Receivables and Revenue Recognition (cont.)

Receivables and Revenue Recognition Corporate Accounting ALLOWANCE FOR RETURNS If customer has the right to return the product, the seller must estimate the dollar value of returns. Revenue is reported net of the amount expected to be returned. Typically, seller sets up a contra-asset account, Allowance for Returns: • Analogous to Allowance for Doubtful Accounts • When return actually occurs, reduce both Allowance and face value of Accounts Receivable (or Cash) by the invoice amount. • Return has no effect on Net Income, nor on Net Assets, just as Write-off of Uncollectible has no effect on these amounts. • BSE: AR - Allowance for Returns = RE Intel takes a slightly different approach: Deferred Income Liability. A Quick Look at Intel’s Statements z Revenue recognition. z The company generally recognizes net revenues upon the transfer of title. However, certain of the company's sales are made to distributors under agreements allowing price protection and/or right of return on merchandise unsold by the distributors. Because of frequent sales price reductions and rapid technological obsolescence in the industry, Intel defers recognition of revenues on shipments to distributors until the merchandise is sold by the distributors. Interpreting Intel’s Revenue Footnote z The company generally recognizes net revenues upon the transfer of title. z z However, certain of the company's sales are made to distributors under agreements allowing price protection and/or right of return on merchandise unsold by the distributors. z z means that when products ship to customers, Intel recognizes net sales revenue (net of allowances for bad debts). means that some products are sold to distributors who will resell them. Intel provides a safety net to distributors: returns and price protection. Because of frequent sales price reductions and rapid technological obsolescence in the industry, Intel defers recognition of revenues on shipments to distributors until the merchandise is sold by the distributors z means that instead of recognizing sales revenue and related COGS when these products ship to distributors, Intel waits for the price/return uncertainty is resolved -- giving rise to a Deferred Income Liability. DEFERRED INCOME: AN EXAMPLE Shipments on 3/1 to OEMs and Distributors: Total Billings $ 350,000 Direct to OEMs 280,000 To Distributors (PP) COGS Direct to OEMs To Distributors (PP) 70,000 $ 90,000 72,000 18,000 • Return / Price Protection expires for $35K of sales on 3/31 • Invoice Price is reduced from $35K to $25K on the remainder of shipment on 4/15 DEFERRED INCOME: AN EXAMPLE AR OEM sales Distrib. Sales PP Expires For $35K PP Applies For 35K + INV Deferred Income + RE DEFERRED INCOME: AN EXAMPLE OEM sales AR + 280 INV Deferred Income + (72) Distrib. Sales PP Expires For $35K PP Applies For 35K Dr AR Cr Revenue – OEM Dr COGS – OEM Cr Inventory 280 280 72 72 RE 280 rev. (72) exp. DEFERRED INCOME: AN EXAMPLE OEM sales AR + 280 INV Deferred Income + (72) Distrib. Sales 70 (18) 70 (18) PP Expires For $35K PP Applies For 35K Dr AR Cr Def Inc– Distr Dr Def Inc – COGS to Distr Cr Inventory 70 70 18 18 RE 280 rev. (72) exp. Deferred Income Liability COGS to distributors =18 Accounts receivables 70 Sales to distributors = 70 Inventory 18 DEFERRED INCOME: Confirmed sales AR + INV Deferred Income + 280 OEM sales 280 rev. (72) exp. (72) Distrib. Sales 70 70 (18) (18) PP Expires For $35K (35) 9 35 rev. (9) exp. PP Applies For 35K Dr Def Inc Cr Revenue – Distr 35 Dr COGS – Distr 9 Cr Def Inc – COGS to Distr RE 35 9 Deferred Income Liability COGS to distributors =18 Sales to distributors = 70 Confirmed Sales = 35 COGS corresponding to confirmed sales = 9 COGS 9 Revenues 35 DEFERRED INCOME: Price reductions OEM sales AR + 280 INV Deferred Income + (72) Distrib. Sales 70 (18) PP Expires For $35K (10) RE 280 rev. (72) exp. 70 (18) (35) 9 (10) 35 rev. (9) exp. PP Applies For 35K Dr Deferred income Cr AR 10 10 Deferred Income Liability COGS to distributors =18 Sales to distributors = 70 Confirmed Sales = 35 COGS corresponding to confirmed sales = 9 Price reductions = 10 Accounts receivables 70 10 DEFERRED INCOME: Confirmed sales (2nd lot) OEM sales AR + 280 INV Deferred Income + (72) Distrib. Sales 70 70 (18) (18) PP Expires For $35K (35) 9 (10) (25) 9 (10) PP Applies For 35K Remaining PP expires Dr Def Inc Cr Revenue – Distr 25 Dr COGS – Distr 9 Cr Def Inc – COGS to Distr RE 280 rev. (72) exp. 35 rev. (9) exp. 25rev. (9) exp. 25 9 Deferred Income Liability COGS to distributors =18 Sales to distributors = 70 Confirmed Sales = 35 Price reductions = 10 COGS corresponding to confirmed sales = 9 Confirmed Sales (2nd lot) = 25 COGS corresponding to second lot =9 88 88 Revenues COGS 9 9 18 35 25 60 Distributors pay up Cash Accounts receivables 70 10 60 35+25 = 60 0 Recognizing Revenue: Is additional service required? z z z Example of Warranty Coverage: Seller promises to repair or replace defective products for a specified period of time Sales transaction commits seller to incur uncertain, but predictable, future costs: must be matched to sales revenues Example: z On 7/1, MicroSystems sells 30 laptops for $2,000 each on account. z Warranty period of 1 year, parts and labor, applies to each unit. z Past experience indicates that warranty costs will average $40/unit and that 5% of credit sales will not be collected. z As of December 31, actual warranty costs incurred are $700. $50K has been collected from the customers, and one account of $2,000 has been written off. Accounting for Warranty Expense (with a refresher on Bad Debt expense...) Cash 7/1 Sale Accrue warranty exp. Accrue bad debts Collect cash Incur warranty costs Write-off uncoll. A/R Accrued Warranty + A/R – ADA Liability + Ret. Earn. Accounting for Warranty Expense (with a refresher on Bad Debt expense...) Cash 7/1 Sale Accrued Warranty + Ret. + A/R – ADA Liability Earn. 60,000 60,000 Accrue warranty exp. Accrue bad debts Collect cash Incur warranty costs Write-off uncoll. A/R Dr Accounts Receivables Cr Revenues 60,000 60,000 Accounting for Warranty Expense (with a refresher on Bad Debt expense...) 7/1 Sale Accrued Warranty + Ret. Cash + A/R – ADA Liability Earn. 60,000 60,000 Accrue warranty exp. Accrue bad debts 1,200 –1,200 Collect cash Incur warranty costs Write-off uncoll. A/R Dr Warranty Expense Cr Accrued Warranty Liability 1,200 1,200 Accounting for Warranty Expense (with a refresher on Bad Debt expense...) 7/1 Sale Accrue warranty exp. Accrue bad debts Accrued Warranty + Ret. Cash + A/R – ADA Liability Earn. 60,000 60,000 1,200 –1,200 –3,000 Collect cash Incur warranty costs Write-off uncoll. A/R Dr Bad debt expense Cr ADA 3,000 3,000 –3,000 Accounting for Warranty Expense (with a refresher on Bad Debt expense...) 7/1 Sale Accrued Warranty + Ret. Cash + A/R – ADA Liability Earn. 60,000 60,000 Accrue warranty exp. Accrue bad debts Collect cash 1,200 –1,200 –3,000 +50,000 –50,000 Incur warranty costs Write-off uncoll. A/R Dr Cash Cr Accounts receivables 50,000 50,000 –3,000 Accounting for Warranty Expense (with a refresher on Bad Debt expense...) 7/1 Sale Accrued Warranty + Ret. Cash + A/R – ADA Liability Earn. 60,000 60,000 Accrue warranty exp. Accrue bad debts Collect cash Incur warranty costs Write-off uncoll. A/R 1,200 –1,200 –3,000 –3,000 +50,000 –50,000 –700 Dr Accrued warranty Liability Cr Cash – 700 700 700 Accounting for Warranty Expense (with a refresher on Bad Debt expense...) Cash 7/1 Sale Accrued Warranty + Ret. + A/R – ADA Liability Earn. 60,000 60,000 Accrue warranty exp. Accrue bad debts Collect cash Incur warranty costs Write-off uncoll. A/R 1,200 –1,200 –3,000 –3,000 +50,000 –50,000 –700 Dr ADA Cr Accounts receivables –700 –2,000 +2,000 2,000 2,000