ACCT-UB 001 Ch. 6 textbook (Sketchers)

The difference between the two methods ^

- Percentage of credit sales: Directly compute the amount to be recorded as Bad Debt Expense on the income statement for the period in the adjusting journal entry. - Aging of Accounts Receivable: Compute the estimated ending balance we would like to have in the Allowance for Doubtful Accounts on the balance sheet after we make the necessary adjusting entry. The difference between the current balance in the account and the estimated balance is recorded as the adjusting entry for Bad Debt Expense for the period.

Effective cash management responsibilities:

1. Accurate accounting so that reports of cash flows and balances may be prepared. 2. Controls to ensure that enough cash is available to meet (a) current operating needs, (b) maturing liabilities, and (c) unexpected emergencies. 3. Prevention of the accumulation of excess amounts of idle cash. Idle cash earns no revenue. Therefore, it often is invested in securities to earn a return until it is needed for operations.

Steps to record a bank reconciliation:

1. Identify the outstanding checks. A comparison of the checks and electronic payments listed on the bank statement with the company's record of all checks drawn and electronic payments made showed the following checks were still outstanding (had not cleared the bank) at the end of the month/ period. 2. Identify the deposits in transit. A comparison of the deposit slips on hand with those listed on the bank statement revealed that a deposit of $1,800 made on June 30 was not listed on the bank statement. This amount was entered on the reconciliation as an addition to the bank account. It will be added by the bank when it records the deposit. 3. Record bank charges and credits: - Interest received from the bank, $20-entered on the bank reconciliation as an addition to the book balance; it already has been included in the bank balance. - NSF check of R. Smith, $18-entered on the bank reconciliation as a deduction from the book balance; it has been deducted from the bank balance. - Bank service charges, $6-entered on the bank reconciliation as a deduction from the book balance; it has been deducted from the bank balance. 4. Determine the impact of errors. At this point, ROW.COM found that the reconciliation did not balance by $9. Upon checking the journal entries made during the month, the electronic payment on June 9 for $100 to pay an account payable was found. The payment was recorded in the company's accounts as $109. Therefore, $9 (i.e., $109 - $100) must be added to the book cash balance on the reconciliation; the bank cleared the electronic payment for the correct amount, $100.

A bank reconciliation accomplished two major objectives

1. It checks the accuracy of the bank balance and the company cash records, which involves developing the correct cash balance. The correct cash balance (plus cash on hand, if any) is the amount of cash that is reported on the balance sheet. 2. It identifies any previously unrecorded transactions or changes that are necessary to cause the company's Cash accounts) to show the correct cash balance. Any transactions or changes on the company's books side of the bank reconciliation need journal entries.Therefore, the following journal entries based on the company's books side of the bank reconciliation must be entered into the company's records:

Most common causes of differences between the ending bank balance and the ending book balance of cash are

1. Outstanding checks. These are checks written by the company and recorded in the company's ledger as credits to the Cash account that have not cleared the bank (they are not shown on the bank statement as a deduction from the bank balance). The outstanding checks are identified by comparing the list of canceled checks on the bank statement with the record of checks (such as check stubs or a journal) maintained by the company. 2. Deposits in transit. These are deposits sent to the bank by the company and recorded in the company's ledger as debits to the Cash account. The bank has not recorded these deposits (they are not shown on the bank statement as an increase in the bank balance).Deposits in transit usually happen when deposits are made one or two days before the close of the period covered by the bank statement. Deposits in transit are determined by comparing the deposits listed on the bank statement with the company deposit records. 3. Bank service charges. These are expenses for bank services listed on the bank statement but not recorded on the company's books. 4. NSF checks. These are "bad checks" or "bounced checks" that have been deposited but must be deducted from the company's cash account and rerecorded as accounts receivable. 5. Interest. This is the interest paid by the bank to the company on its bank balance. 6. Errors. Both the bank and the company may make errors, especially when the volume of cash transactions is large.

Benefits of sale discount

1. Prompt receipt of cash from customers reduces the necessity to borrow money to meet operating needs. 2. Because customers tend to pay bills providing discounts first, a sales discount also decreases the chances that a customer will run out of funds before the company's bill is paid.

Control over accounts receivable- what can help minimize bad debts?

1. Require approval of customers' credit history by a person independent of the sales and collections functions. 2. Age accounts receivable periodically and contact customers with overdue payments. 3. Reward both sales and collections personnel for speedy collections so that they work as a team. To assess the effectiveness of overall credit-granting and collection activities, managers and analysts often compute the receivables turnover ratio.

Effective internal control of cash includes

1. Separation of duties. - Complete separation of the jobs of receiving cash and disbursing cash. - Complete separation of the procedures of accounting for cash receipts and cash disbursements. - Complete separation of the physical handling of cash and all phases of the accounting function. 2. Prescribed policies and procedures. - Require that all cash receipts be deposited in a bank daily. Keep any cash on hand under strict control. - Require separate approval of the purchases and the actual cash payments. Prenumbered checks should be used. Special care must be taken with payments by electronic funds transfers because they involve no controlled documents (checks). - Assign the responsibilities for cash payment approval and check-signing or electronic funds transfer transmittal to different individuals. - Require monthly reconciliation of bank accounts with the cash accounts on the company's books (discussed in detail in the next section).

Bank statement

A monthly report from a bank that shows deposits recorded, checks cleared, other debits and credits, and a running bank balance. This same information is available on a daily basis from the bank's online banking site. (INT- Interest Earned NSF- Not Sufficient Funds SC- Service Charge EFT- Electronic Funds Transfer)

Sales Returns and Allowances

A reduction of sales revenues for return of or allowances for unsatisfactory goods. Deducted from gross sales revenue in determining net sales.

Average collection period (average days sales in receivables)

ACP # of days = 365 / Receivables Turnover Ratio

Bad Debt Recoveries

Adjustment to the original write off, reversed to put the receivable back on the books and then the collection of cash is recorded. e.g. When a company receives a payment on an account that already has been written off, the journal entry to write off the account is reversed to put the receivable back on the books and then the collection of cash is recorded. For example, if the previously written-off amount was $677, it would make the following entries:

Nontrade receivable

Arises from transactions other than the normal sale of merchandise or services. e.g. if Sketchers loaned money to a new vice president to help finance a home at the new job location, the loan would be classified as a non trade receivable

When does the customer save by taking the cash discount?

As long as the bank's interest rate is less than the interest rate associated with failing to take cash discounts, the customer will save by taking the cash discount. For example, even if credit customers had to borrow from the bank at a rate as high as 15 percent, they would save a great deal.

Allowance method

Bases bad debt expense on an estimate of uncollectible accounts, since received debt payments cannot be done until the next accounting period, and after the current one. Two steps 1. Making the end-of-period adjusting entry to record estimated bad debt expense 2. Writing off specific amounts determined to be uncollectible during the period

Percentage of credit sales method

Bases bad debt expense on the historical percentage of credit sales that result in bad debts. The average percentage of credit sales that result in bad debts: credit sales x bad debts loss rate = bad debt expense e.g. if we assume that, during the year 2020, Skechers expected bad debt losses of 1.0 percent of credit sales, and its credit sales were $1,970,000 (all numbers in thousands), it would estimate the current year's bad debts as

Sales (or Cash) Discount

Cash discount offered to encourage prompt payment of an account receivable. e.g. Sketches could offer terms of 2/10, n/30, which means that the customer may deduct 2 percent from the invoice price if cash payment is made within 10 days from the date of sale. If cash payment is not made within the 10-day discount period, the full sales price (less any returns) is due within a maximum of 30 days.

Accounts receivable (trade receivable, receivable)

Created by a credit sale on an open account, owed to the business by trade customers.

Trade receivable

Created in the normal course of business when a sale of merchandize or services on credit occurs.

Aging of accounts receivable method

Estimates uncollectible accounts based on the age of each account receivable. 3 steps: (1) the estimated ending balance in the allowance is calculated (2) which is compared to the current balance (3) to compute the bad debt expense adjustment for the period. e.g. a receivable that was due in 30 days but has not been paid after 120 days is less likely to be collected, on average, than a similar receivable that remains unpaid after 45 days.

Bad debt expense (doubtful accounts expense, uncollectible accounts expense, provision for uncollectible accounts)

Expense associated with estimated uncollectible accounts receivable. An adjusting journal entry

Credit Card Discount

Fee charged by the credit card company for its services when an entity records revenues.

Subsidiary account

For billing and collections purposes, an entity keeps a separate accounts receivable account for each business customer (retailer). The accounts receivable amount on the balance sheet represents the total of these individual customer accounts.

Cash is defined as

Money or any instrument that banks will accept for deposit and immediate credit to a company's account, such as a check, money order, or bank draft.

Bank reconciliation

Process of verifying the accuracy of both the bank statement and the cash accounts of a business. A bank reconciliation should be completed at the end of each month. Usually, the ending cash balance as shown on the bank statement does not agree with the ending cash balance shown by the related Cash ledger account on the books of the company. e.g. the Cash ledger account of ROW.COM showed the following at the end of June (ROW.COM has only one checking account):

Receivables Turnover ratio

RT = Net Sales / Average Net Trade Accounts Receivable

Cash equivalents

Short-term investments with original maturities of three months or less that are readily convertible to cash and whose value is unlikely to change.

*Focus on cash flows

The change in accounts receivable can be a major determinant of a company's cash flow from operations. While the income statement reflects the revenues of the period, the cash flow from operating activities reflects cash collections from customers. Because sales on account increase the balance in accounts receivable and cash collections from customers decrease the balance in accounts receivable, the change in accounts receivable from the beginning to the end of the period is the difference between sales and collections. Effect on Statement of Cash Flows: In General When there is a net decrease in accounts receivable for the period, cash collected from customers is more than revenue; thus, the decrease must be added in computing cash flows from operations. When a net increase in accounts receivable occurs, cash collected from customers is less than revenue; thus, the increase must be subtracted in computing cash flows from operations.*

Revenue recognition principle

The principle that companies recognize revenue in the accounting period in which the performance obligation is satisfied, transfer of goods and services to customers (FOB)

MEASURING AND REPORTING RECEIVABLES

Three ways to classify receivables.

Writing off specific uncollectible accounts

Throughout the year, when it is determined that a customer will not pay its debts (e.g., due to bankruptcy), the write-off of that individual bad debt is recorded through a journal entry. Now that the specific uncollectible customer account receivable has been identified, it can be removed with a credit. At the same time, we no longer need the related estimate in the contra-asset Allowance for Doubtful Accounts, which is removed by a debit. The journal entry summarizing Skechers' total write-offs of $7,912 during 2019 follows: Notice that this journal entry did not affect any income statement accounts. It did not record a bad debt expense because the estimated expense was recorded with an adjusting entry in the period of sale. Also, the entry did not change the net book value of accounts receivable because the decrease in the asset account (Accounts Receivable) was offset by the decrease in the contra-asset account (Allowance for Doubtful Accounts). Thus, it also did not affect total assets.

Interest rate for discount period

To calculate the annual interest rate, first compute the interest rate for the discount period. When the 2 percent discount is taken, the customer pays only 98 percent of the gross sales price. For example, on a $100 sale with terms 2/10, n/30, $2 would be saved and $98 would be paid 20 days early. The interest rate for the 20-day discount period and the annual interest rate are computed as follows:

When do we record sales discounts?

We subtract the discounts from sales if it is made within the accounting period. e.g. If credit sales of 1000 are recorded with terms 2/10, n/30 and payment of $980 (1000x0.98=980) is made within the discount period, net sales of the following amount would be reported. If net payment is made after the discount period, the full 1000 would be reported as net sales.

FOB Free on Board Shipping Point

Where goods are shipped and ownership is transferred, seller normally pays for shipping. When the buyer recieves their goods

Credit Card sales to Customers

Why? For a variety of reasons: 1. Increasing customer traffic 2. Avoiding the costs of providing credit directly to customers, including record keeping and bad debts (discussed later). 3. Lowering losses due to bad checks. 4. Avoiding losses due to bad checks. 5. Receiving money faster. (Because credit card receipts can be deposited directly in its bank account, Sketchers receives its money faster than it would if it provided credit directly to consumers.)

Note receivable

Written promises that require another party to pay the business under specified conditions (amount, time, interest). to (1) Pay a specified amount of money, called the principal, at a definite future date known as the maturity date and (2) A specific amount of interest at one or more future dates, The interest is the amount charged for the use of principal.

Allowance for Doubtful Accounts

contra-asset account containing the estimated uncollectible accounts receivable. As a contra-asset, the balance in Allowance for Doubtful Accounts is always subtracted from the balance of the asset Accounts Receivable. Thus, the entry decreases the net book value of Accounts Receivable and total assets.

Early Payment Incentive

e.g. if the full price is due within 30 days of the invoice date, the credit terms would be noted as n/30. Here, the n means the sales amount net of, or less, any sales returns

*tip

individual bad debts are written off throughout the period when it is determined that a customer won't pay its debts.