B ANK RECONCILIATION AND RECEIVABLES
1. Recording sales revenues and related items
2. Accounting for sales discounts
3. Accounting for bad debts
4. Internal controls
5. Bank reconciliations and adjusting entries A CCOUNTING FOR SALES R EVENUE
Recall the revenue recognition principle: recognize revenues when the following three
conditions are met:
1. The earnings process is complete or nearly complete,
2. An exchange transaction takes place, and
3. Collection is reasonably assured
Despite its simple definition, the application of revenue recognition in practice is not that
straightforward. In this chapter you w ill learn about revenue recognition for
merchandising firms that do not engage in installment sales. For sales transactions, the
earnings process is considered complete when goods are delivered. The determination of
when the delivery of goods takes place is subject to the shipping terms. In this chapter
we will consider only two common shipping terms:
1. F.O.B. Shipping Point: The title of the goods passes from the seller to the buyer as
the goods are loaded on the truck or the container at the seller’s location. The
seller should recognize the revenue at that point.
2. F.O.B Destination: The title of the goods passes from the seller to the buyer when
the goods are delivered to the buyer at the buy er’s location. The seller cannot
recognize revenue before this point.
Reporting sales on the income statement
Sales are reported on the income statement net of the following three Contra-revenue
1. Credit card discounts: when companies accept a credit card as a payment for a
sale, they must pay a fee for the credit card company. That fee is called “credit
card discount” and is a contra-revenue account. Contra-revenue accounts reduce
2. Sales Returns and Allowances: a contra revenue account that accumulates sales
returns and allowances. Sales returns ar e products returned by customers, and
customers receive full credit. Sales allowances occur when customers receive a
credit from the company for keeping low quality merchandise.
3. Sales discounts: also cal led cash discounts, and they are offered to credit
customers to encourage early payments. Sales discounts are expressed as follows:
2/10, n/30, which means that buyers will receive two percent discount if they pay
within ten days, and the total amount is due in 30 days. Another term for sales
discounts is Cash Discounts. Sales discounts should not be confused with trade
discounts, which are discounts given by the seller for bulk purchases.
Net sales are reported on the income statement as follows:
Sales returns and allowances xx
Sales discounts xx (xx)
salest xx Contra revenue accounts are reported separately to allow the management to learn about
sales and credit cards discounts and the sales returns and allowances.
A CCOUNTING FOR S ALES D ISCOUNTS
Sales and receivables are recorded at te gross amount. Sales discounts taken by
customers are debited to the Sales Disounts account, only when the customer pays
within the discount period. The sales discount is a contra revenue account, and hence, is
reported in the income statement as a reduction of sales.
On June 24, 2007 XYZ Inc. sold to ABC Inc. goods for $20,000 on credit with the
following terms: (2/10, n/30). On July 2, 2007, ABC paid 60% of the June 24 invoice
XYZ Co. On July 23, 2007 ABC paid the bala nce of their account to XYZ Co. Prepare
the journal entries for above transactions on the books of XYZ Inc. under both the gross
method and the net method.
June 24, 2007
July 2, 2007
The payment was made during the discount period
Sales discount = (60% x 20,000) x 2% = $240
Cash received = (60,000 x 20%) – 240 = $11,760
Sales discount 240
July 23, 2007
No discount will be given for this payment
Remaining balance on A/R= 20,000 -12,000 = $8,000
A/R,000 A CCOUNTING FOR B AD D EBTS
Accounts receivable are amounts owed by customers as a result of buying the
company’s goods and services on account. Ther e is usually no formal written agreement
of the terms, other than the detailson the sales invoice. Invoices and shipping
documents usually provide the necessary eviden ce of proof that a receivable exists. The
time period is usually sh ort (between 30 to 60 da ys), and interest is not usually charged.
However, interest may be required if the customer does not make payment within the
specified time period.
It is highly unlikely that a company that extends credit to its customers will be successful
in collecting all of its receivables. Uncollectible accounts are receivables determined to
be uncollectible because debtors are unable or unwilling to pay their debts. Uncollectible
accounts are a major cost of granting cto customers and are called- Bad Debts
There are two methods to account for receivables that ultimately prove to be
uncollectible: the direct write-off method and the allowance method.
THE DIRECT W RITE-OFFM ETHOD
The direct write-off method assumes that all sales are fully collectible until proved
otherwise. We should wait to see which receivables will not be paid and write them off
at that time. Thus, it ignores the efof bad debts and the possibility that some
receivable might not be paid until it actually happened.
The method recognizes the unc ollectible account in the period in which the company
determines that the account is uncolltible. When an account is identified as
uncollectible, that account is removed from the books by reducing the AR and an expense
is recorded in the following journal entry:
x R / A
Although it is simple and extremely inexpensive to use, the direct write-off method fails
to apply the matching principle (expensesbe 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.
The direct is not allowed under GAAP.
THE ALLOWANCE M ETHOD :
The allowance method estimates the amount of A/R that will ultimately be uncollectible.
It allows accountants to recognize bdebts during the period in which accounts
receivable originated, before specific uncollectible accounts are identified in a subsequent
period. The allowance method requires a year-end estima te of expected uncollectible accounts
based upon credit sales or outstanding receivables. The estimate is recorded via an
adjusting entry by debiting an expense, and crediting an allowance account in the period
in which the sale is recorded.
Allowance for Doubtful Accounts xx
When an account is deemed to be uncollectib le, an entry is made debiting the allowance
account and crediting accounts receivable.
Allowance for Doubtful Accounts xx
x xR / A
The allowance method provides for a proper ma tching of revenues and expenses as well
as reflecting a proper carrying value for accounts receivable at the end of the period (i.e.,
faithful representation). When the allowan ce method is used, the estimated amount of
uncollectible accounts is normally based upon a percentage of sales or outstanding
The allowance method has two basic elements:
1. The estimation of the amount of receivables that will be uncollectible.
2. The establishment of a c ontra asset account (allow ance for doubtful accounts),
which is deducted from accounts receivable
Presentation of Accounts Receivable under the allowance method:
Accounts receivable $40,000
Less: Allowance for uncollectible accounts (2,000)
Net accounts receivable $38,000
Calculating bad debt expense under the allowance method
There are two methods to calculate the bad debt expense under the allowance method: (a)
the percentage-of-sales method, and (b) the percentage-of-receivables (or the aging)
The percentage-of-sales method (The Income Statement Approach)
This method attempts to match costs with reve nues, and is frequently referred to as the
income statement approach. Under the per centage-of-sales method, the amount recorded
as bad debts expense is the amount determin ed by multiplying the estimated percentage
of uncollectible credit sales times the credit sales.
Example: Martin Company has $150,000 in credit sales. Historically, 2% of credit sales
are estimated to be uncollectible. During the year, Martin Company determines that
$2,000 of receivables to be uncollectible. Wh at are the entries to record the sales,
establish the Allowance account, and write off the uncollectible accounts? The entry to record the sales:
The entry to record the estimate for bad debts:
Bad debts expense 3,000
Allowance for uncollectible accounts 3,000
The entry to record actual uncollectible accounts:
Allowance for bad debts 2,000
Accounts receivable 2,000
The percentage-of-receivables method (The Balance Sheet Approach)
Percentage of accounts receivable method - an approach to estimating bad debts expense
and uncollectible accounts at year end using the historical relations of uncollectible
amounts to 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.