Accounting for Sales - PowerPoint PPT Presentation

1 / 70
About This Presentation

Accounting for Sales


Accounting for Sales Learning Objectives After studying this chapter, you should be able to: Recognize revenue items at the proper time on the income statement. – PowerPoint PPT presentation

Number of Views:29
Avg rating:3.0/5.0
Slides: 71
Provided by: Autho137


Transcript and Presenter's Notes

Title: Accounting for Sales

Chapter 5

Accounting for Sales
Learning Objectives
  • After studying this chapter, you should be able
  • Recognize revenue items at the proper time on the
    income statement.
  • Account for cash and credit sales.
  • Record sales returns and allowances, sales
    discounts, and bank credit card sales.
  • Manage cash and explain its importance to the

Learning Objectives
  • After studying this chapter, you should be able
  • Estimate and interpret uncollectible accounts and
    receivable balances.
  • Assess the level of accounts receivable.
  • Develop and explain internal control procedures.

Recognition of Sales Revenue
  • The timing of revenue recognition is critical to
    the measurement of net income.
  • Revenue is part of the calculation of net income.
  • Net income Revenue - Expenses
  • Measurement of revenue sometimes determines when
    a company recognizes certain expenses because of
    the matching principle.
  • Expenses must be recognized in the same period as
    the revenues that create the expenses.

Recognition of Sales Revenue
  • Some users of financial information
    want revenues to be recorded as soon
    as possible.
  • Others want to be sure that a company
    will actually receive payment before
    revenues are recorded.
  • Accountants must carefully assess when revenue
    should be recognized.

Recognition of Sales Revenue
  • Recognition of revenue requires a two-pronged
  • The revenue is earned.
  • Goods or services must be delivered to the
  • The revenue is realized.
  • Cash or other assets must be received.

Recognition of Sales Revenue
  • Most revenues are recognized at the point of sale
    (when goods are sold and cash changes hands).
  • At this point, both recognition tests are met.
  • Sometimes the tests are not always met at the
    same time. This results in unearned revenue.
  • Cash is received, but nothing is given in

Recognition of Sales Revenue
  • What happens if revenue on one sale is earned
    over a long period of time, for example, on a
    long-term contract?
  • Generally, the revenue from a long-term contract
    should be recognized as the work on that contract
    is performed.
  • For example, if one-fourth of the work is
    completed in the first year, one-fourth of the
    revenue should be recognized.

Measurement of Sales Revenue
  • Revenue is measured in terms of the cash
    equivalent value of the asset received.
  • Journal entries to record sales
  • Cash xxxx
  • Sales revenue xxxx
  • OR
  • Accounts receivable xxxx
  • Sales revenue xxxx

Merchandise Returnsand Allowances
  • What happens when sales are recognized at the
    point of sale and a customer returns the goods
    that were sold?
  • Sales returns - products returned to the seller
    by the purchaser for various reasons
  • These are purchase returns from the customers

Merchandise Returnsand Allowances
  • Sometimes, instead of returning merchandise, the
    customer demands a reduction, (a sales allowance)
    in the selling price.
  • Sales allowance - reduction of the original
    selling price, which is the price previously
    agreed upon by both parties
  • These are purchase allowances from the customers

Merchandise Returnsand Allowances
  • Usually, a contra account called Sales Returns
    and Allowances is used to accumulate both sales
    returns and sales allowances.
  • By using a contra account, the amount of gross
    sales is readily available, which allows managers
    to monitor the level of returns and allowances
    for various reasons.
  • Using the contra account avoids changing the
    original sales entry for the amounts returned.

Merchandise Returnsand Allowances
  • Journal entries for returns and allowances
  • To record the sale
  • Accounts receivable 900,000
  • Sales revenue 900,000
  • To record the returns and allowances
  • Sales returns and allowances 80,000
  • Accounts receivable 80,000

Merchandise Returnsand Allowances
  • Gross sales - total sales revenue before
    deducting sales returns and allowances, if any
  • Net sales - total sales revenue reduced by sales
    returns and allowances
  • Income statement presentation
  • Gross sales 900,000
  • Less Sales returns and allowances 80,000
  • Net sales 820,000

Merchandise Returnsand Allowances
  • Discounts on sales also affect the amount
    reported as sales.
  • Two major types of discounts
  • Trade discounts
  • Cash discounts

Merchandise Returnsand Allowances
  • Trade discounts - reductions to the gross selling
    price for a particular class of customers to
    arrive at the actual selling price (invoice
  • Trade discounts are generally price concessions
    or purchase incentives.
  • The gross sales revenue recognized from a trade
    discount is the price received after deducting
    the discount.

Merchandise Returnsand Allowances
  • Cash discounts - reductions of invoice prices
    awarded for prompt payment of the invoice
  • Encourage prompt payment and reduce
    manufacturers or sellers need for cash
  • Reduces the risk of bad debts (nonpayment)
  • Purchasers should always take purchase discounts
    if possible.

Recording Charge Card Transactions
  • Cash discounts also occur when retailers accept
    charge cards.
  • Retailers accept charge cards for three reasons
  • To attract credit customers who would otherwise
    shop elsewhere
  • To get cash immediately rather than wait for
    customers to pay
  • To avoid the cost of keeping track of many
    customer accounts

Recording Charge Card Transactions
  • Retailers deposit the charge slips in the bank
    (just like cash), but this costs money (usually
    from 1 to 3 of gross sales).
  • This cost must be included in the calculation of
    net sales.
  • 10,000 of sales where the charge card company
    charges 3
  • Cash 9,700
  • Cash discounts for bank cards 300
  • Sales 10,000

Accounting forNet Sales Revenue
  • Cash discounts and sales returns and allowances
    are recorded as deductions from gross sales.
  • Gross sales 20,000
  • Deduct
  • Sales returns and allowances 200
  • Cash discounts on sales 550 750
  • Net sales 19,250

Accounting forNet Sales Revenue
  • The income statement allows different systems for
    accounting for net sales.
  • The preceding example shows sales, sales returns
    and allowances, and cash discounts in separate
  • Net sales can be shown in one account where all
    sales returns and allowances and cash discounts
    directly decrease the sales account.

  • Many companies combine cash and cash equivalents
    on their balance sheets.
  • Cash equivalents - highly liquid short-term
    investments that can easily and quickly be
    converted into cash
  • Cash encompasses all items that
    are accepted for deposit by a bank.
  • Paper money, coins, money orders,
    and checks

Compensating Balances
  • Compensating balances - required minimum cash
    balances on deposit when money is borrowed from
  • The size of the compensating balance usually
    depends on the amount borrowed.
  • Annual reports must disclose the state of any
    significant compensating balances.
  • Without such a disclosure, readers might think
    that a company has more cash available than it
    really does.

Management of Cash
  • Managers spend much time managing cash for
    several reasons.
  • Although cash balances may be small at any one
    time, the flow of cash can be enormous.
  • Because cash is the most liquid asset, it is
    enticing to thieves and embezzlers.
  • Adequate cash is essential to the smooth
    functioning of operations.
  • Cash itself does not earn income. It is
    important not to hold excess cash it should be

Management of Cash
  • To reconcile a bank statement means to verify
    that the bank balance for cash is consistent with
    the accounting records.
  • The accounting balance and the bank balance are
    rarely the same.
  • Deposits and checks are recorded in the books
    when made or written.
  • Banks may receive the deposits or process the
    checks days later.

Management of Cash
  • Internal control procedures to safeguard cash
  • The individuals who receive cash do not also
    disburse cash.
  • The individuals who handle cash cannot access
    accounting records.
  • Cash receipts are immediately recorded and
    deposited and are not used directly to make
  • Disbursements are made by serially numbered
    checks, only with proper authorization by someone
    other than the person writing the check.
  • Bank accounts are reconciled monthly.

Credit Sales andAccounts Receivable
  • Accounts receivable - amounts owed to a company
    by customers as a result of delivering goods or
    services and extending credit in the ordinary
    course of business
  • Also known as trade receivables or simply
  • The main benefit of granting credit
    is a boost in sales and
    profits that would
    otherwise be lost if credit
    were not extended.

Uncollectible Accounts
  • Uncollectible accounts (bad debts) - receivables
    determined to be uncollectible because debtors
    are unable or unwilling to pay their debts
  • Uncollectible accounts are a major cost of
    granting credit to customers.
  • Accountants call this cost bad debts expense.
  • Extent of nonpayment can vary greatly with size
    of companies and industries and depend on the
    credit risk that managers are willing to accept.

Measurement ofUncollectible Accounts
  • Two basic ways to record uncollectibles
  • Specific write-off method - wait to see which
    receivables will not be paid and write them off
    at that time
  • Allowance method - make estimates
    of the portion of accounts receivable
    that will not be collected

Specific Write-off Method
  • The specific write-off method assumes that all
    sales are fully collectible until proved
  • This method is used by companies that rarely
    experience bad debts.
  • When an account is identified as uncollectible,
    that account is removed from the books and an
    expense is recorded.
  • Bad debts expense xxxx
  • Accounts receivable xxxx

Specific Write-off Method
  • Disadvantage
  • It fails to apply the matching principle
    (expenses must be recorded in the same period
    as the related revenues) if the receivable is
    written off in a period other than when the
    receivable is recorded.
  • Advantages
  • It follows the cost-benefit concept because it is
    simple and extremely inexpensive to use.
  • If amounts of bad debts are small (immaterial),
    no great error in measurement of income occurs.

Allowance Method
  • The allowance method estimates the amount of
    uncollectible accounts to be matched to the
    related revenue.
  • It allows accountants to recognize bad debts
    during the proper period, before specific
    uncollectible accounts are identified
    in a subsequent period.

Allowance Method
  • The allowance method has two basic elements
  • An estimate of the amounts that will ultimately
    be uncollectible
  • A contra account, Allowance for Uncollectible
    Accounts, which contains the estimate and is
    deducted from Accounts Receivable
  • The allowance method is based on historical
    experience and the assumption that the current
    year is similar to prior years.

Allowance Method
  • Presentation of Accounts Receivable under the
    allowance method
  • Accounts receivable 40,000
  • Less Allowance for uncollectible accounts
  • Net accounts receivable 38,000

Applying the Allowance Method Using a Percentage
of Sales
  • Percentage of sales method - an approach to
    estimating bad debts expense and uncollectible
    accounts based on historical relations between
    credit sales and uncollectibles
  • Bad debts are assumed to be some percentage of

Applying the Allowance Method Using a Percentage
of Sales
  • Echo Company has 150,000 in credit sales.
    Historically, 2 of credit sales are determined
    to be uncollectible. During the year, Echo
    Company determines that 2,000 of receivables
    will not be collected. What are the entries to
    record the sales, establish the Allowance
    account, and write off the uncollectible accounts?

Applying the Allowance Method Using a Percentage
of Sales
  • The entry to record the sales
  • Accounts receivable 150,000
  • Sales 150,000
  • The entry to record the estimate for bad debts
  • Bad debts expense 3,000
  • Allowance for uncollectible accounts
  • The entry to record actual uncollectible
  • Allowance for uncollectible accounts 2,000
  • Accounts receivable 2,000

Applying the Allowance Method Using a Percentage
of Accounts Receivable
  • Percentage of accounts receivable method - an
    approach to estimating bad debts expense and
    uncollectible accounts at year end using the
    historical relations of
    uncollectibles to accounts

Applying the Allowance Method Using a Percentage
of Accounts Receivable
  • The Allowance for Uncollectible accounts is used
    to estimate the approximate amount of bad debts
    included in the ending Accounts Receivable.
  • Additions to Allowance for Uncollectible Accounts
    are calculated to achieve a desired ending
    balance in the Allowance account.
  • An adjusting journal entry is made to adjust the
    balance in the Allowance account to the desired
    balance at the end of the year.

Applying the Allowance Method Using a Percentage
of Accounts Receivable
  • Calculating the allowance under the percentage of
    receivables method
  • Divide average bad debts by average ending
    balance of Accounts Receivable to calculate the
    historical average uncollectible percentage.
  • Apply the percentage from step 1 to the ending
    Accounts Receivable balance to determine the
    desired ending balance in the Allowance account
    at the end of the year.
  • Prepare an adjusting entry to adjust the
    Allowance account to the amount determined in
    step 2.

Applying the Allowance Method Using the Aging of
Accounts Receivable
  • Aging of accounts receivable method - an analysis
    that considers the composition of year-end
    accounts receivable based on the ages of the
  • The more time elapses after the sale, the less
    likely collection of the receivable becomes.
  • The aging gives a desired balance in the
    Allowance account just as the percentage of
    accounts receivable method does however, the
    amount desired in the Allowance account will
    probably be somewhat different.

Applying the Allowance Method Using the Aging of
Accounts Receivable
  • Accounts receivable aging schedule
  • 1-30 days 31-90 days Over 90 days Total
  • Accounts
  • receivable 70,000 30,000 2,000
  • Percentage 1 2
  • 700 600 1,800 3,100

  • 3,100 is the desired amount in the Allowance
    account. A journal entry will be made to adjust
    the Allowance account to that amount.

Bad Debt Recoveries
  • Sometimes accounts will be collected after they
    have been written off.
  • When this happens, the write-off should be
    reversed and the collection handled as a normal
    receipt on account.

Assessing the Level ofAccounts Receivable
  • Management should monitor the ability of the
    company to control accounts receivable.
  • They often use accounts receivable turnover for
    measuring that ability.

Assessing the Level ofAccounts Receivable
  • Accounts receivable turnover indicates how
    rapidly collections of accounts receivable occur.
  • The ratio tells how many times, on average,
    accounts receivable turn over during the year.
  • Higher turnovers indicate that receivables are
    collected quickly.
  • Lower turnovers indicate that receivables are
    collected more slowly.

Assessing the Level ofAccounts Receivable
  • Days to accounts receivable (average collection
    period) - an indication of how long it takes to
    collect money after a sale is made

Overview of Internal Control
  • The purpose of internal control is the creation
    of a system of checks and balances that assures
    that all actions occurring within a company are
    in accord with organizational objectives and have
    the general approval of top management.
  • At one level, internal control seeks to tie daily
    decisions to corporate strategy.
  • At another level, internal control refers to the
    protection of firm assets from theft or loss.

Overview of Internal Control
  • Types of controls
  • Administrative controls - all methods and
    procedures that facilitate management planning
    and control of operations
  • Accounting controls - the methods and procedures
    for authorizing transactions, safeguarding
    assets, and ensuring the accuracy of the
    financial records

Overview of Internal Control
  • Internal accounting controls should provide
    reasonable assurance concerning
  • Authorization - Transactions are executed in
    accordance with managements general or specific
  • Recording - All authorized transactions are
    recorded in the correct amounts, periods, and
    accounts. No fictitious transactions are
  • Safeguarding - Precautions and procedures
    appropriately restrict access to assets.

Overview of Internal Control
  • Internal accounting controls should provide
    reasonable assurance concerning
  • Reconciliation - Records are compared with other
    independently kept records and physical counts.
  • Such comparisons help ensure that other control
    objectives are attained.
  • Valuation - Recorded amounts are periodically
    reviewed for impairment of values and necessary

Overview of Internal Control
  • The first three objectives, authorizing,
    recording, and safeguarding, are related to
    establishing the system of accountability and are
    aimed at the prevention of errors and
  • The fourth and fifth objectives, reconciliation
    and valuation, are aimed at detecting errors and
  • A sixth objective of internal control is to
    promote operating efficiency.

The Accounting System
  • Accounting system - a set of records, procedures,
    and equipment that routinely deals with the
    events affecting the financial performance and
    position of the entity
  • The focus of the accounting system is on
    repetitive, voluminous transactions that fall
    into four categories
  • Cash disbursements
  • Cash receipts
  • Purchase of goods and services, including payroll
  • Sales or other rendering of goods and services

The Accounting System
  • Most accounting systems make use of computers
    and data processing to handle the
    enormous number of
    transactions that occur
    each day.
  • Well-designed and well-run accounting systems are
    positive contributions to the organization.

Managements Responsibility
  • Although outside auditors attest to the financial
    reports of an entity, management bears the
    responsibility for a companys financial
  • Management reports - explicit statements in
    annual reports of publicly held companies that
    management is responsible for all audited and
    unaudited information in the annual report

The Audit Committee
  • Audit committee - a committee of the board of
    directors that oversees the internal accounting
    controls, financial statements, and financial
    affairs of the corporation

The Audit Committee
  • The committee provides contact and communication
    among the board, the external auditors, the
    internal auditors, the financial executives, and
    the operating executives.
  • The committee is typically composed of members
    from inside the company (managers) and
    outside the company (nonemployees).

Checklist of Internal Controls
  • Good internal control systems have certain
    features in common. The following checklist
    summarizes the guidance found in much of
    the systems and auditing literature.

Checklist of Internal Controls
  • Reliable Personnel with Clear Responsibilities
  • The most important element of successful control
    is personnel.
  • Bad personnel can undermine the system, no matter
    how good that system is.
  • Assigning responsibility means tracking actions
    as far down in the organization as possible so
    that results can be related to individuals.
  • Have sales clerks sign sales slips.
  • Have workers sign time cards.
  • Many retailers assign each cashier a separate
    money tray.

Checklist of Internal Controls
  • Separation of Duties
  • Separation of duties means that responsibility
    for a sequence of related operations should be
    divided among two or more persons.
  • This separation of duties makes it hard for one
    person, acting alone, to defraud the company.
  • Examples of separation of duties
  • One individual should not authorize payment of an
    invoice and also sign the check to pay that
  • One individual should not handle cash receipts
    and post receipts to accounts receivable.

Checklist of Internal Controls
  • Proper Authorization
  • General authorization - usually found in writing
    - often sets limits on what price to pay, what
    price to receive, what credit limits to grant to
    customers, etc.
  • Specific authorization - means that a superior or
    manager must authorize any particular deviations
    from the limits set by general authorizations.
  • Examples of proper authorization
  • A manager may have to approve overtime.
  • A manager may have to approve the return of

Checklist of Internal Controls
  • Adequate Documents
  • Immediate, complete, and tamper-proof recording
    is the aim of adequate documentation, especially
    for handling cash sales.
  • It is encouraged by
  • Optical scanning of bar-coded data
  • Having all source documents prenumbered and
    accounted for
  • Using devices such as cash registers
  • Designing forms for ease of recording

Checklist of Internal Controls
  • Proper Procedures
  • Most organizations use procedures manuals to
    specify the flow of documents and provide
    instructions to facilitate adequate record
  • This basically means doing things by the book.
  • Routine and automatic checks
    are often used.

Checklist of Internal Controls
  • Physical Safeguards
  • Losses can be minimized by using safes, locks,
    guards, and limited access.
  • Examples of physical safeguards
  • Require all visitors to sign a register and
    wear name tags.
  • Doors to research areas or computer
    facilities can be opened only
    special keys or by the use of a
    specific code.

Checklist of Internal Controls
  • Bonding, Vacation, and Rotation of Duties
  • Rotating employees and mandatory vacations ensure
    that more than one employee knows how to do each
  • They also discourage employees from engaging in
    fraudulent activities that might be discovered
    when someone else has access to their records.
  • Bonding is like buying insurance
    against embezzlement, but it is
    not a
    substitute for prevention of the loss.

Checklist of Internal Controls
  • Independent Check
  • All phases of the system should be subjected to
    periodic review by outsiders, such as independent
    external auditors, and by internal auditors.
  • Independent auditors can spot weaknesses that
    management might miss during day-to-day
  • Internal auditors are company employees who help
    design control systems and assess the degree of
    compliance with the existing systems.

Checklist of Internal Controls
  • Cost-Benefit Analysis
  • Investments in more costly systems must be
    compared with the expected benefits.
  • No internal control system is perfect in the
    sense that it can prevent all fraud.
  • The goal of designing an internal control system
    is to design a cost-effective tool that will help
    achieve efficient operations and reduce

Bank Reconciliations
  • Bank reconciliation - the analysis that details
    the items responsible for the difference between
    the cash balance reported in the bank statement
    and the balance of the Cash account in the ledger
  • A bank reconciliation is prepared each month by
    the depositor to make sure that all cash receipts
    and disbursements are accounted for by the bank.

Bank Reconciliations
  • Most bank reconciliations have two sections
  • Balance per books
  • Adjustments are made for items not entered in the
    books but already entered by the bank.
  • Balance per bank
  • Adjustments are made for items not entered by the
    bank but already entered in the books.
  • After adjustments, each section should end with
    identical adjusted cash balances.

Bank Reconciliations
  • Basic form of a bank reconciliation
  • Balance per books
  • Add Amounts collected by the bank on behalf of
    the depositor
  • Deduct Bank service charges
  • Checks returned for insufficient
    funds from customers
  • Adjusted balance per books
  • Balance per bank
  • Add Deposits not recorded by the bank
  • Deduct Outstanding checks
  • Adjusted balance per bank

Introduction to Financial Accounting8th
EditionPowerPoint Presentation

Developed by Eddie Metrejean, MTAX,
CPA University of Mississippi Images provided by
New Vision Technology 1-800-387-0732
Write a Comment
User Comments (0)