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The company's allowance for doubtful accounts has an unadjusted credit balance of $12,000 at December 31, 2015. Based on

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Week 8/9, Chap6 Accounting 1A, Financial Accounting Reporting and Interpreting Sales Revenue, Receivables, and Cash

Instructor: Michael Booth

Learning Objectives Analyze a company’s performance based on return on equity, assets and its components.

Return on Equity (ROE) Return = on Equity

Net Income Average Stockholders’ Equity1

ROE measures how much the firm earned for each dollar of stockholders’ investment. Note: 1(beginning

equity + ending equity) ÷ 2

ROE Profit Driver Analysis

11.3%

=

$169,022 $7,000,000

×

$169.022 $1,493,774

Net Income Net Sales

×

Asset Turnover

Net Sales Average Total Assets

$7,000,000 $2,050,912

×

Financial Leverage

Average Total Assets Average Stockholders’ Equity

×

Net Income Average Stockholders’ = Equity

Net Profit Margin

×

=

×

ROE

$2,050,912 1,493,774

Return on Equity (ROA) Return = on Assets

Net Income Average Total Assets

ROA measures how much the firm earned for each dollar of investment. It is the broadest measure of profitability and management effectiveness, independent of financing strategy. Note: 1(beginning

Total Assets + ending Total Assets) ÷ 2

ROA Profit Driver Analysis

$169,022 $2,050,912

8.2%

Net Profit Margin

=

Net Income Net Sales

=

$169,022 $2,990,520

×

Asset Turnover

Net Sales Average Total Assets

×

Net Income Average Total Assets

=

×

ROA

$2,990,520 $2,050,912

Profit Driver Analysis 1. Net profit margin. Net profit margin is Net Income ÷ Net Sales. It measures how much of every sales dollar is profit. It can be increased by a. Increasing sales volume. b. Increasing sales price. c .Decreasing cost of goods sold and operating expenses. 2. Total asset turnover (efficiency). Total asset turnover is Net Sales ÷ Average Total Assets. It measures how many sales dollars the company generates with each dollar of assets. It can be increased by a. Collecting accounts receivable more quickly. b. Centralizing distribution to reduce inventory kept on hand. c. Consolidating production facilities in fewer factories to reduce the amount of assets necessary to generate each dollar of sales.

Profit Drivers and Business Strategy High-value or product-differentiation. Rely on R&D and product promotion to convince customers of the superiority of your product.

Low-Cost.

Rely on efficient management of accounts receivable, inventory and productive assets to produce high asset turnover.

Learning Objectives Apply the revenue principle to determine the accepted time to record sales revenue for typical retailers, wholesalers, manufacturers, and service companies.

Accounting for Sales Revenue The revenue principle requires that revenues be recorded when earned: Goods or services have been delivered. Amount of customer payments known. Collection is reasonably assured.

Learning Objectives Analyze the impact of credit card sales, sales discounts, and sales returns on the amounts reported as net sales.

Reporting Net Sales Companies record credit card discounts, sales discounts, and sales returns and allowances separately to allow management to monitor these transactions.

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

Credit Card Sales to Consumers Companies accept credit cards for several reasons: 1. To increase sales. 2. To avoid providing credit directly to customers. 3. To avoid losses due to bad checks. 4. To avoid losses due to fraudulent credit card sales. 5. To receive payment quicker.

When credit card sales are made, the company must pay the credit card company a fee for the service it provides.

Credit Card Sales When credit card sales are made, the company must pay the credit card company a fee for the service it provides.

When companies allow customers to purchase merchandise on an open account, the customer promises to pay the company in the future for the purchase.

Sales on Account

Sales Discounts

2/10, n/30 Read as: “Two ten, net thirty” When customers purchase on open account, they may be offered a sales discount to encourage early payment.

Sales Discounts

2/10, n/30 Discount Percentage

# of Days in Discount Period

Otherwise, the Full Amount Is Due

Maximum Days in Credit Period

To Take or Not Take the Discount, That is the Question With discount terms of 2/10,n/30, a customer saves $2 on a $100 purchase by paying on the 10th day instead of the 30th day. Note: discount period is 20days (30 days – 10 days) Interest Rate for 20 Days =

Amount Saved Amount Paid

Interest Rate for 20 Days =

$2 $98

= 2.04%

365 Days × 2.04% = 37.23% 20 Days

Sales Returns and Allowances Debited for damaged merchandise.

Debited for returned merchandise. Contra revenue account.

Sales Returns & Allowance After we post the entry to the T-accounts, the account balances look like this: Sales Returns & Allowance

Revenue

$ Amount of return

$ Sales Accounts Receivable $ Amount of return

Reporting Net Sales Companies record credit card discounts, sales discounts, and sales returns and allowances separately to allow management to monitor these transactions. Sales revenue Less: Credit card discounts Sales discounts Sales returns and allowances Net sales

Learning Objectives Analyze and interpret the gross profit percentage.

Gross Profit Percentage Gross Profit Percentage

=

Gross Profit Net Sales

In 2014, Gaiam Q2 reported gross profit of $36,150,000 on sales of $57,220,000. A higher gross profit results in higher net income. Gross Profit indicates amount per $ remaining from each sale for operational expense and peripheral expense.

Gross Profit Percentage Gross Profit Percentage Gross Profit Percentage

=

Gross Profit Net Sales

=

$36,500 $57,220,000

=

64%

All other things equal, a higher gross profit results in higher net income.

Gaiam 64.0%

2014 Gross Profit Comparisons Industry S & P 500 5.4% 35.5%

In class Exercises The following summarized data were provided by the records of Slate, Incorporated, for the year ended December 31, 2014:

Required: 1.Based on these data, prepare an income statement (showing both gross profit and income from operations). 2.What was the amount of gross profit margin? What was the gross profit percentage ratio? Explain what these two amounts mean.

Learning Objectives Estimate, report, and evaluate : •Effects of uncollectible accounts receivable (bad debts) on financial statements.

Measuring and Reporting Receivables

Accounts Receivable Trade receivables are amounts owed to the business for credit sales of goods, or services.

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

Measuring and Reporting Receivables Accounts receivable are created when companies have sales to customers on open accounts.

Notes receivable are written promises from another party to pay with specified terms.

Trade receivables are amounts owed to the business for credit sales of goods, or services.

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

Balance Sheet Classifications Current (short term) Noncurrent (long term)

Measuring and Reporting Receivables – Notes Receivable $1,200

Term

Sixty days Principal the order of

Goleta, CA

January 5, 2014 Payee

after date I promise to pay to Pacific BioDiesel

One thousand two hundred --------------------------------- Dollars Payable at

Interest Rate Goleta Bank of America, Maker CA 12% Value received with interest at per annum No. 10242 Due

March 6, 2015 Due Date

Jorda Evans

Ben Lomond Feed

Accounting for Bad Debts Bad debts result from credit customers who will not pay the business the amount they owe, regardless of collection efforts.

Accounting for Bad Debts Bad Debt Expense Matching Principle

Record in same accounting period.

Sales Revenue

Accounting for Bad Debts

Most businesses record an estimate of the bad debt expense by an adjusting entry at the end of the accounting period.

Recording Bad Debt Expense Estimates SunSolar estimated bad debt expense for 2014 to be $504,000. Prepare the adjusting entry.

GENERAL JOURNAL Date Dec. 31

Description

Debit

Credit

Recording Bad Debt Expense Estimates SunSolar estimated bad debt expense for 2014 to be $504,000. Prepare the adjusting entry. Bad Debt Expense is normally classified as a GENERAL JOURNAL and is closed at year-end. Date selling expense Description Debit Dec. 31 Bad Debt Expense Allowance for Doubtful Accounts

Contra asset account

Credit

504,000 504,000

Allowance for Doubtful Accounts Balance Sheet Disclosure Accounts receivable Less: Allowance for doubtful accounts Net realizable value of accounts receivable

Amount the business expects to collect.

Writing Off Uncollectible Accounts When it is clear that a specific customer’s account receivable will be uncollectible, the amount should be removed from the Accounts Receivable account and charged to the Allowance for Doubtful Accounts.

Writing Off Uncollectible Accounts Sun Solars’ total write-offs for 2014 were $876,000. Prepare a summary journal entry for these write-offs. GENERAL JOURNAL Date

Description

Debit

Credit

Writing Off Uncollectible Accounts Sun Solars’ total write-offs for 2013 were $876,000. Prepare a summary journal entry for these write-offs. GENERAL JOURNAL Date

Description Allowance for Doubtful Accounts Accounts Receivable

Debit

Credit

876,000 876,000

Writing Off Uncollectible Accounts Before the write-off: • Sun Solars’ Accounts Receivable balance was $11,000,000 • Allowance for Doubtful Accounts balance was $1,000,000 (after the allowance increase of $504,000) What is the effect of total write-offs of $876,000 had on these accounts.

Writing Off Uncollectible Accounts Before WriteOff Accounts receivable $ 11,000,000 Less: Allow. for doubtful accts. 1,000,000 Net realizable value $ 10,000,000

After WriteOff $ 10,124,000 124,000 $ 10,000,000

Notice that the total write-offs of $876,000 did not change the net realizable value nor did it affect any income statement accounts.

Writing Off Uncollectible Accounts Before the write-off: • Sun Solars’ Accounts Receivable balance was $10,660 • Allowance for Doubtful Accounts balance was $1,200 What is the effect of total write-offs of $1,150 had on these accounts.

Writing Off Uncollectible Accounts

Accounts receivable $ Less: Allow. for doubtful accts. Net realizable value $

Before Write-Off 10,660 1,200 9,460

After WriteOff $ 9,510 50 $ 9,460

Notice that the total write-offs of $1,150 did not change the net realizable value nor did it affect any income statement accounts.

Methods for Estimating Bad Debts • Percentage of credit sales • Aging of accounts receivable

Percentage of Credit Sales Bad debt percentage is based on actual uncollectible accounts from prior years’ credit sales.

Focus is on determining the amount to record on the income statement as Bad Debt Expense.

Percentage of Credit Sales Net credit sales  % Bad debt loss rate Amount of journal entry

Percentage of Credit Sales In 2014, XYZ Companyhad credit sales of $127,660. Past experience indicates that bad debts are one percent (1%) of sales.

What is the estimate of bad debts expense for 2014?

$127,660 × .01 = $1,280 Now, prepare the adjusting entry.

Percentage of Credit Sales GENERAL JOURNAL Date

Description

Dec. 31 Bad Debt Expense Allowance for Doubtful Accounts

Debit Credit 1,280 1,280

ESTIMATION AND RECORDING OF UNCOLLECTIBLE ACCOUNTS – PERCENTAGE OF CREDIT SALES RECEIVABLE METHOD Part 1 – During 2015, Santa Cruz Operations reported $300,000 in sales. The company’s allowance for doubtful accounts has an unadjusted credit balance of $12,000 at December 31, 2015. Based on prior experience, management estimates that 2.5% of sales will result in bad debts. Prepare the required adjusting journal entry. Dec. 31

Ensure the equation still balances and debits = credits Assets = Liabilities

+ Bad Debt Expense (E) –

+

Stockholders’ Equity

- Allowance for Doubtful Accounts (xA) +

Part 2 – Assume instead that the company’s allowance for doubtful accounts has an unadjusted debit balance of $400. Prepare the required adjusting journal entry. Dec. 31

Ensure the equation still balances and debits = credits Assets = Liabilities

+ Bad Debt Expense (E) –

+

Stockholders’ Equity

- Allowance for Doubtful Accounts (xA) +

Now let’s discuss another method that is used to account for uncollectible accounts.

Aging of Accounts Receivable Focus is on determining the desired balance in the Allowance for Doubtful Accounts on the balance sheet.

Aging Schedule

Each customer’s account is aged by breaking down the balance by showing the age (in number of days) of each part of the balance.

Aging Schedule Days Past Due

Customer Aaron, R. Baxter, T. Clark, J. Zak, R. Total

Not Yet Due $ 1,200

1-30 $ 235 300

50

Total A/R 61-90 Over 90 Balance $ 235 1,500 $ 200 $ 500 750

325 $ 1,830

325 $10,660

31-60

$ $ 3,500

$ 2,550

$ 1,540

$ 1,240

Based on past experience, the business estimates the percentage of uncollectible accounts in each time category.

Aging Schedule Days Past Due Not Yet Due

Customer Aaron, R. Baxter, T. Clark, J.

$ 1,200

1-30 $ 235 300

31-60

$

Zak, R. Total % Uncollectible

$ 3,500 0.01

$ 2,550 0.04

50

325 $ 1,830 0.10

Total A/R 61-90 Over 90 Balance $ 235 1,500 $ 200 $ 500 750 $ 1,540 0.25

$ 1,240 0.40

These percentages are then multiplied by the appropriate column totals. Note: based on historical past experience

325 $10,660

Aging Schedule Days Past Due

Customer Aaron, R. Baxter, T. Clark, J. Zak, R. Total % Uncollectible Estimated Uncoll. Amount

Not Yet Due $ 1,200

1-30 $ 235 300

31-60

$

50

$ 3,500 0.01

$ 2,550 0.04

325 $ 1,830 0.10

$

$

$

35

102

183

Total A/R 61-90 Over 90 Balance $ 235 1,500 $ 200 $ 500 750 $ 1,540 0.25

$ 1,240 0.40

$

$

385

496

The column totals are then added to arrive at the total estimate of uncollectible accounts of $1,201.

325 $10,660

$ 1,201

Aging of Accounts Receivable Days Past Due

Customer Aaron, R. Baxter, T. Clark, J. Zak, R. Total % Uncollectible Estimated Uncoll. Amount

Not Yet Due $ 1,200

1-30 $ 235 300

31-60

$

50

$ 3,500 0.01

$ 2,550 0.04

325 $ 1,830 0.10

$

$

$

35

102

183

Total A/R 61-90 Over 90 Balance $ 235 1,500 $ 200 $ 500 750 $ 1,540 0.25

$ 1,240 0.40

$

$

385

496

325 $10,660

$ 1,201

Record the Dec. 31, 2014, adjusting entry assuming that the Allowance for Doubtful Accounts currently has a $50 credit balance.

Aging of Accounts Receivable GENERAL JOURNAL Date

Description

Dec. 31 Bad Debt Expense Allowance for Doubtful Accounts

Post. Ref.

Debit

Credit

1,151 1,151

1,201 Desired Balance After posting, the Allowance 50 Credit Balance account would $ 1,151 Adjusting Entry look like this . . .

Aging of Accounts Receivable Adjusting entry Year End Allowance for Doubtful Accounts 50

Notice that the balance after adjustment is equal to the estimate of $1,201 based on the aging analysis performed earlier.

1,151 1,201

Balance at 12/31/2014 before adj. 2014 adjustment Balance at 12/31/2014 after adj.

Aging of Accounts Receivable Accounts Receivable  % Estimated Uncollectible Desired Balance in Allowance Account - Allowance Account Credit Balance Amount of Journal Entry Accounts Receivable  % Estimated Uncollectible Desired Balance in Allowance Account + Allowance Account Debit Balance Amount of Journal Entry

ESTIMATION AND RECORDING OF UNCOLLECTIBLE ACCOUNTS – AGING OF ACCOUNTS RECEIVABLE METHOD Part 1 – During 2015, Santa Cruz Operations reported $300,000 in sales. The company’s allowance for doubtful accounts has an unadjusted credit balance of $12,000 at December 31, 2015. Santa Cruz OperationsIndustries accountants prepared the following Aging of Accounts Receivable: Customer

Total

Alpha Sales $ 700 Gamma Manufacturing Co. 11,900 Delta Shipping Corp. 2,200 Epsilon Industries 6,000 Theta Manufacturing 1,800 Zeta Industries 600 Other customers 136,800 Totals $160,000

Number of days unpaid 0-30 30-60 60-90 Over 90 $ 700 $ 11,900 $ 2,200 $ 6,000 1,800 600 88,100 26,900 9,800 12,000 $100,000 $30,000 $12,000 $18,000

Santa Cruz Operations accountants believe that receivables 0-30 days old have a 4% chance of noncollection. Receivables 30-60 days old have a 10% chance of noncollection. Receivables 60-90 days old have a 20% chance of noncollection. Receivables over 90 days old have a 40% chance of noncollection. The company’s allowance for doubtful accounts has an unadjusted credit balance of $12,000. Prepare the required adjusting journal entry. Dec. 31

Ensure the equation still balances and debits = credits Assets = Liabilities

+ Bad Debt Expense (E) –

+

Stockholders’ Equity

– Allowance for Doubtful Accounts (xA) +

Part 2 – Assume instead that the company’s allowance for doubtful accounts has an unadjusted debit balance of $400. Prepare the required adjusting journal entry. Dec. 31

Ensure the equation still balances and debits = credits Assets = Liabilities

+ Bad Debt Expense (E) –

+

Stockholders’ Equity

– Allowance for Doubtful Accounts (xA) +

Learning Objectives Analyze and interpret the accounts receivable turnover ratio and the effects of accounts receivable on cash flows.

Receivables Turnover Receivables Turnover =

Net Sales Average Net Trade Receivables

Gaiam reported 2014 net sales of $262,943. December 31, 2013, receivables were $25,324 and December 31, 2014, receivables were $30,157. This ratio measures how many times average receivables are recorded and collected for the year.

Receivables Turnover Receivables Turnover =

Net Sales Average Net Trade Receivables

Receivables $262,943 = Turnover ($25,324 + $30,157) ÷ 2

= 9.48

This ratio measures how many times average receivables are recorded and collected for the year.

2008 Receivables Turnover Comparisons Gaiam 9.48

Revelon 7.57

Mary-Kay 6.51

Avg Days Receivable Outstanding Gaiam: Avg Days Sales = # days in year Outstanding A/R Turn = 365 /9.48 Avg Days Sales Outstanding = 38.5 days Revelon:

365/7.57 =

Mary-Kay: 365/6.51 =

48.2 days 56.1 days

Focus on Cash Flows Add Decrease in Accounts Receivable Sales Revenue Subtract Increase in Accounts Receivable

Cash Collected from Customers

In class exercise Recording, Reporting, and Evaluating a Bad Debt Estimate During 2013, Dorothy's Ceramics Shop had sales revenue of $70,000, of which $25,000 was on credit. At the start of 2013, Accounts Receivable showed a $4,000 debit balance, and the Allowance for Doubtful Accounts showed a $300 credit balance. Collections of accounts receivable during 2013 amounted to $19,000. Data during 2013 follows: a. On December 31, 2013, an Account Receivable (Toby's Gift Shop) of $700 from a prior year was determined to be uncollectible; therefore, it was written off immediately as a bad debt. b. On December 31, 2013, on the basis of experience, a decision was made to continue the accounting policy of basing estimated bad debt losses on 2.5 percent of credit sales for the year. Required: 1. Give the required journal entries for the two items on December 31, 2013 (end of the accounting period). 2. Show how the amounts related to Accounts Receivable and Bad Debt Expense would be reported on the income statement and balance sheet for 2013. Disregard income tax considerations. 3. On the basis of the data available, does the 2.5 percent rate appear to be reasonable? Explain.

Learning Objectives

Report, control, and safeguard cash.

Cash and Cash Equivalents Checks

Money Orders

Cash and Cash Equivalents Certificates of Deposit

Bank Drafts T-Bills

Internal Control of Cash Internal control refers to policies and procedures that are designed to: Properly account for assets.

Safeguard assets.

Ensure the accuracy of financial records.

Cash is the asset most susceptible to theft and fraud.

Internal Control of Cash Custody

Separation of Duties

Recording

Authorization

Internal Control of Cash Bank Reconciliations Daily Deposits

Cash Controls

Payment Approval

Purchase Approval

Check Signatures Prenumbered Checks

Bank Reconciliation Explains the difference between cash reported on bank statement and cash balance on company’s books.

Provides information for reconciling journal entries.

Bank Reconciliation Balance per Bank

Balance per Book

+ Deposits in Transit

+ Deposits by Bank (credit memos)

- Outstanding Checks

- Service Charge - NSF Checks

± Bank Errors

± Book Errors

= Correct Balance

= Correct Balance

Bank Reconciliation

All Balance per Bank reconciling items on the + Deposits in Transit book side require an - Outstanding Checks adjusting entry to the ± Bank Errors cash account. = Adjusted Balance

Balance per Book + Deposits by Bank (credit memos) - Service Charge - NSF Checks ± Book Errors = Correct Balance

Bank Reconciliation Example: July 31 bank reconciliation statement and the resulting journal entries for the Simmons Company. • The July 31 bank statement indicated a cash balance of $9,610 • Cash ledger account on that date shows a balance of $7,430.

Bank Reconciliation • Outstanding checks totaled $2,417. • A $500 check mailed to the bank for deposit had not reached the bank at the statement date. • The bank returned a customer’s NSF check for $225 received as payment of an account receivable. • The bank statement showed $30 interest earned on the bank balance for the month of July. • Check 781 for supplies cleared the bank for $268 but was erroneously recorded in our books as $240. • A $486 deposit by Acme Company was erroneously credited to our account by the bank.

Bank Reconciliation A

$486 deposit by Acme Ending bank balance, July 31Company was $ 9,610 erroneously credited to our account by the Additions: Outstanding checks totaled $2,417. bank. Deposit in transit 500 Deductions: Bank error $ 486 A $500 check mailed to the bank for deposit Outstanding checks 2,417 2,903 had not reached the bank at the statement Correct cash balance $ 7,207 date.

Bank Reconciliation Ending bank balance, July 31 $ 9,610 Additions: Deposit in transit 500 The bank statement showed $30 interest Deductions: earnedBank on the for the errorbank balance $ 486 month of July. Outstanding checks 2,417 2,903 Check 781 for supplies cleared the bank Correct cash balance $ 7,207

for $268 but was erroneously recorded in ourEnding books asbalance, $240.aJuly ($268-$240=$28) The bankbook returned customer’s NSF $ 7,430 31 check for $225 received as payment of an Additions: account receivable. Interest 30 Deductions: Recording error NSF check Correct cash balance

$

28 225

253 $ 7,207

Bank Reconciliation GENERAL JOURNAL Date

Description

Jul 31 Cash

Post. Ref.

Debit 30

Interest Revenue 31 Supplies Inventory Accounts Receivable Cash

Credit 30

28 225 253

Recording Discounts and Returns

Credit Card Sales On January 2, a Gaiam Retail Store credit card sales were $3,000. The credit card company charges a 3% service fee. Prepare the Gaiam’s journal entry.

Credit Card Sales On January 2, a Gaiam’s Retail store credit card sales were $3,000. The credit card company charges a 3% service fee. Prepare the Gaiam’s journal entry. Credit Card Discounts are reported as a contra-revenue account.

Sales Discounts On January 6, Gaiam sold $1,000 of merchandise on credit with terms of 2/10, n/30. Prepare the Gaiam’s journal entry. GENERAL JOURNAL Date Jan.

6

Description

Debit

Credit

Sales Discounts On January 6, Gaiam’s sold $1,000 of merchandise on credit with terms of 2/10, n/30. Prepare the Gaiam’s journal entry. GENERAL JOURNAL Date Jan.

Description

6 Accounts Receivable Sales Revenue

Debit

Credit

1,000 1,000

Sales Discounts On January 14, Gaiam receives the appropriate payment from the customer for the January 6 sale. Prepare the Gaiam’s journal entry. GENERAL JOURNAL Date Jan. 14

Description

Debit

Credit

Sales Discounts On January 14, Gaiam receives the appropriate payment from the customer for the January 6 sale. Prepare the Gaiam’s journal entry. $1,000 × 2% = $20 sales discount $1,000 - $20 = $980 cash receipt GENERAL JOURNAL Date

Description

Jan. 14 Cash Sales Discounts Accounts Receivable

Contra-revenue account

Debit

Credit

980 20 1,000

Sales Discounts If the customer remits the appropriate amount on January 20 instead of January 14, what entry would Gaiam make?

Sales Discounts If the customer remits the appropriate amount on January 20 instead of January 14, what entry would Gaiam make? GENERAL Since the customer paidJOURNAL outside of the discount Date Description period, a sales discount is not Debit granted. Credit Jan. 20 Cash Accounts Receivable

1,000 1,000

Sales Returns and Allowances

On July 8, before paying, a customer returns $500 of sandals originally purchased on account from Gaiam. The sandals originally cost Gaiam $300. Prepare the Gaiam journal entry.

Sales Returns and Allowances

On July 8, before paying, a customer returns $500 of sandals originally purchased on account from Gaiam. The sandals originally cost Gaiam $300. Prepare the Gaiam’s journal entry. GENERAL JOURNAL Date July

Description

8 Sales Returns and Allowances

Debit 500

Accounts Receivable

July

8 Merchandise Inventory Cost of Goods Sold

Credit 500

300 300

Applying the Revenue Principle in Special Circumstances

Delayed Revenue Recognition: Installment Method Generally, revenue is recognized when:  An exchange has taken place.  The earnings process is nearly complete.  Collection is probable. Uncertain collectibles result in delaying revenue recognition until cash is collected. Installment method: revenue is recognized as cash is collected, often over several accounting periods.

Revenue Recognition Before the Earnings Process is Complete: Long-Term Construction Contracts Completed Contract Method

Percentage-ofCompletion Method

 Revenue and expenses are recognized in the year the contract is completed.  Construction-in progress years show no revenue or expenses.

 Revenue and expenses recognized each year as work is accomplished.  Revenues each year are based on the ratio of costs incurred to total costs.

Revenue Recognition Before the Earnings Process is Complete: Long-Term Construction Contracts •An example of the percentage-of-completion method. Acme Construction is constructing a building for Jones Foods over a three-year period for a total price of $50,000,000. Acme reported the following progress in year one: Estimated total cost Cost incurred in year one

Year 1 40,000,000 10,000,000

How much revenue and expense should be recognized on the project in year one using the percentage of completion method?

Year 2

Year 3

Revenue Recognition Before the Earnings Process is Complete: Long-Term Construction Contracts Acme Construction is constructing a building for Jones Foods over a three-year period for a total price of $50,000,000. Acme reported the following progress in year one:

Estimated total cost Cost incurred in year one

Year 1 40,000,000 10,000,000

Year 2

Year 3

Percent complete =

Total costs incurred to date Estimate of total project cost

Percent complete =

$10,000,000 = 25% $40,000,000

Revenue Recognition Before the Earnings Process is Complete: Long-Term Construction Contracts Acme Construction is constructing a building for Jones Foods over a three-year period for a total price of $50,000,000. Acme reported the following progress in year one: Estimated total cost Cost incurred in year one

Year 1 40,000,000 10,000,000

Year 2

Year 3

$10,000,000 Percent complete = = 25% $40,000,000 Construction revenue (25% of $50,000,000) Construction expense Construction income

$ $

12,500,000 10,000,000 2,500,000

Assignments: See web: http//cabrillo.blacboard.com This will be updated weekly as required •Update your weekly journal for the Final Journal •Work weekly on your final project, do the analysis with information learned during the week

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