AFM101 Textbook and lecture Notes on Chapter 7: reporting and interpreting sales revenue, receivables and cash.docx

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University of Waterloo
Accounting & Financial Management
AFM 101
Donna Psutka

Chapter 7: reporting and interpreting sales revenue, receivables and cash  Gross profit = net sales – COGS  FOB shipping – buyer pays and ownership is the buyer’s o Revenue recognized at shipment: title and risk transferred to buyer  FOB destination – seller pays and ownership remains with seller until buyer receives it o Revenue recognized at delivery  Motivating customers to buy and pay for its products 1. Allowing customers to use credit cards; treated as cash payments a. Involves credit card discount: fee charged by the credit card company 2. Providing credit and discounts for early payment 3. Allowing returns a. These all impact net sales revenue 1. If daily credit sales were $3 000, company would report Sales revenue $3000 Less: credit card discounts (0.03 x 3000) (90) Net sales (reported on Income statement) $2910 Sales discounts to businesses Benefits of giving sales discount  Prompt receipt of cash from customers reduces the necessity to borrow money to meet operating needs  Decreases likelihood that customer will run out of funds before invoice is paid  Similar to allowing the use of credit cards: attractive service, promote faster receipt of cash thereby reducing recordkeeping costs and minimizing bad debts 2. Giving sales discount of 2/10 n/30 on $1 000 sales, company would report (if it is within discount period) Sales revenue $1000 Less: sales discount (0.02 x 1000) (20) Net sales (reported on income statement) $980 Amount saved ÷ amount paid = interest rate/ days of discount Annual interest rate = interest rate for (x) days x 365 days 3. Customer bought $2000 worth of merchandise but returned 500 of them, company would record Sales revenue $2000 Less: sales returns (500) Net sales (reported on income statement) $1 500  Credit card discounts, sales discounts and sales return and allowances are contra revenue accounts Gross profit percentage  Measures how much gross profit is generated from every sales dollar  Higher gross profit = higher profit  Ratio used to assess the effectiveness of company’s product development, marketing and production strategy Measuring and reporting receivables Classifying receivables 1. Can be trade or non-trade receivables a. Trade receivable: open accounts owed to business by trade customers b. Non-trade receivable: arises from transactions other than the normal sale of merchandise or services ex. Gildan loaned money to key employees to assist them in financing the purchase of their first homes. 2. May be account receivable or note receivable a. Account receivable: sale of products on open account to customers or when company expects to receive payment from other parties b. Note receivable: written promise by another company with amount, time and interest 3. Can be current or non-current (short or long term) depending on when cash is expected to be collected Accounting for bad debts  Matching process requires the recording of bad debt expense in the same accounting period in which related sales are made  Two methods of estimating bad debts Allowance method: 1. Estimating and recording bad debt expense 2. Writing off specific accounts determined to be uncollectible during period e.g. Gildan estimated bad debt expense to be $6000, adjusting entry: Bad debt expense 6000 Allowance for doubtful accounts 6000  AFDA is a contract asset account which is subtracted from the balance of trade receivables o Entry decreases net realizable value of trade receivables and total assets Write off: determined that customer cannot pay AFDA 2800 Trade receivable 2800  Does not affect income statement accounts  Did not change carrying amount of trade receivables – decrease in trade receivables was offset by decrease in AFDA thus did not affect total assets Recovery of write off: Cash 200 Trade receivables 200 Trade receivables 200 AFDA 200  Reopening of what was previously written off  Account for cash collected  Net effect of recovered amount on trade receivables is zero Estimating bad debts Aging of trade receivables method - Total of estimated uncollectible is ending balance for AFDA  This is the estimated ending balance - Adjustment figure is your bad debt expense - If the adjustment figure is debit amount, means company underestimated its uncollectible - Increase in AFDA reflects management’s increased concern that additional customers may default on their debt Percentage of credit sales method - Calculated based on historical percentage of credit sales that result in bad debts - Average percentage of credit sales = total bad debts/total credit sales - amount is directly recorded as bad debt expense and credit increase to AFDA Comparing two methods Aging of trade receivables - computes final ending balance in allowance for double accounts - bad debt expense is difference between estimated uncollectible accounts and balance of allowance for doubtful accounts at the end of period before the adjusting entry is made - beginning balance of allowance account – write offs + bad debt expense (inferred) = ending AFDA balance (computed) Percentage of credit sales - directly compute amount for bad debt expense - beginning balance of allowance account – write offs + bad debt expense (computed) = ending AFDA balance (inferred) When estimates are found to be incorrect, financial statement values for prior annual accounting periods are not corrected Prudence in valuation of trade
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