue is the amount realized by a business from the sale of goods or services. Service revenue is the sales reported by a business that relate to services provided to its customers. This revenue has usually already been billed, but it may be recognized even if unbilled, as long as the revenue has been earned.

Is a contra account part of the accounting equation?

No. A contra account offsets an account within the balance sheet. A contra account is a general ledger account with a balance that is opposite of the normal balance for that account classification. The use of a contra account allows a company to report the original amount and also report a reduction so that the net amount will also be reported. If the related account is an asset account, then a contra asset account is used to offset it with a credit balance. If the related account is a liability account, then a contra liability account is used to offset it with a debit balance.

You purchased the air ticket to New York after two month : Can American Airline recognize the revenue today?

No; 'Seller substantially executing all the requirements of the agreement' is not satisfied! You have not taken the plane yet! When should they recognize the revenue? When you have already taken the flight.

Does the income statement usually present sales returns and sales allowance?

No; usually the income statement only presents the Net Sales, which is already net of return and allowance.

Accounts Receivables, Net

On a company's balance sheet, accounts receivable is typically reported as "accounts receivable, net." That means accounts receivable minus the value of the allowance for doubtful or uncollectible accounts - in other words, net realizable value.

Timing Difference Fraud

Recognizing revenue early, before a service or product has been provided. Recognizing expenses late; this makes the current year's revenue appear larger. This also shrinks the following year's revenue.

Contra Account : Returns and Allowances

Returns and allowances is another type of contra account that offsets sales. Sales Account is typically a credit account. Returns and allowances is typically a debit account. By displaying the 2 amounts side-by-side, managers are able to determine what percentage of sales their customers are returning.

Sales Revenue : On which financial statement is it found?

Revenue Account; Income Statement.

Revenue

Revenue is often referred to as the "top line" because it sits at the top of the income statement. Revenue is the income a company generates before any expenses are subtracted from the calculation.

Best Buy : Merchandise Revenue

Revenue is recognized for store sales when the customer receives and pays for merchandise. In the case of items paid for in store but subsequently delivered to the customer, revenue is recognized once delivery has been completed. Online Transactions: For in-store pick up, we recognize revenue once the customer has taken possession of merchandise. For items delivered directly to the customer, we recognize revenue when delivery has been completed.

Why is revenue important on an income statement? Why is COGs so important?

Revenue is the source of net income. All companies want larger revenue. COGs takes away from net earnings. The higher the COGs, the lower the net earnings will be. Higher revenue and lower COGs means more earnings, and that is what all businesses want!

Best Buy : Services (Income Statement)

Revenue related to consultation, design, installation, set-up, repair and educational classes are recognized once the service is complete.

Sales Return and Sales Allowance reduce which part of the accounting equation?

Revenue.

Sales Can Exceed Revenue

Sales may be defined as prices paid by customers, while revenue signals the overall money a business generates during a given time period. Although revenue is nearly always the larger figure, it may occasionally be smaller than sales. Take, for example, a business that only sells hats, with no other inventory on its shelves. If the store's revenue formula deducts any discounted sales, returns or damaged merchandise, the company's gross sales could theoretically shake out to be larger than its revenue.

Understanding How Sales and Revenue Can Differ

Some companies inaccurately use the term "sales" and "revenue" interchangeably. However, while sales might be considered to be revenue, all revenue doesn't necessarily derive from sales. As a result, companies may post revenue that's higher than the sales-only figures, given supplementary income sources.

Straight Line Basis

Straight line basis is a method of calculating depreciation and amortization. Also known as straight line depreciation, it is the simplest way to work out the loss of value of an asset over time. Straight line basis is calculated by dividing the difference between an asset's cost and its expected salvage value by the number of years it is expected to be used.

Lower of Cost or Market Method

The lower of cost or market (LCM) method states that when valuing a company's inventory, it is recorded on the balance sheet at either the historical cost or the market value. With this method, investors will have more accurate and more conservative cost information of the inventory. Most companies use this method.

Net Realizable Value (NRV)

The amount a company should expect to receive once it sells or disposes of an asset, minus costs that stem from its sale or disposal. Expected sales price minus the cost to complete the sale. The selling price minus costs to sell. Gives investors confidence, as inventory reflects current value based upon the market. E.G. A store expects to sell $10,000 of computers. It will cost $480 to ship, and $40 for paperwork. Thus the NRV is $9,480.

Why have a sales return and sales allowances accounts for contra revenue accounts?

The company wants to keep track of how much was given back to customers in returns. They also want to see how much was given back in sales allowances. They must parse these two parts out in order to see how much is given back, respectively. Think about it; A product which is frequently returned probably isn't liked by many! This is good information to have. You can't know this information if you only care about net sales.

Sales Allowance Definition

The customer does not need to bring the item back. A price reduction granted for damaged goods kept by the customer. An allowance granted to a customer who had purchased merchandise with a pricing error or other problem not involving the return of goods.

What is the difference between direct write off method and allowance method?

The direct write-off method recognizes bad accounts as an expense at the point when judged to be uncollectible and is the required method for federal income tax purposes. The allowance method provides in advance for uncollectible accounts think of as setting aside money in a reserve account.