Financial Accounting Receivables and Sales PDF

Financial Accounting Sixth Edition Receivables and Sales CHAPTER 5 Spiceland Thomas Herrmann Copyright ©2022 McGraw-Hill. All rights...

Financial Accounting Sixth Edition Receivables and Sales CHAPTER 5 Spiceland Thomas Herrmann Copyright ©2022 McGraw-Hill. All rights reserved. No reproduction or distribution without the prior written consent of McGr 5-1 aw-Hill Education. PART A RECOGNIZING ACCOUNTS RECEIVABLE Copyright ©2022 McGraw-Hill. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 5-2 Learning Objective 1 LO5–1 Recognize accounts receivable at the time of credit sales. Copyright ©2022 McGraw-Hill. All rights reserved. No reproduction or distribution without the prior written consent of McGr 5-3 aw-Hill Education.  Credit Sales and Accounts Receivable Credit sales transfer goods or services to a customer today while bearing the risk of collecting payment from that customer in the future. At the time of a credit sale, a company will record:  Accounts receivable. Accounts receivable represent amounts owed to a company by its customers from the sale of goods or services on account.  Revenue. Even though no cash is received at the time of the credit sale, the seller records revenue immediately once 5-4 Copyright ©2022 McGraw-Hill. All rights reserved. No reproduction or distribution without the prior written consent of McGr aw-Hill Education. Recording a Credit Sale On March 1, a company provides services to a customer for $500. The customer doesn’t pay cash at the time of service, but instead promises to pay the $500 by March 31. The company records the following at the time of the service: March 1 Debit Credit Accounts Receivable ……………………. 500 Service Revenue …………….......... 500 (Provide services on account) Copyright ©2022 McGraw-Hill. All rights reserved. No reproduction or distribution without the prior written consent of McGr 5-5 aw-Hill Education. Recording the Subsequent Receipt On March 1, a company provides services to a customer for $500. The customer later pays the $500 by March 31. The company records the following at the time of the service: March 31 Debit Credit Cash ……………………………………………. 500 Accounts Receivable …………….. 500 (Provide services on account) Copyright ©2022 McGraw-Hill. All rights reserved. No reproduction or distribution without the prior written consent of McGr 5-6 aw-Hill Education. Key Point Companies record an asset (accounts receivable) and revenue when they sell goods or services to their customers on account, expecting collection in the future. Once the receivable is collected, the balance of accounts receivable is reduced. Copyright ©2022 McGraw-Hill. All rights reserved. No reproduction or distribution without the prior written consent of McGr 5-7 aw-Hill Education. Concept Check 5–1 Which of the following generally is recorded at the time a company provides services to customers on account? a. Accounts receivable b. Interest receivable c. Notes receivable d. Tax refund claims Accounts receivable represent cash owed to the company by its customers from sales or services on account. Nontrade receivables include tax refund claims, interest receivable, and loans by the company to other entities. Copyright ©2022 McGraw-Hill. All rights reserved. No reproduction or distribution without the prior written consent of McGr 5-8 aw-Hill Education. Learning Objective 2 LO5–2 Calculate net revenues using returns, allowances, and discounts. Copyright ©2022 McGraw-Hill. All rights reserved. No reproduction or distribution without the prior written consent of McGr 5-9 aw-Hill Education. Net Revenues Companies often offer discounts and guarantees that can reduce the amount of cash the company is entitled to receive from those customers: 1. Trade discounts 2. Sales returns 3. Sales allowances 4. Sales discounts Net revenues equals total revenues less any amounts for returns, allowances, and discounts. Copyright ©2022 McGraw-Hill. All rights reserved. No reproduction or distribution without the prior written consent of McGr 5-10 aw-Hill Education. Trade Discounts Reduction in list price of a product or service  Used to provide incentives to larger customers or consumer groups to purchase from the company Because sellers are entitled to receive only the discounted amount, sale is recorded at this lower amount. Copyright ©2022 McGraw-Hill. All rights reserved. No reproduction or distribution without the prior written consent of McGr aw-Hill Education. 5-11 Example of a Trade Discount F.Y.Eye typically provides laser eye surgery for $3,000. The company offers laser eye surgery in the month of March for only $2,400. The company records the following at the March 1 time of service: Debit Credit Accounts Receivable ……………………. 2,400 Service Revenue …………….......... 2,400 (Provide services of $3,000 on account for the trade discount price of $2,400) Copyright ©2022 McGraw-Hill. All rights reserved. No reproduction or distribution without the prior written consent of McGr aw-Hill Education. 5-12 Sales Returns and Allowances Customers sometimes return goods or are dissatisfied with products or services because of a deficiency Sales Sales Return Allowances Customer returns Customer does NOT goods previously return goods purchased (a) Seller issues a (a) Seller issues a cash refund if cash refund if original sale was original sale was for cash for cash (b) Seller reduces (b) Seller reduces balance of balance of accounts accounts receivable if receivable if original sale was Copyright ©2022 McGraw-Hill. All rights reserved. No reproduction or distribution without the prior written consent of McGr aw-Hill Education. 5-13 Sales Returns On March 2, F.Y.Eye sells sunglasses to one of its customers for $200 on account. On March 4, the customer decides she doesn’t want eyeglasses and receives full credit from F.Y.Eye. March The4company records the Debitfollowing: Credit Sales Returns………………………… 200 Accounts Receivable ……………... 200 (Customer return on account.) Copyright ©2022 McGraw-Hill. All rights reserved. No reproduction or distribution without the prior written consent of McGr 5-14 aw-Hill Education. Sales Allowances The customer having laser eye surgery on March 1 for $2,400 is not completely satisfied with the outcome of the surgery. On March 5, F.Y.Eye allows a $400 reduction in the amount owed by the customer. The company records the following: March 5 Debit Credit Sales Allowances.………………………… 400 Accounts Receivable ……………... 400 (Provide sales allowance for previous credit sale) Copyright ©2022 McGraw-Hill. All rights reserved. No reproduction or distribution without the prior written consent of McGr 5-15 aw-Hill Education. Common Mistake Students sometimes misclassify contra revenue accounts—sales returns and sales allowances—as expenses. Like expenses, contra revenues have normal debit balances and reduce the reported amount of net income. However, contra revenues represent reductions of revenues, whereas expenses represent the separate costs of generating revenues. Copyright ©2022 McGraw-Hill. All rights reserved. No reproduction or distribution without the prior written consent of McGr 5-16 aw-Hill Education. Sales Discounts Reduction in the amount to be received from a credit customer if collection on account occurs within a specified period. Discount terms, such as 2/10, n/30, are a shorthand way to communicate the amount of the discount and the time period within which it’s available.  The term “2/10,” pronounced “two ten,” for example, indicates the customer will receive a 2% discount if the amount owed is paid within 10 days.  The term “n/30,” pronounced “net thirty,” means that if the customer does not take the discount, full payment net of any returns or allowances is due within 30 days. Copyright ©2022 McGraw-Hill. All rights reserved. No reproduction or distribution without the prior written consent of McGr 5-17 aw-Hill Education.  Collection During the Discount Period F.Y.Eye typically provides laser eye surgery for $3,000. The company offers laser eye surgery in the month of March for only $2,400. F.Y.Eye provides laser eye surgery to a customer on March 1 for $2,400 on account with terms of 2/10, n/30. Cash is collected from the customer on March 10, which is within the 10-day discount period. The March 10 company Debit records the following: Credit Cash ……………………………………………. 1,960 Sales Discounts …………………………… 40 Accounts Receivable ……………... 2,000 (Collect cash on account with a 2% sales discount ) Copyright ©2022 McGraw-Hill. All rights reserved. No reproduction or distribution without the prior written consent of McGr 5-18 aw-Hill Education. Illustration 5–1 Income Statement Reporting Revenues Net of Sales Returns, Allowances, and DiscountsF.Y.EYE Income Statement (partial) $3,000 less $600 Service revenue $2,400 trade Sales revenue 200 discount Less: Sales returns (200) Less: Sales (400) allowances Less: Sales discounts (40) Net revenues $1,960 Copyright ©2022 McGraw-Hill. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill 5-19 Education.  Illustration 5–2 Balance of Accounts Receivable after Credit Sales, Sales Return, Sales Allowance, and Collection on Account after Sales Discount Credit sale $2,400 Accounts Receivable after $600 trade Mar. 1 2,400 Mar. 4 Sales return of discount 200 $200 Mar. 2 200 Credit sale of $200 Mar. 5 Sales allowance of 400 $400 Bal. 0 Cash collection of Ending balance Mar. 10 2,000 $1,960 with $40 sales discount Copyright ©2022 McGraw-Hill. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill 5-20 Education.  Collection After the Discount Period F.Y.Eye typically provides laser eye surgery for $3,000. The company offers laser eye surgery in the month of March for only $2,400. F.Y.Eye provides laser eye surgery to a customer on March 1 for $2,400 on account with terms of 2/10, n/30. Cash is collected from the customer on March 31, which is not within the 10-day discount March 10period. Debit Credit The company Cash records the following: ……………………………………………. 2,000 Accounts Receivable ……………... 2,000 (Collect cash on account) Copyright ©2022 McGraw-Hill. All rights reserved. No reproduction or distribution without the prior written consent of McGr 5-21 aw-Hill Education. Key Point Revenues are reported for the amount the company is entitled to receive. This amount equals total revenues minus trade discounts, sales returns, sales allowances, and sales discounts. Trade discounts reduce revenue directly, while sales returns, sales allowances, and sales discounts are recorded in separate contra revenue accounts and subtracted when calculating net revenues. Copyright ©2022 McGraw-Hill. All rights reserved. No reproduction or distribution without the prior written consent of McGr 5-22 aw-Hill Education. End-of-Period Adjustment For Contra Revenues The previous discussion deals with how companies record contra revenues—sales returns, sales allowances, and sales discounts—during the year. However, companies also must adjust for these amounts at the end of the year using adjusting entries. The revenue recognition standard requires a company to report revenues equal to the amount of cash the company “expects to be entitled to receive.” Copyright ©2022 McGraw-Hill. All rights reserved. No reproduction or distribution without the prior written consent of McGr aw-Hill Education. 5-23 Concept Check 5–2 The effect of a sales allowance will result in which of the following: a. An increase to net income b. A decrease to net income c. An increase to accounts receivable d. An increase to sales revenue The effect of a sales allowance is to decrease net income. A sales allowance decreases sales revenue in the income statement. A sales allowance also decreases assets by decreasing the balance of accounts receivable. Copyright ©2022 McGraw-Hill. All rights reserved. No reproduction or distribution without the prior written consent of McGr 5-24 aw-Hill Education. Concept Check 5–3 Which of the following computations would be used to compute Net Revenues? a. Total Revenue + Accounts Receivable – Sales Allowances – Sales Discounts b. Total Revenue – Sales Returns – Sales Allowances – Sales Discounts c. Total Revenue – Sales Allowances – Sales Discounts d. NetNet Income Revenues – Change is equal in Revenue to Total Accountsless Receivable Sales Returns, Sales Allowances, and Sales Discounts. Copyright ©2022 McGraw-Hill. All rights reserved. No reproduction or distribution without the prior written consent of McGr 5-25 aw-Hill Education. PART B ESTIMATING UNCOLLECTIBLE ACCOUNTS Copyright ©2022 McGraw-Hill. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 5-26 Learning Objective 3 LO5–3 Establish an allowance for uncollectible accounts. Copyright ©2022 McGraw-Hill. All rights reserved. No reproduction or distribution without the prior written consent of 5-27 McGraw-Hill Education. Key Point Customers’ accounts receivable we no longer expect to collect are referred to as uncollectible accounts, or bad debts. Copyright ©2022 McGraw-Hill. All rights reserved. No reproduction or distribution without the prior written consent of McGr 5-28 aw-Hill Education. Allowance Method (GAAP) Generally accepted accounting principles (GAAP) require that we account for uncollectible accounts using the allowance method. Companies must:  Estimate the amount of current accounts receivable that will prove to be uncollectible in the future.  Report this estimate as a contra asset to its accounts receivable. Under the allowance method, companies are required to estimate future uncollectible accounts and report those estimates in the current year. Copyright ©2022 McGraw-Hill. All rights reserved. No reproduction or distribution without the prior written consent of McGr 5-29 aw-Hill Education. Key Point Under the allowance method, accounts receivable are reported for the net amount expected to be collected. At the end of the current year, estimated future uncollectible accounts are reported in a contra asset account, reducing net accounts receivable. Copyright ©2022 McGraw-Hill. All rights reserved. No reproduction or distribution without the prior written consent of McGr 5-30 aw-Hill Education. Applying the Allowance Method 1. At the end of the initial year, establish an allowance by estimating future uncollectible accounts 2. During the subsequent year, write off actual bad debts as uncollectible  Note that actual write-offs may differ from the previous year’s estimate. 3. At the end of the subsequent year, once again estimate future uncollectible accounts. Copyright ©2022 McGraw-Hill. All rights reserved. No reproduction or distribution without the prior written consent of McGr aw-Hill Education. 5-31 Estimating Uncollectible Accounts At the end of 2024, Kimzey is owed $20 million from customers and estimates that 30% will not be collected. The company December 31, 2024 records the following: ($ in millions) Debit Credit Bad Debt Expense ……………………………………. 6 Allowance for Uncollectible Accounts... 6 (Estimate future bad debts) ($20 million × 30% = $6 million) Copyright ©2022 McGraw-Hill. All rights reserved. No reproduction or distribution without the prior written consent of McGr aw-Hill Education. 5-32 Allowance for Uncollectible Accounts Companies report their estimate of future bad debts using an allowance for uncollectible accounts.  Allowance for Uncollectible Accounts is a contra asset account that represents the amount of accounts receivable not expected to be collected. We report the allowance for uncollectible accounts in the asset section of the balance sheet, but it represents a reduction in the balance of accounts receivable.  The difference between total accounts 5-33 Copyright ©2022 McGraw-Hill. All rights reserved. No reproduction or distribution without the prior written consent of McGr aw-Hill Education. Illustration 5–4 Accounting for Uncollectible Accounts and the Accounts Receivable Portion of the Balance ($ in Sheet millions) 2024 2025 (next (current $20 $50 year) $14year) Not collected Credit sales Estimat Collectible by end of during 2024 e $6 year Uncollectible KIMZEY MEDICAL CLINIC Asse Balance Sheet (partial) Contr t December 31, 2024 a Current assets: Asset Accounts receivable $20 Less: Allowance (6) Net accounts receivable $14 Copyright ©2022 McGraw-Hill. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill 5-34 Education. Common Mistake Because Allowance for Uncollectible Accounts has a normal credit balance, students sometimes misclassify this account as a liability, which also has a normal credit balance. Instead, a contra asset represents a reduction in a related asset. Copyright ©2022 McGraw-Hill. All rights reserved. No reproduction or distribution without the prior written consent of McGr 5-35 aw-Hill Education. Illustration 5–5 Income Statement Showing Estimated Bad Debt Expense KIMZEY MEDICAL CLINIC Income Statement For the year ended 2024 ($ in millions) Revenue from credit $50 sales Expenses: $ 6 Bad debt expense 34 40 Other operating $10 expenses Net Income Copyright ©2022 McGraw-Hill. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill 5-36 Education. Key Point Establishing an allowance for uncollectible accounts correctly reports accounts receivable in the balance sheet at the amount expected to be collected. Bad debt expense is reported in the income statement. Copyright ©2022 McGraw-Hill. All rights reserved. No reproduction or distribution without the prior written consent of McGr 5-37 aw-Hill Education. Concept Check 5–4 Which of the following is true regarding Allowance for Uncollectible Accounts? a. It is a liability account. b. It is added to the total of Sales Discounts, Sales Returns, and Sales Allowances. c. It is subtracted from the balance of Accounts Receivable in the balance sheet. d. It appears in the income statement as an expense. The allowance account is a contra asset and is used to record estimated future uncollectible accounts. The balance is subtracted from Accounts Receivable in the balance sheet to arrive at Accounts Receivable’s carrying value. Copyright ©2022 McGraw-Hill. All rights reserved. No reproduction or distribution without the prior written consent of McGr aw-Hill Education. 5-38 Learning Objective 4 LO5–4 Write off accounts receivable as uncollectible. Copyright ©2022 McGraw-Hill. All rights reserved. No reproduction or distribution without the prior written consent of McGr 5-39 aw-Hill Education. Example of Writing Off Accounts Receivable On February 23, based on information about a former patient, Kimzey believes it is unlikely the patient will pay his account of $4,000. The company will adjust the allowance and reduce the accounts receivable balance itself as follows: February 23, 2025 Debit Credit Allowance for Uncollectible Accounts … 4,000 Accounts Receivable ……………………… 4,000 (Write off a customer’s account) Overall, the write-off of the account receivable has no effect on total amounts reported in the balance sheet or in the income statement. Copyright ©2022 McGraw-Hill. All rights reserved. No reproduction or distribution without the prior written consent of McGr 5-40 aw-Hill Education. Writing Off Accounts Receivable When it becomes clear a customer will not pay, the company writes off the customer’s account balance as uncollectible. The write-off:  Reduces the balance of Accounts Receivable.  Reduces the balance of the contra account Allowance for Uncollectible Accounts. The write-off has no effect on total assets (balance sheet) or total expenses (income statement). 5-41 Copyright ©2022 McGraw-Hill. All rights reserved. No reproduction or distribution without the prior written consent of McGr aw-Hill Education. Collecting on Accounts Previously Written Off Later in 2025, on September 8, Kimzey receives a payment from the customer whose account had been written off of $1,000. The company records the collection using two entries: September 8, 2025 Debit Credit Accounts Receivable ………………………………… 1,000 Allowance for Uncollectible Accounts… 1,000 (Reestablish portion of account previously written off) Cash …………………………………………………………. 5-42 1,000 Copyright ©2022 McGraw-Hill. All rights reserved. No reproduction or distribution without the prior written consent of McGr aw-Hill Education. Concept Check 5–6 When writing off an uncollectible account: a. Bad debt expense is debited. b. Net income is decreased. c. Total assets are unchanged. d. The allowance account is The credited. write-off of an account receivable has no effect on total amounts reported in the balance sheet or in the income statement. There is no decrease in total assets and no decrease in net income. Copyright ©2022 McGraw-Hill. All rights reserved. No reproduction or distribution without the prior written consent of McGr 5-43 aw-Hill Education.