Reporting And Interpreting Sales Revenue, Receivables,

Reporting and Interpreting SalesRevenue, Receivables, and CashCHAPTER 6McGraw-Hill/Irwin 2009 The McGraw-Hill Companies, Inc.

Accounting for Sales RevenueThe revenue principle requires thatrevenues be recorded when earned:Goods or serviceshave been delivered.Amount of customerpayments known.Collection isreasonably assured.McGraw-Hill/IrwinSlide 2

Credit SalesSelling on credit creates both benefits and costs:Benefits - Customers who are unwilling orunable to pay cash immediately may make apurchase on credit, and company revenuesand profits rise as sales increaseCosts - The company will be unable to collectfrom some of its credit customersMcGraw-Hill/IrwinSlide 3

00FOPUSeng01IRICOCredit SalesWhat is Men’s Warehouse inbusiness for?Selling great looking clothesRunning a credit agencyConcept of“partnering”“outsourcing”is provided by GE Money Bank, the issuer of the Perfect FitCredit Card (the "Issuer").McGraw-Hill/IrwinSlide 4

Credit Card SalesCompanies accept credit cards for several reasons:1. To increase sales.2. To avoid providing credit directly to customers.3. To avoid losses due to bad checks.4. To avoid losses due to fraudulent credit card sales.5. To receive payment quicker.When credit card sales are made,the company must pay the creditcard company a fee for the serviceit provides.McGraw-Hill/IrwinSlide 5

Sales DiscountsWhen customers purchase on open account, they may beoffered a sales discount to encourage early payment.2/10, n/30DiscountPercentage# of Days inDiscountPeriodOtherwise, theFull Amount IsDueMaximum Daysin Credit PeriodRead as: “Two ten, net thirty”McGraw-Hill/IrwinSlide 6

To Take or Not Take the DiscountWith discount terms of 2/10,n/30, a customersaves 2 on a 100 purchase by payingon the 10th day instead of the 30th day.Interest Rate for 20 Days Amount SavedAmount PaidInterest Rate for 20 Days 2 98Annual Interest Rate McGraw-Hill/Irwin365 Days20 Days 2.04% 2.04% 37.23%Slide 7

What did we accomplish?CASH IS KINGIn one of the most restrictive credit environments in history, we were able to secure an Asset Backed Loan(ABL) agreement. We then drove a “cash is king” culture across the company, placing intensescrutiny on all that contributed to our fixed and variable expenses in order to maximize cash flow.Throughout 2009, we worked closely with the bank group to secure less restrictive amendments to the ABLas our financial position improved quarter to quarter. Beyond instituting operating measures to generate cash,we tirelessly — and successfully — led lobbying efforts in Washington, DC to include an extension of the netoperating loss carryback provisions in the American Recovery and Reinvestment Act of 2009 — a campaignthat ultimately resulted in our receipt of a tax refund of approximately 167 million in March 2010, allowing usto further pay down our debt balance.McGraw-Hill/IrwinSlide 8

Why do Firms Offer Discounts?Cash in your handsis most important!Incentivize customer to transfer cash to youSpeed your cash collectionsReduce your need for cash borrowingsCompetitive advantage lost if no discount offeredMcGraw-Hill/IrwinSlide 9

Sales Returns and AllowancesDebited for damagedmerchandise.Debited for returnedmerchandise.Contra revenueaccount.McGraw-Hill/IrwinSlide 10

Sales Returns and AllowancesA sales discount is a decrease in the cost ofpurchases earned by making an early payment tothe vendorA sales return is a decrease in the cost of purchasesbecause the buyer returned the goods to the sellerA sales allowance is a decrease in the cost ofpurchases because the seller granted the buyer asubtraction (an allowance) from the amount owedMcGraw-Hill/IrwinSlide 11

Reporting Net SalesCompanies record credit card discounts,sales discounts, and sales returns and allowancesseparately to allow managementto monitor these transactions.ResponsibilityAccountingSales revenueLess: Credit card discountsSales discountsSales returns and allowancesNet salesMcGraw-Hill/IrwinSlide 12

Reviewing Components of Net SalesSales revenueLess: Credit card discountsSales discountsSales returns and allowancesNet salesSales potential at MSRP, Original “sticker” priceCost of allowingcredit card salesCost of reducing sales pricesto move items not selling(poor buying decisions, non-competitive price)Cost of customer serviceor poor quality of goodsMcGraw-Hill/IrwinSlide 13

Gross Profit PercentageGross ProfitPercentage Gross ProfitNet SalesIn 2006, Deckers reported gross profit of 141,199,000 on sales of 304,423,000.Gross ProfitPercentage 141,399,000 304,423,000 46.4%2006 Gross Profit ComparisonsDeckersSkechers U.S.A.Timberland46.4%43.4%47.3%Other things equal, higher gross profit results in higher net income.McGraw-Hill/IrwinSlide 14

Measuring and Reporting ReceivablesWhen companies allow customers to purchase merchandiseon an open account, the customer promises to pay thecompany in the future for the purchase.OpenAccountMcGraw-Hill/IrwinSlide 15

Measuring and Reporting ReceivablesWhen companies allow customers to purchase merchandiseon an open account, the customer promises to pay thecompany in the future for the purchase.Accounts ReceivableTrade receivables areamounts owed to thebusiness for credit sales ofgoods, or services.McGraw-Hill/IrwinNontrade receivables areamounts owed to thebusiness for other thanbusiness transactions.Slide 16

Accounting for Bad DebtsBad debts result from credit customers who will not pay thebusiness the amount they owe, regardless of collection efforts.Bad Debt ExpenseMatching PrincipleRecord in sameaccounting period.Sales RevenueMcGraw-Hill/IrwinSlide 17

Accounting for Bad DebtsBad debts result from credit customers who will not pay thebusiness the amount they owe, regardless of collection efforts.Bad Debt ExpenseMatching PrincipleRecord in sameaccounting period.Sales RevenueMost businesses record an estimate of the bad debt expensewith an adjusting entry at the end of the accounting period.McGraw-Hill/IrwinSlide 18

Recording Bad Debt Expense EstimatesDeckers estimated bad debt expensefor 2006 to be 4,685,000.Prepare the adjusting entry.Bad Debt Expense is normally classified as a sellingexpense and is closed at year-end.GENERAL JOURNALDateDescriptionDec. 31 Bad Debt Expense ( E, -SE)Allowance for Doubtful Accounts ( XA)DebitCredit4,685,0004,685,000Contra asset accountMcGraw-Hill/IrwinSlide 19

Allowance for Doubtful AccountsAllowance for Doubtful Accounts is: the estimated amount of the receivables that thebusiness expects not to collect a contra account related to Accounts Receivable another name for Allowance for Bad DebtsMcGraw-Hill/IrwinSlide 20

Allowance for Doubtful AccountsBalance Sheet DisclosureAccounts receivableLess: Allowance for doubtful accountsNet realizable value of accounts receivableAmount the businessexpects to collect.McGraw-Hill/IrwinSlide 21

Writing Off Uncollectible AccountsWhen it is clear that a specific customer’s account receivable will beuncollectible, the amount should be removed from the AccountsReceivable account and charged to the Allowance for Doubtful Accounts.Deckers’ total write-offs for 2006 were 6,969,000.Prepare a summary journal entry for these write-offs.GENERAL JOURNALDateDescriptionAllowance for Doubtful Accounts (-XA)Accounts Receivable Slide 22

Writing Off Uncollectible AccountsAssume that before the write-off, Deckers’ Accounts Receivablebalance was 62,640,000 and the Allowance for DoubtfulAccounts balance was 13,069,000. Let’s see what effect thetotal write-offs of 6,969,000 had on these accounts.Before WriteOffAccounts receivable 62,640,000Less: Allow. for doubtful accts.13,069,000Net realizable value 49,571,000After WriteOff 55,671,0006,100,000 49,571,000The total write-offs of 6,969,000 did not change the netrealizable value nor did it affect any income statement accounts.McGraw-Hill/IrwinSlide 23

Estimating Bad Debt ExpensePercentage of Credit SalesBad debt percentage is based on actual uncollectibleaccounts from prior years’ credit sales.Alternatively, bad debt percentage can be based onindustry standardsFocus is on determining the amount to record on theincome statement as Bad Debt Expense.McGraw-Hill/IrwinSlide 24

Estimating Bad Debt ExpensePercentage of Credit SalesNet credit sales % Bad debt loss rateAmount of journal entry toBad Debt ExpenseCalculatesMcGraw-Hill/IrwinSlide 25

Percentage of Credit SalesIn 2008, Kid’s Clothes had credit sales of 600,000. Pastexperience indicates that bad debts are one percent of sales.What is the estimate of bad debts expense for 2008? 600,000 .01 6,000Now, prepare the adjusting entry.GENERAL JOURNALDateDescriptionDec. 31 Bad Debt Expense ( E, -SE)Allowance for Doubtful Accounts ( XA)McGraw-Hill/IrwinDebit Credit6,0006,000Slide 26

Estimating Bad Debt ExpenseBy Aging of Accounts ReceivableFocus is on determining the desiredbalance in the Allowance for DoubtfulAccounts on the balance sheet.Each customer’s account is aged by breaking down(stratifying) the balance by showing the age(in number of days) of each part of the balance.McGraw-Hill/IrwinSlide 27

Aging ScheduleDays Past DueCustomerAaron, R.Baxter, T.Clark, J.Zak, R.Total% UncollectibleNot YetDue 1,2001-30 23530031-60 3,5000.01 2,5500.0450325 1,8300.10TotalA/R61-90 Over 90 Balance 2351,500 200 500750 1,5400.25 1,2400.40325 10,660Based on past experience, the business estimates the percentageof uncollectible accounts in each time category. These percentagesare then multiplied by the appropriate column totals.McGraw-Hill/IrwinSlide 28

Aging ScheduleDays Past DueCustomerAaron, R.Baxter, T.Clark, J.Zak, R.Total% UncollectibleEstimatedUncoll. AmountNot YetDue 1,2001-30 23530031-60 50 3,5000.01 2,5500.04325 1,8300.10 35102183TotalA/R61-90 Over 90 Balance 2351,500 200 500750 1,5400.25 1,2400.40 385496325 10,660 1,201The column totals are then added to arrive at thetotal estimate of uncollectible accounts of 1,201.CalculatesMcGraw-Hill/IrwinSlide 29

Aging of Accounts ReceivableRecord the Dec. 31, 2008, adjusting entry assuming that the Allowance forDoubtful Accounts currently has a 50 credit balance.GENERAL JOURNALDateDescriptionDec. 31 Bad Debt Expense ( E, -SE)McGraw-Hill/IrwinCredit1,151Allowance for Doubtful Accounts ( XA)1,201 Desired Balance50 Credit Balance 1,151 Adjusting EntryDebit1,151After posting, the Allowanceaccount would look like this . . .Slide 30

Aging of Accounts ReceivableAllowance for Doubtful Accounts50Notice that the balanceafter adjustment is equalto the estimate of 1,201based on the aginganalysis e at12/31/2008before adj.2008 adjustmentBalance at12/31/2008after adj.Slide 31

Aging of Accounts ReceivableAccounts Receivable % Estimated UncollectibleDesired Balance in Allowance Account- Allowance Account Credit BalanceAmount of Journal EntryAccounts Receivable % Estimated UncollectibleDesired Balance in Allowance Account Allowance Account Debit BalanceAmount of Journal EntryMcGraw-Hill/IrwinSlide 32

Review T-AccountsMcGraw-Hill/IrwinSlide 33

Receivables TurnoverReceivablesTurnover Net SalesAverage Net Trade ReceivablesThis ratio measures how many times averagereceivables are recorded and collected for the year.McGraw-Hill/IrwinSlide 34

Receivables TurnoverDeckers reported 2006 net sales of 304,423,000.December 31, 2005, receivables were 39,683,000 andDecember 31, 2006, receivables were 49,571,000.Receivables 304,423,000 6.8 Turnover( 39,683,000 49,571,000) 22006 Receivables Turnover w-Hill/IrwinSlide 35

Receivables Turnover10.477.714.4McGraw-Hill/IrwinSlide 36

Focus on Cash FlowsAdd Decreasein AccountsReceivableSalesRevenueSubtractIncrease inAccountsReceivableMcGraw-Hill/IrwinCash CollectedfromCustomersSlide 37

Cash and Cash EquivalentsChecksMoneyOrdersCash andCashEquivalentsCertificatesof DepositBank DraftsT-BillsMcGraw-Hill/IrwinSlide 38

Internal Controls Internal control is the organizational planand all the related measures that an entityadopts to McGraw-Hill/IrwinSafeguard assetsEncourage adherence to company policiesPromote operational efficiencyEnsure accurate and reliable accounting recordsSlide 39