sales n collection cycle

7/31/2019 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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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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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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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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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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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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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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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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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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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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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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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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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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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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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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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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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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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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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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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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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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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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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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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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2. Collected $6,000 Cash From AccountReceivable.


+6000(6000)

Income Statement:



no effect on income

no effect on equity

increases cash flow


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3. At year-end it was estimated that $200 ofaccounts receivable will never be collected.


(200) (200)

Income Statement:



Decreases income

Decreases equity



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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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9,0006,000

3,000 Bad Debt Expense

200

200


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9,0006,000

3,000

200

50

50


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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.


+5000 A/R +5000 SalesRevenue

Income Statement:



Increases income

Increases equity



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2. Collected $4,000 Cash FromAccounts Receivable.


+4000 cash

(4000) A/R

Income Statement: Statement of Changes in Equity:


No effectNo effect

Increases cash flow


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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:



Decreases income

Decreases equity


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



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.


+6000 AR +6000 revenue

Income Statement:



Increases incomes

Increases equityNo effect on cash flow

$


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3-b. Collected $4,500 Cash FromAccounts Receivable.


+4500 Cash

(4500) AR



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.)


Income Statement:




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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:



Decreases incomes

Decreases equity



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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.


+5000 +5000

(4000) (4000)



Increases incomesIncreases equity



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2. Estimated That $100 Of Warranty Cost WillBe Incurred Over The Next Two Years OnThe Goods Sold In Transaction 1.


+100 (100)

Income Statement:



Decreases incomes

Decreases equity


3. A Customer Returned Goods Under


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Warranty For Repair. The Cost Of TheRepair Was $30 Cash.


(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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