sales n collection cycle
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Copyright 2003 Prentice Hall Publishing Company 1
Chapter 7
Sales and Collection Cycle
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Copyright 2003 Prentice Hall Publishing Company 2
Sales And Services Are TheBackbone Of Any Business Sales forecasts are
the starting point formaking any plans for
the business. New ways of making
sales are becoming
very important tobusinesses.
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Copyright 2003 Prentice Hall Publishing Company 3
Receiving Orders
In person By mail
By phone
By fax By computer
Ordering merchandise over theinternet is becoming a very
significant portion of manybusinesses.
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Copyright 2003 Prentice Hall Publishing Company 6
Controlling CASH
Cash has universal appealand ownership is difficult toprove.
Both cash receipts and cashpayments should be recordedimmediately when receivedand made.
Checks should beprenumbered and kept secure.
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Copyright 2003 Prentice Hall Publishing Company 7
Safeguarding Cash
Separation of dutiesDifferent people receive and disburse
the cash.
Procedures for the record keeping ofcash receipts and disbursements areseparate.
Handling the cash and record keepingare completely separate.
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Copyright 2003 Prentice Hall Publishing Company 8
Procedures To Have In Place
Both cash receipts and cash paymentsshould be recorded immediately whenreceived and made.
Keep cash under strict physical control,and deposit cash receipts daily.
Have separate approvals for purchases
and the payment for those purchases.
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Copyright 2003 Prentice Hall Publishing Company 9
Procedures
Use pre-numbered checks, and keep a log ofelectronic transfers.
Payment approval, check signing, andelectronic funds transfer should be assignedto different individuals.
Bank accounts and cash balances should bereconciled monthly.
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Copyright 2003 Prentice Hall Publishing Company 10
Accounting For Cash:Reconciling The Bank Statement
An important part of internalcontrol
Need for calculating a truecashbalance
Two sides to be reconciled balance per bank
balance per books
If there are any mistakes or
transactions that have not beenrecorded in the companys books,the companys records should beupdated.
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Copyright 2003 Prentice Hall Publishing Company 11
Terminology
Bank statement
Monthly report prepared by bank thatcontains details of a companys deposits,
disbursements, and bank charges.
Bank reconciliationReport prepared by the company afterreceiving the bank statement that
compares the bank statement with thecompanys records to verify the accuracyof both.
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Copyright 2003 Prentice Hall Publishing Company 12
More Terminology
Outstanding checkA check written by the company that hasbeen recorded on the companys records
but has not yet cleared the bank
Deposit in transit
A deposit that the company has made andrecorded, but it has not reached the banks
record keeping system yet.
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Copyright 2003 Prentice Hall Publishing Company 13
More Terminology
NSF checkA bad check written by a customer that
must be deducted from the companys
records. The company recorded the check
as a cash receipt (and then deposited it),but the check writer didnt have the money
in his or her account to cover it. The bankwill have already deducted it from the
companys balance (in the banks records),but the company will have to make anadjustment to their records.
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Copyright 2003 Prentice Hall Publishing Company 14
More Terminology
Credit memo
An addition to the companys balance in
the banks records for a reason such as
the bank having collected a note for the
company (from a third party who owed thecompany).
Debit memo
A deduction from the companys balancein the banks records for a reason such as
a bank service charge.
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Copyright 2003 Prentice Hall Publishing Company 15
An Example Of A Reconciliation
Given the following information:
Balance per bank at 4/30 $8,750
Balance per books at 4/30 6,900
Outstanding checks at 4/30 1,380
Bank service charge for April 30
Deposit in transit at 4/30 400
Customers NSF check 100
(returned with bank statement)Bank collected note receivable 1,000 for
company
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Copyright 2003 Prentice Hall Publishing Company 16
Balance Per Bank Section Of TheReconciliation
Balance per bank $8,750
Plus: Deposit in transit 400
Less: Outstanding checks (1,380)Cash Balance at 4/30 $7,770
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Copyright 2003 Prentice Hall Publishing Company 17
Balance Per Books Section OfThe Reconciliation
Balance per books $6,900
Plus: Note collected by bank 1,000
Less: NSF check returned (100)Service charge ( 30)
Cash balance at 4/30 $7,770
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Copyright 2003 Prentice Hall Publishing Company 18
There Is One TrueCash Balance
Bank balance perstatement isreconciled to the
TRUE cash balance Book balance
(companys records)
is reconciled to the
TRUE cash balance
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Copyright 2003 Prentice Hall Publishing Company 19
Cash (Bank) ReconciliationHas Two Independent Parts
++ deposits in transit
++-- outstanding
checks
--True cash balance
++ collections for us
made by the bank++
-- NSF checks (fromcustomers)
-- Service charges
True cash balance
Balance per bank Balance per books
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Copyright 2003 Prentice Hall Publishing Company 20
A/R are the expected futurecash receipts of a company.They are typically small and areexpected to be received within
30 days. N/R are used when longer
credit terms are necessary.The note specifies the maturity
date, the rate of interest, andother credit terms.
Accounts And Notes Receivable
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Copyright 2003 Prentice Hall Publishing Company 21
Value Of Receivables
Receivables are reported at theirface value less an allowance foraccounts which are likely to beuncollectible.
The amount which is actuallyexpected to be collected is calledthe net realizable value (NRV).
GAAP requires that A/R bereported at NRV.
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Copyright 2003 Prentice Hall Publishing Company 22
Used only when bad debtsare a very small item orwhen credit sales areinsignificant.
GAAP Not GAAP
Two Methods
Allowance Method Direct Write-OffMethod
A/RMethod
SalesMethod
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Copyright 2003 Prentice Hall Publishing Company 23
The Most Common Method
Allowance method Estimate the bad debt expense as an
adjustment when it is time to prepare thefinancial statements.
Record the amount as a reduction inACCOUNTS RECEIVABLE, even thoughyou dont know whose accounts will be
bad.
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Copyright 2003 Prentice Hall Publishing Company 24
Allowance Method, continued
We will base the estimate on: Sales, or
Accounts Receivable
This method attempts to match theexpense (bad debt) with the revenue (sale)by recording the expense in the sameperiod as the sale even though the
company has not specifically identifiedwhich accounts will go unpaid.
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Copyright 2003 Prentice Hall Publishing Company 25
The Other MethodDirect Write-Off
No estimates of bad debts are made.
Only when a specific account is known to beuncollectible (customer files bankruptcy, for
example) is bad debt expense recorded. This doesnt do a very good job of matching
the revenue (sale) with the expense (baddebt), because a company often discovers an
account is uncollectible in a period subsequentto the one in which the sale was made.
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Assume the following selected eventsoccurred at Cell-It. For each event:
Determine how the accounting equationwas affected.
Determine the effect on the financialstatements.
Transaction Analysis
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Copyright 2003 Prentice Hall Publishing Company 27
1. Provided services to customers for $9,000,on account.
Assets = Liab. + Cont. Cap. + Ret. Earnings
+9000 +9000
Income Statement:
Statement of Changes in Equity:
Statement of Cash Flows:
Increases income
Increases equity
No effect on cash flow
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Copyright 2003 Prentice Hall Publishing Company 28
2. Collected $6,000 Cash From AccountReceivable.
Assets = Liab. + Cont. Cap. + Ret. Earnings
+6000(6000)
Income Statement:
Statement of Changes in Equity:
Statement of Cash Flows:
no effect on income
no effect on equity
increases cash flow
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Copyright 2003 Prentice Hall Publishing Company 29
3. At year-end it was estimated that $200 ofaccounts receivable will never be collected.
Assets = Liab. + Cont. Cap. + Ret. Earnings
(200) (200)
Income Statement:
Statement of Changes in Equity:
Statement of Cash Flows:
Decreases income
Decreases equity
No effect on cash flow
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Copyright 2003 Prentice Hall Publishing Company 30
How Do We Report AR On TheBalance Sheet?
Net Realizable Value of AR = what we expect to collect
On the balance sheet:
Accounts Receivable $3,000less allowance foruncollectible accounts (200)
Net AR $2,800
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Heres What The T-accountsWould Look Like:
Accounts Receivable Allowance for U.Accts.
9,0006,000
3,000 Bad Debt Expense
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Copyright 2003 Prentice Hall Publishing Company 32
Heres What The T-accountsWould Look Like:
Accounts Receivable Allowance for U.Accts.
9,0006,000
3,000 Bad Debt Expense
200
200
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Heres What The T-accountsWould Look Like:
Accounts Receivable Allowance for U.Accts.
9,0006,000
3,000
200
50
50
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Copyright 2003 Prentice Hall Publishing Company 35
Effect of Transaction 4 onAR Net Realizable Value
Before Event 4 After Event 4
AR $3,000 AR $2,950
Allow. 200 Allow. 150
N.R.V. $2,800 N.R.V. $2,800
Net realizable value of accounts receivabledid not change as a result of the write-off.
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An Example
Two years of transactions Effect on accounting equation
Financial statements
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1. Provided $5,000 ServicesOn Account.
Assets = Liab. + Cont. Cap. + Ret. Earnings
+5000 A/R +5000 SalesRevenue
Income Statement:
Statement of Changes in Equity:
Statement of Cash Flows:
Increases income
Increases equity
No effect on cash flow
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Copyright 2003 Prentice Hall Publishing Company 38
2. Collected $4,000 Cash FromAccounts Receivable.
Assets = Liab. + Cont. Cap. + Ret. Earnings
+4000 cash
(4000) A/R
Income Statement: Statement of Changes in Equity:
Statement of Cash Flows:
No effectNo effect
Increases cash flow
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Copyright 2003 Prentice Hall Publishing Company 39
3. Adjusting Entry Booked ToReflect The Estimate Of 5% Of
Ending A/R To Be Uncollectible.
Assets = Liab. + C C. + Ret. Earnings
(50) Allowance (50) Bad Debt Expense
Income Statement:
Statement of Changes in Equity:
Statement of Cash Flows:
Decreases income
Decreases equity
No effect on cash flow
Fi i l St t t
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Financial StatementsAt The End Of Year 19X4:
Income StatementFor the year 19X4
Sales $5,000Bad debt expense 50
Net Income $4,950
Statement of Cash FlowsFor the year 19X4
Cash from operations $4,000Cash from investing -0-Cash from financing -0-
Total change in cash $4,000
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Assets:Cash $4000
AR 1,000Allowance (50)
Net A/R 950
Total Assets $4,950 $4,950
Liab. + Equity:
RE $4,950
Balance SheetAt 12/31/X4
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1-b. Wrote Off A $40 A/RThat Was Determined To
Be UncollectibleAssets = Liab. + Cont. Cap. + Ret. Earnings
(40) AR
+40 Allowance
Income Statement: Statement of Changes in Equity:
Statement of Cash Flows:
No effectNo effect
No effect
2 b P id d $6 000 W th Of
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2-b. Provided $6,000 Worth OfServices On Account.
Assets = Liab. + Cont. Cap. + Ret. Earnings
+6000 AR +6000 revenue
Income Statement:
Statement of Changes in Equity:
Statement of Cash Flows:
Increases incomes
Increases equityNo effect on cash flow
$
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3-b. Collected $4,500 Cash FromAccounts Receivable.
Assets = Liab. + Cont. Cap. + Ret. Earnings
+4500 Cash
(4500) AR
Income Statement: Statement of Changes in Equity:
Statement of Cash Flows:
No effect
No effect
Increases cash flow
4 b Adjusted the accounting records to reflect
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4-b. Adjusted the accounting records to reflectthe expectation that 5% of the ending AR balance
would be uncollectible. (Balance is $2460.)
Assets = Liab. + Cont. Cap. + Ret. Earnings
Income Statement:
Statement of Changes in Equity:
Statement of Cash Flows:
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Where Do We Stand?
We overestimated bad debts by $10--we estimated $50but we only wrote off $40 in the subsequent year.
This year our estimate is 5% of $2460 (BB 1,000 + 6,000credit sales - $4,500 collections -$40 accounts written off)=$123. But since we overestimated last year, we only need
to record $113 this year.
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4.b Adjusted The Accounting Records To Reflect theExpectation That 5% Of The Ending AR Balance
Would Be Uncollectible.Assets = Liab. + Cont. Cap. + Ret. Earnings
(113) allowance (113) bad
for doubtful debt expenseaccounts
Income Statement:
Statement of Changes in Equity:
Statement of Cash Flows:
Decreases incomes
Decreases equity
No effect on cash flow
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To summarize:
Two methods: the allowance
method
the direct write-off
method Which one involves
estimating futureuncollectibles?
Summary Of The Allowance
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Summary Of The AllowanceMethod Continued
One way to estimate bad debt expenseis to use a percentage of ending A/R (oran aging schedule)
When an actual account is written off asuncollectible, it is credited out of A/Rand debited out of the Allowance.THERE IS NO NET EFFECT ON
ASSETS and NO EXPENSE at the timeof the write-off.
Other Accounting Issues
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Other Accounting IssuesRelated to Sales: Warranty
Costs Why give warranties?
Whenshould expense be recognized?
Warranty
We willrepair orreplace this
item...
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Warranties
How is the warrantyobligation met andsubsequently removed fromthe balance sheet?
How do all of the aboveaffect financial statements?
What other issues are
similar to warranties?
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Transaction Analysis
Assume the following selected eventsoccurred at Cell-It. For each event:
Determine how the accounting equation
was affected. Determine the effect on the financial
statements.
Record the event in t-accounts.
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1. Sold Merchandise For $5,000 Cash ThatHad Originally Cost $4,000. These GoodsWere Sold With A Two-year Warranty.
Assets = Liab. + Cont. Cap. + Ret. Earnings
+5000 +5000
(4000) (4000)
Income Statement: Statement of Changes in Equity:
Statement of Cash Flows:
Increases incomesIncreases equity
No effect on cash flow
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2. Estimated That $100 Of Warranty Cost WillBe Incurred Over The Next Two Years OnThe Goods Sold In Transaction 1.
Assets = Liab. + Cont. Cap. + Ret. Earnings
+100 (100)
Income Statement:
Statement of Changes in Equity:
Statement of Cash Flows:
Decreases incomes
Decreases equity
No effect on cash flow
3. A Customer Returned Goods Under
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Warranty For Repair. The Cost Of TheRepair Was $30 Cash.
Assets = Liab. + Cont. Cap. + Ret. Earnings
(30) (30)
Income Statement:
Statement of Changes in Equity: Statement of Cash Flows:
No effect on income
No effect on equityDecreases cash flow
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