Chapter 4 revenue

 Record sales returns and allowances, sales discounts, and bank credit card sales.. Merchandise Returnsand Allowances  What happens when sales are recognized at the point of sale and a

Chapter 4

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

 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 company

Learning Objectives

After studying this chapter, you should

be able to:

 Estimate and interpret uncollectible

accounts and receivable balances

 Assess the level of accounts receivable

 Develop and explain internal control

procedures

Recognition of 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.

revenues are recorded.

 Accountants must carefully assess when revenue should be recognized

Recognition of Revenue

two-pronged test:

• The revenue is earned.

 Goods or services must be delivered to the customers.

• The revenue is realized.

 Cash or other assets must received.

Recognition of 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

exchange.

• For example, if one-fourth of the work is

completed in the first year, one-fourth of the revenue should be recognized.

Measurement of Revenue

cash equivalent value of the asset

Merchandise Returns

and 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

customer’s perspective

Merchandise Returns

and 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

customer’s perspective

Merchandise Returns

and 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.

To record the returns and allowances:

Sales returns and allowances 200 Accounts receivable 200

Merchandise Returns

and Allowances

amount reported as sales.

• Trade discounts

• Cash discounts

Merchandise Returns

and Allowances

 Trade discounts - reductions to the gross selling price for a particular class of

customers to arrive at the actual selling

price (invoice price)

• 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 Returns

and Allowances

 Cash discounts - reductions of invoice

prices awarded for prompt payment of the invoice

manufacturer’s or seller’s need for cash

• Reduces the risk of bad debts

(nonpayment)

 Purchasers should always take purchase discounts if possible

Accounting for Net Sales Revenue

 Cash discounts and sales returns and allowances are recorded as deductions from gross sales.

Deduct:

Sales returns and allowances $200

Cash discounts on sales 550 750

Accounting for Net Sales Revenue

different systems for accounting for net sales.

• The preceding example shows sales,

sales returns and allowances, and cash discounts in separate accounts

• Net sales can be shown in one account

where all sales returns and allowances and cash discounts directly decrease the sales account

cash equivalents on their balance

sheets.

• Cash equivalents - highly liquid

short-term investments that can easily and

quickly be converted into cash

are accepted for deposit

by a bank.

• Paper money, coins, money orders,

and checks

Credit Sales and Accounts 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 receivables

• The main benefit of granting credit is a

boost in sales and profits that would

otherwise be lost if credit were not

extended

Assessing the Level of Accounts Receivable

ability of the company to control

accounts receivable.

• They often use accounts receivable

turnover for measuring that ability

receivable accounts

Average

sales

Credit turnover

Assessing the Level of Accounts 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 of Accounts Receivable

collection period) - an indication of

how long it takes to collect money

after a sale is made

turnover A/R

days

365 A/R

collect to

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:

References:

Horngren, Introduction to financial accounting