CH6-Concepts

Credit Sales Inter-company sales (wholesale) generally are made "on account" for credit. Credit sales raise a number of issues both from a managerial and from an accounting point of view. All of them are related to the ultimate objective getting cash. Racking up a high level of sales is nice, but if the revenue can not be realized (getting that cash) you don't have sales (revenue), you have an "involuntary charitable donation and eventually you'll go out of business. From an information perspective point of view, this is equally important. Recall that investors view revenue as a surrogate for future cash flow. It is therefore very important to (a) ensure cash collections and (b) report only that level of revenue or income that is judged realizable. Credit sales can be made "on account", resulting in accounts receivable. These are revolving credit arrangements. Once a customer has been evaluated and has established a credit relationship with the company, all sales can be made on account without further formality. Of course, it is expected that each will be promptly paid, once the bill has been received Issues relating to sales on account: Sales remment and allowances Sales discounts Bad debt expense Raising cash quickly • Borrowing: assigning plesiging factoring (with recourse (borrowing), factoring without recourse selling receivables) Sales Returns and Discounts Credit sales must be reported net of sales returns and allowances and sales discountt. Sales returns and allowances: sales returns result because for whatever reason the merchandise has been returned. A sales allowance, on the other hand, means that the price of the merchandise was reduced. Sales dusunan: are something different than what you probably think they are: They are not really discounts, but a thinly disguised method to charge (high) usterest to encourage prompt payment of the bill. Remember that the buyer and the seller have diametrically opposite objectives: The seller wants to get cash as quickly as possible, the buyer wants to hang on to cash for as long as possible Think of sales discounts as "an offer (to pay quickly) you just can't refuse". How is it done? Credit sales usually carry terms, for example, (2/10/n/20) this means: If the bill is paid within ten days, the customer only has to pay 98% of the invoice price. If the bill is paid within twenty days, the full invoice price must be paid. After that you are a bad person and will be charged interest on the outstanding balance. Example Bad Debt Expense Companies try very hard to sell only to customers who eventually will pay the bill. Unfortunately, that is not always the case. To ensure that income will not be overstated in the period in which a sale is made on account that may have to be written off in another year, GAAP requires that companies recognize uncollectible accounts expense in the period in which the sale is made. This raises a little problem: How much bad debt expense should be recognized? Who should be assumed to be a dead-beat? Obviously, one does not know ahead of time which customer won't pay (you wouldn't sell to him in that case, would you?) This means that no actual account can be written off when bad debt expense is recognized That, on the other hand, causes a little problem with the debits and credits. If you can't have a credit to accounts receivable (writing off an account), where should the credit go? It is made to a new account- allowance for uncollectible accounts. This is a "contra-asset" account, meaning it will reduce an associated asset-accounts receivable. The result of recognizing (estimated) bad debt expense in the period when sales are made is to reduce income to a "net-realizable" level and to reduce accounts receivable (on the balance sheet) also to a "net-realizable" value. As a result can make more realistic estimates of expected future cash flows. Methods for estimating uncollectible accounts expense: The aging of accounts method The percentage of credit sales method