Chapter 6: Reporting and Interpreting

Sales Revenue, Receivables, and Cash

Hui Fan
February 9, 2023
Agenda
1. Sales revenue
• Shipping terms
• Bundled Goods & Services
• Credit card sales
• Sales discounts
• Returns and allowances
• Reporting net sales
2. Receivables
• Classifying receivables
• Bad debts
• Reporting receivables
• Control
3. Cash
• Cash and cash management
• Internal control
• Bank reconciliation

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Accounting for Sales Revenue: Principle
Revenue Recognition Principle: Revenues are recognized when they are earned

 The revenue recognition principle requires that revenues be recorded when the following
conditions are met
1) Risks and rewards of ownership of the goods transferred to the buyer
 Legal title (physical possession)
2) Seller ≠ manages or controls goods
3) Seller’s revenue = readily measurable
 No measurement uncertainties (e.g., invoices)
4) Probable benefits of the transaction flow to seller
 Buyer is likely to pay (e.g., credit worthiness)
5) All seller’s transaction costs = readily measurable

Business entity recognizes revenue to depict the transfer of the risks and benefits of ownership
of an asset to customers at an agreed-upon transaction price

How to identify?
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Accounting for Sales Revenue: Shipping Terms
• There are straightforward ways to identify when the core principle is fulfilled, and the risks
and benefits of ownership have been transferred from the seller to the customer
• A contract, written, oral, or based on conventions and norms, will specify when the risks and
benefits of ownership are transferred
• It is customary to use the shipping terms in a sales contract to determine the point at which
title (ownership) changes hands
• When goods are shipped FOB (free on board) shipping point, title changes hands at
shipment, and the buyer normally pays for shipping. Revenues from goods sold FOB
shipping point are normally recognized at shipment
• When they are shipped FOB destination point, title changes hands on delivery, and the seller
normally pays for shipping. Revenues from goods sold FOB destination point are normally
recognized at delivery

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Shipping Terms

Revenues recognized Revenues recognized

here (at shipment) here (at delivery)

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Accounting for Sales Revenue
 Companies disclose the specific revenue recognition policies they use in the note to their
financial statements titled “Significant Accounting Policies.” The rules should be applied
consistently
 Auditors expend a lot of effort to ensure that revenue recognition rules are applied
consistently, and revenues are recognized in the proper time period

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Bundled Goods & Services
 A seller promises to provide more than one good or service in a single sales contract
 Goods (services) + goods (services)
 Goods + guarantees, warranties, return opportunities, other benefits
 Example:
 cars + 5-year warranty + 5-year scheduled maintenance
 iPad + future upgrades for certain years
 Home insurance + auto insurance
 Instax camera + film packs
 Combo meals
 International Financial Reporting Standards (IFRS) specify a five-step process to determine
the amount to be recognized as revenue

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 Bundled Goods & Services: Example
 Assume total selling price for an iPad is $800: (1) $700 relates to the hardware; (2) $100
relates to future software upgrades that would be provided over five years

Step 1: Identify the contract between the Bundled: iPad and related future upgrade
company and customer services
Step 2: Identify the performance obligations #1: Hardware with essential software
(promised goods and services) #2: Future software upgrades

Step 3: Determine the transaction price $800 total

Step 4: Allocate the transaction price to the #1: Hardware with essential software → $700
performance obligations #2: Future software upgrades → $100
#1: Hardware with essential software → $700 in
Step 5: Recognize revenue when each
year 1
performance obligation is satisfied (or over time
#2: Future software upgrades → $100/5 = $20
if a service is provided over time)
each year for 5 years

Year 1 2 3 4 5 Total
Revenue $700+20=$720 $20 $20 $20 $20 $800

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Motivating Sales and Collections
 Companies use a variety of methods to motivate its customers to buy its products and make
payment for their purchases
 allowing all customers to use credit cards to pay for purchases
 providing business customers direct credit and discounts for early payment
 allowing returns from all customers under specific circumstances
 These methods affect the way companies compute net sales revenue

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Credit Card Sales
 Companies accept credit cards (i.e., American Express, MasterCard, and VISA) for several
reasons:
 To increase sales
 To avoid providing credit directly to customers
 To avoid losses due to bad cheques (insufficient funds cheques)
 To avoid losses due to fraudulent credit card sales (the credit card company absorbs losses from
fraudulent card use if the merchant complies with the credit approval verification process)
 To receive payment quicker (since credit card receipts can be directly deposited in seller’s bank
accounts)
 When credit card sales are made, the company must pay the credit card company a fee for
the service it provides
 This fee is the credit card discount
 The fee is usually a percentage of the amounts of the credit card receipts
 It is an expense or cost to the seller
 This expense may be reported as a contra revenue account (a reduction of gross revenues in
arriving at net sales) or as a selling expense (an operating expense). In either case, net income is
reduced by the credit card discount charge

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 Credit Card Sales: Example
 If daily credit card sales were $3,000 and cash sales were $1000; and the credit card
company charges a 3% service fee, assuming the items sold cost $2,000; the following
would be reported:
Sales revenue ($3,000 + $1,000) $4,000
Less: Credit card discounts ($3,000 × 3%) 90
Net sales (reported on the statement of earnings) $3,910

Keep track of the Cash (+A) 3,910

fees charged by
credit card firm Credit card discounts (+XR or +E→ -SE) 90
for its services Sales revenue (+R→ +SE) 4,000

Cost of sales (+E → -SE) 2,000

Inventory (-A) 2,000
Assets = Liabilities + Shareholders’ Equity
Cash +3,910 Sales revenue +4,000
Inventory −2,000 Credit card discounts −90
Cost of sales −2,000
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Sales Discounts
 A company sells goods or performs
services to customers on account 
customers promise to pay at a later date
 credit sales (not credit card sales!!)
 To encourage sales and prompt early
payment from customers  sales (or
cash) discount is granted by a seller
 When credit is extended, credit terms
are printed on the invoice.
 The credit period indicates when the
invoice amount (net of sales returns and
allowances) is due (e.g., n/30)

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Sales Discounts

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Sales Discounts: Example
 The sale price of item = $1000, the items sold cost = $700, and sales on credit
 Credit terms: 2/10, n/30
a) If payment is made within the discount period,
 Payment = $1,000 × (1-0.02)= $1,000 × 0.98 = $980  discount is applied
 Net sales would be reported:

Sales revenue $1,000

Less: Sales discounts (0.02 × $1,000) 20
Net sales (reported on the statement of earnings) $ 980

b) If payment is made after the discount period,

 Payment = $1,000 = Sales revenue = Net sales  discount is not applied

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Sales Discounts: Example continued
Journal entries for initial sales transaction :

Accounts receivable (+A) 1,000

Sales revenue (+R) 1,000

Cost of sales (+E) 700

Inventory (-A) 700
Assets = Liabilities + Shareholders’ Equity
Accounts receivable +1,000 Sales revenue +1,000
Inventory − 700 Cost of sales − 700

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Sales Discounts: Example continued
Scenario 1: Journal entries for subsequent collection within the discount period, 2% discount
is applied:
Cash (+A) ($1,000 × (1-0.02)= $980) 980
Sales discount (+XR → -SE) ($1,000 × 0.02 = $20) 20
Accounts receivable (-A) 1,000
Assets = Liabilities + Shareholders’ Equity
Cash + 980 Sales discount −20
Accounts receivable −1,000

Scenario 2: If the payment is made after the discount period, $1,000 would be received in cash
and reported as net sales
Cash (+A) 1,000
Accounts receivable (-A) 1,000
Assets = Liabilities + Shareholders’ Equity
Cash + 1,000
Accounts receivable −1,000
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Sales Returns and Allowances
 Returns are often accumulated in a separate contra-revenue account (XR) called sales returns
and allowances and must be deducted from gross sales revenue in determining net sales
 It is important to maintain this account rather than to directly debit the sales revenue
account. This account provides important information for management regarding the quality
of service and customer satisfaction

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Sales Returns and Allowances: Example
 A customer bought 40 T-shirts from a company for $2,000 on account, but before paying for
the T-shirts, the customer discovered that 10 T-shirts were not the color ordered and returned
them. The items sold (40 T-shirts) cost $1,400
 Initial sales transactions are recorded as follows

Accounts receivable (+A) 2,000

Sales revenue (+R) 2,000

Cost of sales (+E) 1,400

Inventory (-A) 1,400
Assets = Liabilities + Shareholders’ Equity
Accounts receivable +2,000 Sales revenue +2,000
Inventory −1,400 Cost of sales −1,400

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Sales Returns and Allowances: Example continued
 Subsequent return of goods sold: 10 T-shirts were returned
 AR: ($2,000 / 40 )×10 = $500
 Cost of sales: ($1,400 /40 )×10 = $350

Sales returns and allowances (+XR → -SE) 500

Accounts receivable (-A) 500

Inventory (+A) 350

Cost of sales (-E) 350
Assets = Liabilities + Shareholders’ Equity
Accounts receivable −500 Sales returns and allowances −500
Inventory +350 Cost of sales +350

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Reporting Net Sales
 Companies record credit card discounts, sales discounts, and sales returns and allowances
separately to allow management to monitor these transactions

Sales revenue XX
Less: Credit card discounts (a contra revenue) XX
Sales discounts (a contra revenue) XX
Sales returns and allowances (a contra revenue) XX
Net sales (reported on the statement of earnings) XX

Example: E6-5 in excel

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Measuring and Reporting Receivables: Classifying Receivables

1. Current vs. non-current receivables (short-term or long-term)

• When is it collected?
• Whether the cash is expected to be collected within one year of the date of the statement
2. Account vs. note receivables
• Written promise?
• Accounts receivable are created when companies have sales to customers on open accounts (on
credit)
• Notes receivable are written promises from another party to pay with specified terms. A note
receivable usually contains the following information:
• Sum of money due (principal)
• Date the principal is due (maturity date)
• Interest rate and interest due dates

3. Trade vs. non-trade receivables

• Regular business activities?
• Trade receivables are amounts owed to the business for normal credit sales of goods, or services
• Non-trade receivables are amounts owed to the business for other than normal business transactions
Examples include loans to officers and employees not evidenced in a formal way
**Not mutually exclusive**

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Measuring and Reporting Receivables: Accounting for Bad Debts
 Providing sales on credit can increase sales but it also has a cost!
 Bad debts result from credit customers who will not pay the amount they owe, regardless
of collection efforts
 Most businesses record an estimate of the bad debt expense with an adjusting entry at the
end of the accounting period
 Accounting for bad debts involves three steps

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 Bad Debts: Estimate Bad Debt Expense
Step 1: Estimate and record bad debts expense (adjusting entry at the end of accounting period)

Bad debt expense (+E) 500

Allowance for doubtful accounts (+XA → -A) 500
Assets = Liabilities + Shareholders’ Equity
Allowance for doubtful accounts −500 Bad debt expense −500
 Most businesses record an estimate of the bad debt expense with an adjusting entry at the
end of the accounting period
• Bad debt expense should be recorded in the same accounting period in which the related sale is made
(matching principle)
• When preparing the entry, Bad Debt Expense is debited, and Allowance for Doubtful Accounts is
credited.
• Bad debt expense (doubtful accounts expense) is the expense associated with estimated
uncollectible accounts receivable
• Allowance for doubtful accounts (allowance for bad debts or allowance for uncollectible accounts)
is a contra asset account containing the estimated amount of uncollectible accounts receivable
• Specific accounts receivable cannot be credited for the estimated amount of uncollectible accounts
since it is not known which specific accounts will not be paid

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 Bad Debts: Writing Off Specific Uncollectible Accounts
Step 2: Write off specific accounts determined to be uncollectible during the period

Allowance for doubtful accounts (-XA → +A) 100

Accounts receivable (-A) 100
Assets = Liabilities + Shareholders’ Equity
Allowance for doubtful accounts +100
Accounts receivable -100

• When it is determined that an account will not be paid by a customer, that account should be
written off
• JE: debit Allowance for Doubtful Accounts and credit A/R for the uncollectible amount
• The specific account in the A/R subsidiary ledger should also be credited
• Only statement of financial position accounts are involved when writing off uncollectible
accounts
• Also, note that the net realizable value (A/R minus Allowance for Doubtful Accounts) is not
changed by write-offs since both accounts are reduced by the same amount

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 Bad Debts: Recovery of Accounts Previously Written Off
Step 3: When a customer makes a payment on an account previously written off: recovery
 It is important to “reinstate” the A/R in order to maintain a complete credit history for each
customer

Reverse Accounts receivable (+A) 100

first Allowance for doubtful accounts (+XA → -A) 100

Record the Cash (+A) 100

collection
of Cash Accounts receivable (-A) 100
Assets = Liabilities + Shareholders’ Equity
Accounts receivable +100
Allowance for doubtful accounts −100
Cash +100
Accounts receivable −100

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Reporting Accounts Receivable
 Accounts receivable on the Statement of Financial Position
 Report net value (AR – allowance for doubtful accounts)

Accounts receivable XX
Less: Allowance for doubtful accounts XX
Net values of AR XX

 Disclose details of the changes to the allowance for doubtful accounts in Note

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 Summary of the Accounting for Bad Debts
 Accounting for bad debts is a three-step process:

Financial
Step Timing Accounts Affected
Statement Effects

1. Record End of period in Bad Debt Expense (E) Net Earnings

estimated bad which sales are
debts adjustment made Allowance for Doubtful Accounts (XA) Assets (AR, Net)

Throughout Accounts Receivable (A) Net Earnings

2. Identify and
period as bad
write off actual
debts become
bad debts
known Allowance for Doubtful Accounts (XA) Assets (AR, Net)

3. Record Accounts Receivable (A) Net earnings

Throughout
recovery of bad
period as bad
debts that were Allowance for doubtful accounts (XA) Assets (A/R, Net)
debts are
written off
recovered
previously Cash (A) Cash

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Estimating Bad Debts (Step 1)
1. A percentage of total credit sales for the period (easy)
 % of credit sales (sales on credit)
• The % is estimated by the company based on historical % of credit sales hat result in bad debts
 Directly compute bad debt expense:
• % ×credit sales = bad debt expense
 Example: Credit sales $ 270,000
× Bad debt rate (0.5%) 0.005
Bad debt expense $ 1,350

Bad debt expense (+E) 1,350

Allowance for doubtful accounts (+XA → -A) 1,350

Another Example: E6-12 in excel

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Estimating Bad Debts (Step 1)
2. An aging of accounts receivable (more accurate)
 Estimate uncollectible accounts based on the age of each account receivable
• Older receivables = less likely to collect (higher %)
• Newer receivables = more likely to collect (lower %)
 Compute estimated ending balance of the allowance for doubtful accounts (XA)
 Bad debt expense = Ending bal.- [Beginning bal. - Write-offs (throughout the year) ]

Allowance for doubtful accounts

(XA)
Beg. Bal Bad debt expense (+E) xx
Write-off
Plug in
Allowance for doubtful accounts (+XA → -A) xx
End. Bal (Estimated
in aging method)

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Estimating Bad Debts (Step 1)
2. An aging of accounts receivable (more accurate): Example

AR

Another Example: E6-14 in excel Ending balance of allowance

for doubtful accounts (XA)

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Internal Control and Management Responsibility
 Internal Control
 The process by which a company’s board of directors, audit committee, management, and other
personnel provide reasonable assurance that the accounting system minimizes the risk of both types
of fraud, either misappropriation of assets or material misstatement of reported financial information
 Internal controls are policies and procedures designed to safeguard all assets of the business
(including cash) and to ensure the accuracy of financial records
 Controls over assets are designed to protect them from unauthorized use
 Controls over the accounting records are designed to prevent errors and fraud
 The internal control system must assure both the effectiveness and efficiency of the company’s
operations, and its compliance with all laws and regulations
 Management has the responsibility to maintain and enhance internal controls
 The company's independent auditor should review these policies and procedures
 The Canadian Securities Administrators have established regulations for internal control systems,
which require the certification of the quality of the internal control and financial reporting system by
the CEO and CFO

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Internal Control and Management Responsibility
 Control over Accounts Receivable – To minimize bad debts:
 Require approval of customers’ credit history by a person independent of the sales and collection
functions
 Monitor the age of accounts receivable periodically, and contact customers with overdue payments
 Reward both sales and collection personnel for speedy collections so that they work as a team

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Cash and Cash Equivalents
 Cash: cash on hand, a cheque, money order, or bank draft
 Cash equivalents: cybercurrency, bank certificates of deposit, and treasury bills issued by the
government
 Short-term
 Highly liquid
 Insignificant risk of changes in value
 Frequently cash and cash equivalents are combined into one line item on the statement of
financial position

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Cash Management
 Cash can be used by anyone
 Therefore, management has the responsibility to protect it for its intended business purposes
 Such responsibilities include:
• Protect cash from theft, fraud, loss through carelessness
• Accurate accounting so that reports of cash flows and balances may be prepared
• Enough adequate cash balances to meet current needs (e.g., pay maturing liabilities and
unexpected emergencies)
• Avoid excess amounts of idle cash (produce no revenue)

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Internal Control of Cash
Effective internal control of cash includes:
1. Implement separation of duties
 Separate jobs of receiving and disbursing cash
 Separate procedures of accounting for cash receipts and cash disbursements
 Separate handling of cash and accounting for cash
2. Prescribed policies and procedures
 Establish a cash budget and diligently follow up all variances
 Deposit cash receipts daily and keep any cash on hand under strict control
 Separate the approval for purchases and approval for payments
 Use pre-numbered documents (e.g., checks)
 Reconcile the bank accounts at least monthly. This task should be done by independent people
other than cheque signers or those responsible for recordkeeping
 Duties should be rotated among the staff

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Bank Reconciliation
 Compare and verify the accuracy of the ending cash balance on company’s book and on
bank statements
 Why not equal?
 Bank service charges (on bank statements but not on company’s book)
 Interest revenue (on bank statements but not on company’s book)
 Deposits in transit (on company’s book but not on bank statements)
 Outstanding cheques (on company’s book but not on bank statements)
 NSF (Non-Sufficient Funds) cheques
 Errors
 A bank reconciliation should be completed for each separate chequing account at the end of
each month
 Before reconciliation:
 Ending balance on bank statement ≠ Ending balance of cash account on company’s book
 After reconciliation:
 Reconciled (corrected) Ending balance on bank statement = Reconciled (corrected) Ending balance
of cash account on company’s book
 The additions and deductions to the company's cash account related to the bank reconciliation
require journal entries to update the cash account for proper statement of financial position
presentation
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 Bank Reconciliation
The general format for the bank reconciliation is:

Ending cash balance per books $xxx Ending cash balance per bank statement $xxx
+ Collections by bank (e.g.,
xx + Deposits in transit xx
interest earned)
− NSF cheques/Service charges xx − Outstanding cheques xx

± Company errors xx ± Bank errors xx

Ending correct cash balance $xxx Ending correct cash balance $xxx

Example: E6-27 in excel

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Ratio Analysis
 Gross profit percentage
• How much gross profit is generated from every sales dollar
• Reflect the ability to charge premium prices and produce goods and services at low cost. All other
things being equal, a higher gross profit results in higher net earnings.

 Receivables turnover
• How effective are credit granting and collection activities?
• Reflect how many times average accounts receivable are recorded and collected during the period
• The higher the ratio, the faster the collection of receivables.

 Average collections period

• How many days would be needed, on average, to turn the receivables over once?

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