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BU8101

Accounting: A User Perspective


Week 3
Sales Revenue, Receivables and Cash

Lau Yin Kheng

Learning Outcomes
Once you have completed this lesson, you should be able
to:
1. Explain how companies measure and report sales
revenue.
2. Explain how companies measure, report and manage
receivables.
3. Apply internal control principles to cash and explain
reporting of cash.

Lau Yin Kheng

Learning Objectives
1. Explain how companies measure and report sales
revenue.
2. Explain how companies measure and report
receivables and impairment of accounts receivable
expenses.
3. Explain how companies manage accounts receivables.
4. Explain and apply internal control principles to cash.
5. Prepare a bank reconciliation and explain its purpose.
6. Explain the reporting of cash.

Lau Yin Kheng

Learning Objective 1

EXPLAIN HOW COMPANIES


MEASURE AND REPORT SALES
REVENUE
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The Effect of Sales of Goods and


Services on the Financial Statements

LO 1

Activity
Sales of
goods and
services to
customers

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Income
Statement

Balance
Sheet
Cash

Sales revenue

Accounts
Receivable

Statement of
Cash Flows
Cash received
from customers

LO 1

Sales Revenue

Sales revenue is recorded when the performance


obligation is satisfied.

Performance obligation is satisfied when the goods are


transferred from the seller to the buyer or when service
obligation is performed.

Sales revenues are reported in the income statement as


Net sales as shown in Procter & Gambles
consolidated statement of earnings.

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LO 1

Sales Revenue

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LO 1

Deductions from Sales Revenue


Sales revenue
Less: Sales discounts
Sales returns and allowances
Credit card discounts
Net Sales

Three types of transactions are recorded in contrarevenue accounts

Contra-revenue means theyll have a debit balance.


Why are they recorded in separate accounts and not
deducted directly from sales revenue?

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LO 1

Sales Discounts

When selling on credit, companies may offer customers a


sales discount to encourage early payment.

Read as two ten, net thirty.


Terms
Discount Period

Credit Period

Full amount
less discount

Full amount due

Time
Due

Discount
Period

Purchase or Sale
Read as: Two ten, net thirty
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Discount
Percent

Otherwise, Net
(or All) is Due

2/10,n/30

Credit
Period

LO 1

Example: Sales Discounts

On 25th June 2015, Barry Best sells biscuits priced at


$5,000 to a customer on terms 2/10, n/30.
The customer pays within the discount period on 2nd
July 2015.
The entries would be:

Date

Description

Debit Credit

Jun 25 Accounts receivable (A+)


Sales Revenue (R+)

5,000

Jul

4,900
100

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2 Cash (A+)
Sales Discount[5,000x2%] (R-)(OE-)
Accounts Receivable (A-)

5,000

5,000

LO 1

Sales Returns and Allowances


Debited for
damaged
merchandise.
Debited for
returned
merchandise.
Contra revenue
account.

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Customer Service
Reason for
the return?

LO 1

Credit Card Discounts

On 1st August 2015, Mary uses her Visa card to buy


$200 worth of biscuits from Barry Best Biscuit Company.
DBS Visa charges a 2% fee.
Barry Best would record (ignore COGS):

Date

Description

Aug 1 Cash DBS Bank (A+)

Credit Card Discount (R-)(OE-)


Sales Revenue (R+)(OE+)

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Debit Credit
196

4
200

End of Learning Objective

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Objective!
Try the review questions that follow.

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Learning Objective 2

EXPLAIN HOW COMPANIES


MEASURE AND REPORT
RECEIVABLES AND IMPAIRMENT
OF ACCOUNTS RECEIVABLE
EXPENSES
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LO 2

Types of Receivables
Amounts due from individuals and other companies that
are expected to be collected in cash.
Accounts
Receivable

Notes
Receivable

Other
Receivables

Amounts owed to
the business for
credit sales of
goods, or services.

Amounts owed to
the business for
which formal
instruments of credit
are issued as proof
of debt.

Nontrade amounts
owed to the
business for other
than business
transactions.

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LO 2

Impairment of Accounts Receivable


When companies allow customers to purchase
merchandise on credit, and customers promise to pay in
the future, it is inevitable that some of these receivables
might not be collectible.
Example:
Bank loans are receivables.
During the subprime mortgage crisis, borrowers of bank loans
defaulted in their mortgage payments (receivables for banks) due
to increased interest rate.
Banks had to foreclose their homes and write off a portion of the
credit losses .
hence the term bad debts or Impairment of Accounts
receivable
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LO 2

Impairment of Accounts Receivable

We sell amounts
biscuits on
The estimated
of Why cant we just
Accounting
rules
credit.
It is known
likely aswrite off accounts
doubtful
accounts
are
require you
tosome
after they turn
that
impairments
of
accounts
estimate the
amountand
bad?
customers
may
receivable
expense
they
of doubtful
accounts
notwith
pay.revenues
should
be matched
forsame
each fiscal
fiscal period that
in the
period.
created
those accounts.

How do Barry and Best account for impairment of accounts


receivable in their business?
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LO 2

Impairment of Accounts Receivable


Methods of Accounting for Impairment of Accounts
Receivable (AR)

Allowance Method

Direct Write-Off
Theoretically undesirable:

No matching.

Not acceptable for


financial reporting.

Losses are estimated:

Matched with sales revenue


in the same accounting
period.

Receivable stated at cash


realizable value.

Required by GAAP.

Receivable not stated at


cash realizable value.

Not GAAP

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LO 2

Impairment of Accounts Receivable

Assume that up to 30th June 2015, Barry Best Biscuit


Company have unrealistically assumed that all of the
accounts receivable will be collectible.

At 30th June, accounts receivable amounted to $10,000.


Barry Best makes
most sales on credit
30th June

Accounts receivable $10,000


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LO 2

Impairment of Accounts Receivable


Barry and Best reviews the list of accounts receivable at 30th
June 2015 and estimates that approximately $1,500 of these
accounts will prove to be uncollectible or impaired
Also known as Uncollectible Account Expense, Doubtful Debts or
Bad debts

Date

Description

Debit Credit

Jun 30 Impairment of Accounts Receivable (E+)(OE-)


Allowance for Impairment of Accounts
Receivable (A-)

Selling expense
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1,500
1,500

Contra-asset account

LO 2

Reporting Accounts Receivable and


Impairment of Accounts Receivable Expenses
Barry Best Biscuit Company
Balance Sheet at 30 June (partial)
Current Assets:
Also called Allowance for Doubtful Debts
Cash
Accounts receivable
$ 10,000
Less: Allowance for impairment of accounts receivable
(1,500)
Inventory
Prepaid expense
Net realizable value
Total current assets

XXX
8,500
XX
XX
XXXX

Barry Best Biscuit Company


Income Statement for June 2015 (partial)
Net sales revenue
Less: Expenses
Impairment of accounts receivable expense
Utlities
Salaries
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XXX
XXX
1,500
XX
XX

LO 2

Writing Off an
Uncollectible Account Receivable
Barry Best Biscuit Company
JulyBalance
2015,Sheet
Barryat Best
Biscuit
30 June
(partial)Company

Assume in
learns
that
Chill Caf has gone out of business and that the $500
Current
Assets:
Cash
account receivable from this customer is now worthless. XXX

Accounts receivable
$ 10,000
When
an account
is determined
to be completely
impaired,
Less:
Allowance
for impairment
of accounts receivable
(1,500)
8,500
Inventory
XX
it no longer qualifies as an asset and should be written off.
Prepaid expense
XX
Total current assets
XXXX

Date

Description

Allowance for Impairment of Accounts


Jul 15 Receivable (A+)
Accounts Receivable (Chill Cafe)(A-)

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Debit Credit
500
500

LO 2

Writing Off an
Uncollectible Account Receivable
Before write-Off

Accounts receivable

After Write-Off

10000

-500

9500

Less: Allow. for impairment of AR

1500

-500

1000

Net realizable value

8500

8500

Notice that the $500 write-off did not change


the net realizable value nor did it affect any
income statement accounts.

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LO 2

Recovery of Accounts

Chill Caf comes out of bankruptcy and on 1st November


2015 and sends a cheque to Barry Best for $500.

When there is recovery of a customers account that has


previously been written off, the entry to write off the
account is first reversed and
Date
Description
Debit Credit
Accounts Receivable (Chill Cafe)
Nov 1 (A+)
500
Allowance for Impairment of
Accounts Receivable (A-)
500

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LO 2

Recovery of Accounts
Then the collection of the account is recorded in the usual
manner:

Date

Description

Nov 1 Cash (A+)


Accounts Receivable (A-)

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Debit

Credit

500
500

Estimating Impairment of
Accounts Receivable

LO 2

At the end of each accounting period, management estimate


the probable amount of impaired accounts and adjust the
Allowance for Impairment of Accounts Receivable to this new
estimate.
Example:
Sunny Company assess its accounts receivable for impairment on
the following basis:
Customers E, G & H are considered individually significant.
Other customers are collectively assessed and aged. Each age
grouping has a different likelihood of being uncollectible.
Estimate of impairment is based on past collection experience,
the customers financial status
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LO 2

Customer
Individually
significant
E
G
H
Sub-total
Age analysis
A
B
C
D
F
Sub-total
x % impairment
Est impairment
Total
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Sunny Company
Schedule of Accounts Receivable
at 31 December 2014
Total AR

Current

Days
Past Due
1-30
31-60

> 60

$130,000 $120,000
$10,000
150,000
145,000
$3,000
2,000
100,000
80,000 $10,000
5,000
5,000
380,000
345,000
10,000
8,000
17,000
4,000
12,000
5,000
20,000
35,000
76,000

456,000

3,500
10,000
5,000
8,000
30,000
56,500
1%
565

500
1,000

1,000

5,000
3,000
9,500
3%
285

4,000
1,500
6,500
5%
325

3,000
500
3,500
10%
350

Total
Estimated
Impairment

10,000
5,000
10,000
25,000

1,525
26,525

LO 2

Reporting Accounts Receivable


at Net realizable Value

Method 1

Sunny Company
Balance Sheet at 31 December 2014(partial)

Current Assets:
Cash
Accounts receivable
Less: Allowance for impairment of accounts receivable
Inventory
Prepaid expense
Total current assets

Method 2

$ 456,000
(26,525)

429,475
8,120
40
470,635

Sunny Company
Balance Sheet at 31 December 2014(partial)

Current Assets:
Cash
Accounts receivable, net of $26,525 allowance
Inventory
Prepaid expense
Total current assets
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$ 33,000

33,000
429,475
8,120
40
470,635

Adjustments for Impairment of


Accounts Receivable

LO 2

Compare the current balance in the Allowance for


Impairment of AR before any adjustments with the desired
balance in the account.
Assume that Allowance for Impairment of AR before any
adjustment:
Case 1:

$ 10,000 credit balance

Case 2:

$ 2,000 debit balance

At 31 December 2014, how much impairment of accounts


receivable expense should be recognized in Case 1 and Case 2
respectively?

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LO 2

Adjustments for Impairment of


Accounts Receivable
Allowance for
Impairment of AR
Case 1

Allowance for
Impairment of AR
Case 2
2,000

Balance before adjustment

10,000

Adjustment needed

16,525

28,525

Desired balance

26,525

26,525

Date

(Case 1) Description
Impairment of Accounts Receivable

Date

Allowance for Impairment of AR


(Case 2) Description
Impairment of Accounts Receivable
Allowance for Impairment of AR

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Dr

Cr

16,525
Dr

16,525
Cr

28,525
28,525

End of Learning Objective

You have come to the end of this Learning


Objective!

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Learning Objective 3

EXPLAIN HOW COMPANIES


MANAGE ACCOUNTS
RECEIVABLES
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LO 3

Managing Accounts Receivable

Tight or relax credit policies?


Tight reduces risk of uncollectible accounts.
Relax increases volume of credit sales but higher

Factoring
Accounts
Receivable

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Credit Card
Sales

LO 3

Managing Accounts Receivable

A higher turnover ratio suggests:


the company is managing its credit-granting and
collection activities effectively.
Accounts
Receivable
Turnover

Net Sales
Average Net Acc. Receivable

This ratio measures how many times a company converts its


receivables into cash each year and is used as an indication
of the liquidity of the company.
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LO 3

Managing Accounts Receivable


Average
Collection =
Period

365 Days
Accounts Receivable Turnover

Average
Collection =
Period

365 Days
27.03 Times

= 13.50 days

This ratio measures, on average, how many days it


takes to collect an account receivable.

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End of Learning Objective

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Objective!
Try the review questions that follow.

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Learning Objective 4

EXPLAIN AND APPLY INTERNAL


CONTROL TO CASH
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LO 4

Internal Control System


Barry and Best are celebrating their first six months in
business with their accounting professor. Net sales for the
first six months to 30 June was $400,000, more than four
times the original projection. Customers love their biscuits
and orders are streaming in from all over Singapore. They
expect to hit the million
dollaran
mark
for sales by end of 2015.
Implement
internal
control system in your
business. It We
will are
helpnow
to worried
that
we may not be
prevent fraud
and
able toand
be your
in control
safeguard assets
of our
business.
interests in the
business.

Lau Yin Kheng

LO 4

Fraud and Internal Control

A fraud occurs when an employee act dishonestly for


personal benefit at the cost of the employer.

Three factors contribute to fraudulent activities as depicted by


the fraud triangle below.
Opportunity

Financial Pressure
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Rationalization

LO 4

Internal Control System

Policies and procedures adopted to:

Safeguard assets.

Ensure the accuracy and reliability of accounting


records.

Increase operational efficiency.

Ensure adherence to companys policies and


compliance with laws and regulations.

All transactions affect cash and Cash is the asset


most susceptible to theft and fraud.
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LO 4

Internal Control Principles

Establish Responsibility
Assign responsibility and identify specific individual for a
given task at a time.
Cash receipts: only cashiers are authorised to handle
cash receipts
Cash payments: only authorised persons can sign
cheques and authorise payments.
Segregation of Duties
Responsibility for record keeping, custody of assets and
authorization should be separate.
Related activities should be assigned to different
individual.

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LO 4

Internal control Procedures

Documentation Procedures
Use prenumbered documents to account for all
documents. Source documents should be promptly
given to accounting department for timely recording.
Physical Controls
Relate to safeguarding of assets and enhance the
accuracy and reliability of the accounting records.
Cash and cheques to be deposited in bank account on a
daily basis.

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LO 4

Internal Control Procedures

Independent Internal Verification


Periodic check by an individual or department on the
work of another.
For example, Supervisors count cash receipts daily;
assistant treasurer compares total receipts to bank
deposits daily.
Human Resource Controls
Conduct background check.
Require employees to take vacations and rotate
employees duties.
Bond employees who handle cash.

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LO 4

Limitations of Internal Control

Costs should not exceed benefit.

Human element.
Ineffective internal control could be caused by
employees indifference, fatigue or negligence.
Employees in collusion can override the best controls.
Size of the business.
Small companies find it difficult to segregate duties.

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LO 4

Petty Cash Funds


Used for minor
expenditures.

Petty Cash
Funds

Has one
custodian.
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Replenished
periodically.

End of Learning Objective

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Objective!

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Learning Objective 5

PREPARE A BANK
RECONCILIATION AND EXPLAIN
ITS PURPOSE
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LO 5

Bank As A Control Over Cash


Safeguard cash by using a
bank as a depository.

Bank minimizes the amount


of cash on hand.

Bank creates a double


record for all bank
transactions.

Bank reconciliation.

Lau Yin Kheng

LO 5

Bank Reconciliation
Explains the difference between cash reported on bank
statement and cash balance on companys books and provides
information for reconciling journal entries.
Balance per Bank
+ Deposits in Transit (late
deposits not yet reflected in
the bank statement)
Outstanding Cheques
(Issued but not yet
presented to the bank)

Balance per Book


+ Deposits by Bank
(electronic transfers)
-Service Charge
-Giro payments,
-NSF or Cancelled Cheques

Bank Errors

Interest Revenue/ Expenses


Book Errors

= Adjusted Balance

= Adjusted Balance

Lau Yin Kheng

LO 5

Bank Reconciliation
The bank statement for Simmons Company indicated a cash
balance of $9,610 on 31st July. On this date, the cash ledger account
shows a balance of $7,430. Using 4 reconciling steps, Simmons
determine the following reconciling items:
STEP 1: Deposits in transit: Deposit received by bank
on 1st August.
STEP 2: Outstanding cheques: Totaled
STEP 3: Bank memoranda:
Debit: A customers NSF cheque
Credit: Interest on bank balance for July
STEP 4: Errors: Cheque 781 for supplies cleared the bank
for $268 but was erroneously recorded as $240.
A $486 deposit by Acme Company was
erroneously credited to our account by the bank.
Lau Yin Kheng

$500
$2,417
$225
$30
$28
$486

LO 5

Bank Reconciliation
Balance per bank statement, 31st July

9,610

Additions:
Deposit in transit (Step 1)

500

Deductions:
Outstanding cheques (Step 2)

Bank error (Step 4)

2,417
486

(2,903)

Adjusted cash balance

7,207

Balance per depositor's records, 31st July

7,430

Additions:
Interest (Step 3)

30

Deductions:
NSF cheque (Step 3)
Recording error (Step 4)
Adjusted cash balance
Lau Yin Kheng

225
28

(253)
$

7,207

LO 5

Reconciling Journal Entries


Reconciling journal entries for items in the bank statement
not yet recorded in the ledger and for errors in recording.
GENERAL JOURNAL
Date

Account Titles and Explanation

31 July Cash (A+)

Debit

Credit
30

Interest Revenue (R+)(OE+)


31 July Supplies (A+)
Accounts Receivable (A+)
Cash (A-)

Lau Yin Kheng

30
28
225
253

End of Learning Objective

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Objective!

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Learning Objective 6

EXPLAIN THE REPORTING OF


CASH
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LO 6

Cash and Cash Equivalents


Deposits in bank accounts - current accounts, savings
accounts, fixed deposits accounts etc.

Bank credit
card sales

Bank drafts

Cash & Cash


Equivalents are
disclosed together in
the balance sheet

Coins and
paper money

Cheques

Cash equivalents - short-term investments, usually with a


maturity date of less than three months, that have little risk of
market value changes. For example: Treasury Bills
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Reporting Other Cash


on the Balance Sheet

LO 6

Restricted Cash

Line of Credit

Including compensating
balance must be disclosed

Unused line of credit must


be disclosed as a note to
the accounts

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End of Learning Objective

You have come to the end of this Learning


Objective!
Try the review questions that follow.

Lau Yin Kheng