Accounting Chapter 5
Sales Return
Accepted of return merchandise.
Prinicpal
Amount Lent.
Noncurrent Receivables
If the due date is over a year.
Expense Recognition Principle
Match expenses with revenues in the period when the company makes efforts to generate those revenues.
Accounting for Notes Receivable (Concept)
Notes receivable are recognized for the amount of cash loaned or goods/services sold. This is the principal amount of the note receivable. Any excess of the amount received over principal is recognized as interest income in the period the interest was earned.
Receivable
money due from another business or individual.
Required 1: Estimate the Bad Debt Expense for the period.
$620,000 x 0.0143 = $8,866
EX: Assume at the end of the first year of operations Hawthorne has an accounts receivable balance of $1,000,000. Although no customers have defaulted, Hawthorne estimates that $25,000 of that balance is uncollectible. At the end of the first year, Hawthorne would make the following adjusting entry:
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EX: For example, at year end GCD Advisors has an Accounts Receivable balance of $1,000,000. Based on past experience, GCD Advisors estimates that allowances will be made for 0.2% of this balance. In this case, GCD would need to make the following journal entry at the end of the year.
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Required. (1) (2) (3)
1. Prepare the journal entry to record the sale using the net method. 2. Prepare the journal entry assuming the payment is received on May 15, 2019 (within the discount period). 3. Prepare the journal entry assuming the payment is received on May 25, 2019 (after the discount period).
Advantages supplying the credit card :
1. Sellers receive the money immediately. 2. Sellers avoid bad debts because as long as the credit card verification procedures are followed, the credit card company absorbs the cost of customers who do not pay. 3. Recordkeeping costs decrease because employees are not needed to manage these accounts. 4. Sellers believe that by accepting credit cards their sales will increase.
Look how to solve in BOOK.
5-8B.
Sales Allowance
A customer will agree to keep goods that have minor defects, arrived late, or in some other way are rendered less valuable in return for a price reduction.
Sales Return
A customer will return goods as unsatisfactory.
Notes Receivable
A legal document given by the borrower to a lender stating the timing of repayment and the amount (principal and / or interest) to be repaid.
Trade Discount
A reduction in the selling price granted by the seller to a particular class of customers, for example, to customers who purchase goods for resale rather than for use.
Sales Discount (Buyers)
A reduction to the cost of goods and services.
Internal Control for Sales (3)
A sale and its associated receivable are recorded only when the order, shipping, and billing documents are all present.
Credit Card
A special form of factoring. The issuer of the credit card (i.e., the bank) pays the seller the amount of each sale minus a service charge (on the date of purchase) and then collects the full amount of the sale from the buyer (at some later date).
Written Off Debt
A specific amount is ultimately determined to be uncollectible under the allowance method , it is written off to the allowance account and a credit to accounts receivable. It removes the defaulted balance from the accounts receivable balance and also removes it from the estimate storage account.
Internal Control for Sales (1)
Accounting for a sale begins with the receipt of a purchase order or some similar document from a customer. The order document is necessary for the buyer to be obligated to accept and pay for the ordered goods.
Information : On January 1, 2019, Sullivan Inc. has the following balances for accounts receivable and allowance for doubtful accounts:
Accounts Receivable - $224,400 (debit). Allowance for doubtful accounts - $6,700 (credit). During 2019, Sullivan had $3,100,000 of credit sales, collected $3,015,000 of accounts receivable, and wrote off $60,000 of accounts receivable as uncollectible.
Current Receivable
Accounts receivable due in 30 to 60 days and do not have interests while notes receivable have interest and are typically due within from 3 to 12 months.
Nonbank Credit Cards
Also result in a receivable for the seller because the issuer of the credit card (American Express) does not immediately pay the cash to the seller. American Express also charges a higher service charge to the seller.
For example, if a retail customer uses a Citibank Visa Card to pay $100 for a haircut, the salon would make the following entry assuming Citibank charges a 1.55% service charge:
Although a 1.55% service charge may seem expensive, credit card sales provide sellers with a number of advantages over supplying credit directly to customers, including the following:
Accounts Receivable
Amounts to be received in the future due to the sale of goods or services, do not have a formal note.
Estimating the Allowance for Doubtful Accounts Using the Aging Method. (Concept)
An aging of the accounts receivable balance estimates the ending balance for the "allowance for doubtful accounts." The proper balance in the allowance for doubtful accounts values accounts receivable at net realizable value on the balance sheet.
Profitably Ratios
Analysts are interested in a large number of ratios that incorporate sales. Many of these ratios attempt to measure the return the company is earning on sales.
Debit Card
Authorizes a bank to make an immediate electronic withdrawal (debit) from the holder's bank account. The debit card is used like a credit card except that a bank electronically reduces (debits) the holder's bank account and increases (credits) the merchant's bank account for the amount of a sale made on a debit card.
Allowance Procedure
Bad debt expense have two methods here such as percentage of credit sales method and the aging method.
Allowance Method
Bad debt expense is recognized in the period of the sale, which allows it to be properly matched with revenues.
(Gross or net)
Companies should record the revenue and associated receivable at the amount they expect to receive from the customer.
Information.
Crimson Company has credit sales of $620,000 during 2019 and estimates at the end of 2019 that 1.43% of these credit sales will eventually default. Also, during 2019, a customer defaults on a $524 balance related to goods purchased in 2018. Prior to the write-off and the adjusting entry, Crimson's accounts receivable and allowance for doubtful accounts balances were $304,000 and $134 (credit), respectively.
EX: Occasionally, accounts receivable that are written off are later partially or entirely collected. Suppose on February 5, 2019, Crimson receives $25 of the $524 that was written off at the end of the previous year.
Crimson's first entry reverses the appropriate portion of the write-off by restoring the accounts receivable and allowance for doubtful accounts balances. The second entry records the cash collection in the typical manner.
Debit Card Info.
Debit cards appear to be somewhat disadvantageous to the card holder as transactions cannot be rescinded by stopping payment. Further, a purchase using a debit card causes an immediate reduction in a bank account balance, while a check written at the same time will require at least 1 or 2 days to clear, allowing the depositor to benefit from the additional money in the account until the check is presented at the bank for payment. However, debit cards offer significant advantages to banks and merchants in reduced transaction-processing costs. Thus, banks and merchants have incentive to design debit cards that minimize or eliminate the disadvantages and costs to card users.
Information:
Dover Electric Company purchased, on account, $50,000 of consulting services from Thomas Ltd. on November 1, 2019. The amount is due in full on January 1, 2020. Dover Electric is unable to pay the account by the due date and negotiates an extension with a 10% note in lieu of the unpaid account receivable.
Gross Amount
For customers expected to fail to pay in the discount period, sales revenue should be recorded at this.
Net Amount
For customers expected to take the discount, sales revenue should be recorded at this.
Sales Discounts
For example, customers who stop taking sales discounts may be experiencing cash flow problems and therefore are potential credit risks. On the other hand, failure of a large number of customers to take discounts may indicate that an increase in the discount percentage is needed.
Internal Control for Sales
For sales returns and allowances, internal control procedures must be established that identify the conditions and documentation required before a sales return or a sales allowance can be recorded. These controls protect the firm from unwarranted reductions in revenues and receivables.
EX: This entry looks very similar to the entry that would be made under the direct write-off method. The major difference is the timing of the entry. The direct write-off method would make the entry in the period the customer defaults, while the allowance method makes the entry in the period of sale. Hawthorne's balance sheet would report accounts receivable as follows:
However, it is important to recognize that under the direct write-off method, Hawthorne's balance sheet would report the full $1,000,000 as accounts receivable at the end of the first year.
2/10 or ?/10.
If payment is made within the 10-day discount period, the amount owed is 2% less the gross (pre-discount) amount of the invoice. It is referred to as net price (net of the 2% discount). If payment is made within the 20 days following the end of the discount period, then the amount owed is equal to the gross (pre-discount) amount of the invoice.
EX: Then as allowances are made to specific customers in the following year, both the customers' receivable and the return and allowance are reduced. For instance, if Metzler Enterprises is granted an allowance of $1,500 on January 18th, the following entry is made:
If the bill has already been paid, the seller can either refund a portion of the purchase price and record a credit to cash or apply the allowance against future purchases by the customer.
n/30.
Indicates the gross amount of the invoice (the full pre-discount amount) must be paid in 30 days.
Interest Formula
Interest = Principal x Annual Interest Rate x Fraction of 1 year.
Required (2) How much interest will be paid if Dover Electric repays the note on (a) July 1, 2020, (b) December 31, 2020, or (c) March 31, 2021?
Interest = Principal x Annual Interest Rate x Fraction of 1 year.
Percentage of Credit Sales Method Formula
It is multiplied by the total credit sales for the period to calculate the estimated bad debt expense for the period. Total Credit Sales X Percentage of Credit Sales Estimated to Default = Estimated Bad Debt Expense.
Secularization
Large businesses and financial institutions frequently package factored receivables as financial instruments or securities and sell them to investors.
Net Profit Margin
Net income/Net Sales
Information.
On May 5, 2019, GCD Advisors billed Richardson's Wholesale Hardware $15,000 for consulting services provided during April. GCD offered terms of 2/10, n/30.
Factoring Arrangements
Range from 1-3%. This fee compensates the factor for the time value of money (i.e., interest), the risk of uncollectability, and the tasks of billing and collection.
Cash Basis Accounting
Recognizes revenue in the period the cash is received (as on your tax returns).
Accrual-basis Accounting
Recognizes revenue when the company's performance obligation is satisfied.
Sales Return and Allowance
Recorded in the period of sale to correctly report sales revenue at the amount a company expects to collect. The problem is that for sales made near the end of the year, the return or allowance may not occur until the following period. Therefore, companies must estimate the amount of returns and allowances so that sales revenue can be reduced to their proper amounts.
Sales Revenue
Reduced to reflect sales returns and allowances. It might seem logical to reduce sales revenues in the same way when customers default on account receivables arising from credit sales, this treatment is inappropriate. Reductions in sales revenue should be recorded only for transactions that result from the actions of the seller.
GAAP
Requires accounts receivable to be shown at their "net realizable value," which is the amount of cash the company expects to collect. Unfortunately, the amount of cash collected will almost never equal the total amount recognized in accounts receivable because some customers will not pay (for example, a customer declares bankruptcy and ceases operations).
Bad Debts
Result from actions of the purchaser (nonpayment), the amount of bad debt expense is influenced by the credit policies of the seller.
Recording Receivables Using the Net Method (Concept) .
Sales discounts offered to encourage prompt payment are generally recorded at the net (discount) amount of the invoice because most customers are expected to pay within the discount period. If the discount is not taken, the additional amount paid (the difference between gross and net) is recognized as additional sales revenue.
Net Price
Sales discounts typically offer terms that make it attractive to pay the net amount during the discount period, conceptually a company should report sales revenue at a net price for most of its customers.
Internal Control for Sales (2)
Shipping and billing documents are prepared based on the order document. Billing documents are usually called invoices.
Bad Debts
Should not be recorded as revenue reductions. If bad debts are not treated as negative revenues, then they must be treated as expense, and if they are expenses, the question arises as to when the expense should be recorded.
Comparison of Percentage of Credit Sales Method and Aging Method (Aging)
The aging method, on the other hand, is a balance sheet approach that analyzes the accounts receivable to estimate its net realizable value. This estimate provides the necessary ending allowance for doubtful accounts balance to report net accounts receivable at net realizable value.
Amount of Revenue Recognized
The appropriate amount of revenue to recognize is generally the cash received or the cash equivalent of the receivable. However, companies often induce customers to buy by modifying the terms of the sale. In this section, we discuss three changes to sales revenues: discounts, returns, and allowances.
3. Prepare the adjusting entry to record the bad debt expense for 2019.
The calculation in Solution 1 estimated the ending balance of bad debt expense. This amount is also the adjustment because the balance before the adjustment is zero. This is usually the case for income statement accounts because they were closed at the end of the prior year.
Sales Discount (Sellers)
The cash is more available and collection costs are reduced. For example, when cash is not available quickly, the seller may need to borrow money in order to pay its suppliers, employees.
Interest
The excess or total amount of money collected over the amount lent.
Calculating the Gross Profit Margin, Operating Margin, Net Profit Margin, and Accounts Receivable Turnover Ratios (Why)
The gross profit margin, operating margin, and net profit margin ratios provide measures of the return the company is earning on sales. The accounts receivable turnover ratio provides a measure of how many times average accounts receivable are collected during the period.
Sale Invoices EX:
The invoice of a seller who expects payments in 30 days and offers a 2% discount if payment is made within 10 days would bear the notation of 2/10, n/30.
Estimating Bad Debt Expense Using the Percentage of Credit Sales Method (Concept)
The percentage of credit sales method estimates the ending balance in bad debt expense based on past experience. This amount is recognized in the period of sale in accordance with the expense recognition principle.
Comparison of Percentage of Credit Sales Method and Aging Method (Percentage)
The percentage of credit sales method is primarily concerned with appropriately estimating bad debt expense on the income statement. Because of the focus on the expense account, any existing balance in the allowance account is ignored when determining the amount of the adjusting entry.
Allowance or Doubtful Accounts
The result is that bad debt expense is recognized before the actual default. Because defaults for the current period's sales have not yet occurred, the specific accounts receivable are not lowered; instead, an account is established to "store" the estimate until specific accounts are identified as uncollectible.
Accounting Purposes
The selling or invoice price is usually assumed to be the price after adjustment for the trade or quantity discounts ; accordingly, trade and quantity discounts are not recorded separately in the accounting periods.
Percentage of Credit Sales
The simple method. Using past experience and management's views of how the future may differ from the past (for example, if credit policies change), it is possible to estimate the percentage of the current period's credit sales that will eventually become uncollectible.
EX: At the end of each accounting period, the individual accounts receivable are categorized by age. Then an estimate is made of the amount expected to default in each age category based on past experience and expectations about how the future may differ from the past. As you may expect, the overdue accounts are more likely to default than the currently due accounts, as.
The total amount expected to default on year end accounts receivable, $7,200 in the above example, is the amount that should be the ending balance in the allowance for doubtful accounts.
Comparison of Percentage of Credit Sales Method and Aging Method
The underlying difference is what is being estimated.
Sales Invoices
They use a standard notation to state discount and credit terms.
Bad Debt Expense
Two methods which is the direct-write off method and the allowance method.
4. What is the net accounts receivable balance at the end of the year? How would this balance have changed if Crimson had not written off the $524 balance during 2019?
Under the allowance method, the write-off of a specific account does not affect net accounts receivable.
Direct-Off Method
Waits until an account is deemed uncollectible before reducing accounts receivable and recording the bad debt expense. Since accounts are often determined to be uncollectible in accounting periods subsequent to the sale period. It is inconsistent with the expense recognition principle and can only be used if bad debts are immaterial under GAAP.
Bad Debts
When customers do not pay their accounts receivable, debts are made. Although efforts are made to control bad debts, it is an expense of providing credit to customers.
Factor
When receivables are factored, the seller receives an immediate cash payment reduced by the factor's fees. The factor, the buyer of the receivables, acquires the right to collect the receivables and the risk of uncollectibility. In a typical factoring arrangement, the sellers of the receivables have no continuing responsibility for their collection.
Internal Credit Cards
When these cards are used, the seller records it like any other accounts receivable and no service charge expense is incurred; however, they are accepting the risk of uncollectible accounts and the cost of servicing these accounts.
Quantity Discount
a reduction in the selling price granted by the seller because selling costs per unit are less when larger quantities are ordered.
Sales Discount
a reduction of the normal selling price and is attractive to both the seller and the buyer.
Nontrade receivables.
arise from transactions not involving inventory (such as interest receivable or cash advances to employees).
Aging Method
bad debt expense is estimated by determining the collectability of the accounts receivable rather than by taking a percentage of total credit sales.
Trade Receivables
due from customers purchasing inventory in the ordinary course of business.
Gross Profit Margin
gross profit/net sales
APPENDIX 5A.
look in book.
Accounts Receivable Turnover
net sales / average accounts receivable, net.
Operating Margin
operating income/net sales
Sales Allowance
price reductions offered to customers who accept slightly damaged or soiled merchandise.
Notes Receivable
receivables that generally specify an interest rate and a maturity date at which any interest and principal must be repaid.
