Selling Goods and Services May 2010©Kimberly Lyons 1

CHAPTER 6Selling Goods and Services

May 2010©Kimberly Lyons

1

REVENUE RECOGNITION PRINCIPLE

Revenue should be recognized (recorded) when earned, and realized or realizable (collectible)

Revenue is earned when an exchange has taken place, and the company has provided goods or services that entitle them to collect


2

CASH COLLECTION OF RECEIVABLES

Usually, a company will collect its receivables and convert them to cash

Issues that result in reduced cash collections include: Sales Discounts Sales Returns and Allowances Uncollectible Accounts (bad debts)


3

SALES DISCOUNTS

Discounts are offered to customers to encourage timely payment

Example: Simco Inc. sells goods to Balto for $1,000 on September 27th, with credit terms 2/10, net/30

The credit terms allow Balto a 2% discount on payments made within 10 days, the remainder (net) is due within 30 days

Simco records the initial sale:9/27 Accounts Receivable1,000

Sales Revenue 1,000


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SALES DISCOUNTSCONTINUED

Balto pays the bill on October 5th and Simco records the following10/5 Cash 980

Sales Discounts 20Accounts Receivable 1,000

Sales Discounts is a “contra revenue” account Contra = opposite This account has a debit balance and will

reduce sales revenue indirectly in the income statement


5

SALES RETURNS AND ALLOWANCES

Occasionally customers return goods or are allowed a reduced price allowance for defective products

Example: Simco Inc. sells goods to Patton Inc. for $1,000 on September 25th with credit terms 2/10, net/30. Patton returns half of the goods on September 30th and pays for the remainder on October 15th (outside of the discount period)

Simco records the following:9/25 Accounts Receivable 1,000

Sales Revenue 1,000

9/30 Sales Returns & Allow. 500Accounts Receivable 500

10/15 Cash 500Accounts Receivable 500


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SALES RETURNS AND ALLOWANCESCONTINUED

Sales returns and allowances are also a contra revenue account

They have a debit balance and reduce sales revenue indirectly in the income statement

When both of Simco’s transactions are complete, accounts receivable is zero, and total cash collected of $1,480 equals net sales which is the net “inflow” from the transaction

Sales Revenue $2,000

Sales discounts (20)

Sales returns (500)

Net sales $1,480

©Kimberly Lyons

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May 2010

UNCOLLECTIBLE ACCOUNTS AND BAD DEBT EXPENSE

There are two methods of accounting for uncollectible accounts Direct write-off method Allowance method

Direct write-off method: when accounts are known to be uncollectible they are written off immediately

Bad Debt Expense XXXAccounts Receivable

XXX


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DIRECT WRITE-OFF METHOD CONTINUED

The direct write-off method often results in the recording of sales revenue in one period and bad debt expense in another

No matching of related revenues and expenses

Not GAAP Used for tax purposes instead


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ALLOWANCE METHOD

Achieves matching by recording bad debt expense in the same period related sales revenue is recorded (GAAP)

Estimates are used to record uncollectibles before they happen

An allowance account is credited instead of accounts receivable, since specific uncollectible receivables are not yet known

When actual write-offs occur at a later date, they are debited against the existing credit in the allowance account


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ALLOWANCE METHOD CONTINUED

Example: Piper Inc. estimates uncollectible accounts receivable of $1,300. This estimate is recorded at December 31st as part of the year-end adjustment process:

12/31 Bad Debt Expense 1,300Allowance for Uncollectibles

1,300

When actual bad debts become known (in a later period) piper writes them off with:

5/13 Allowance for Uncollectibles 1,250Accounts Receivable 1,250


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ALLOWANCE FOR UNCOLLECTIBLES

Allowance for uncollectibles is a contra accounts receivable account

It has a credit balance that will net against and reduce receivables in the balance sheet

Net receivables is also referred to as net realizable value of receivables

A more conservative value of assets


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MAKING ESTIMATES% OF CREDIT SALES

Example: Piper Inc. estimates uncollectibles of 1% of credit sales. Credit sales for the period are $150,000:

150,000 x .01 = $1,500

12/31 Bad Debt Expense 1,500Allowance for Uncollectibles

1,500


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MAKING ESTIMATES% OF CREDIT SALESCONTINUED

When estimates are made as a % of credit sales, the adjustment will be recorded without considering any existing balance in the allowance account

Allowance Write-offs 1,250 1,300 Beginning

1,500Adjustment

1,550End


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MAKING ESTIMATES% OF ACCOUNTS RECEIVABLE

Example: Piper Inc. estimates uncollectibles of 5% of outstanding accounts receivable. Accounts receivable at 12/31 are $28,400. Piper started the year with a credit balance in the allowance account of $1,300, against which $1,250 was written off. The balance in the allowance account before adjustment is $50 (credit). Estimate of uncollectibles = (28,400 x .05) = $1,420 year-end adjustment = $1,420 – 50 = $1,370

12/31 Bad Debt Expense 1,370Allowance for Uncollectibles 1,370


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MAKING ESTIMATES% OF ACCOUNTS RECEIVABLECONTINUED

When estimates are made as a % of accounts receivable, the adjustment must take the existing allowance balance into consideration

The estimate will become the new balance in the allowance account and will go to the balance sheet to net with accounts receivable

Allowance

Write-offs 1,250 1,300Beginning 1,370 Adjustment

1,420 Estimate


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BALANCE SHEET PRESENTATION

Assets:

Accounts Receivable

$28,400

Less: Allowance (1,420)

Net Realizable Value

$26,980

©Kimberly Lyons

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May 2010

MAKING ESTIMATES REVIEW

When making estimates of uncollectibles as a % of sales, ignore the existing balance in the allowance account and record the estimate as bad debt expense

When making estimates of uncollectibles as a % of accounts receivable, adjust the allowance account so that the estimate will become its ending balance


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PRODUCT WARRANTIES

Selling products with attached warranties gives rise to related expenses

These expenses should be matched with related revenues at the time of sale

Use of estimates allows recoding warranty expense with the related liability without having to wait for future returns


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WARRANTY EXAMPLE

Tilton Inc. Sells goods that are under warranty The company sells 2,000 units for $25 each and expects 2%

to be returned for replacement at a cost of $17 each At the time of sale Tilton must record the warranty expense:

(DR) Accts rec. 50,000(CR) Sales revenue 50,000

(DR) Cost of goods sold 34,000(CR) Inventory 34,000

(DR)Warranty expense 680(CR) Warranty liability 680

(2,000 x .02 x $17 = $680)


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WARRANTY EXAMPLE

Suppose 10 units are returned in the future and Tilton replaces the units at cost:

(DR) Warranty liability 170(CR) Inventory 170(10 units x $17 = $170)


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PRODUCT WARRANTIES

The recorded warranty expense is matched with the related revenue at the time of sale

The warranty liability remains in the balance sheet (carries over to the next period or later) until it is honored


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REVIEW FOR EXAM

State the revenue recognition principle Calculate and record sales discounts and

sales returns and allowances Calculate net sales Record bad debts with the direct write-off

method of accounting for uncollectibles Calculate and record bad debt expense using

the allowance method and a % of credit sales Calculate and record bad debt expense using

the allowance method and a % of accounts receivable


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REVIEW FOR EXAMCONTINUED

Which method of accounting for bad debts is GAAP?

Why? Calculate net receivables, or net realizable

value of receivables Account for warranties


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Documents

Selling Goods and Services May 2010©Kimberly Lyons 1