Sales, Receivables & Cash

• Discounts are recognised as an expense in the income statement.
• Discounts are reported in the contra-revenue account, which is debited alongside cash, with the relevant revenue account being credited, as usual.
• Sale returns are debited in the contra-revenue account, and accounts receivable are credited. The cost of goods sold entry is also reversed for the returned amount.
• Discount Period Notation Example: 2/10, n/30. This means payments within the first 10 days will result in a 2% discount, and all payments must be made within 30 days.
• A trade receivable is created during the normal course of business.
• A non-trade receivable arises from transactions outside the normal course of business.
• Net Sales = Sales Revenue - (Credit Card Discounts + Sales Discounts + Sales Returns & Allowances)
• Bad Debt Expense is accounts receivables deemed uncollectible
• The expense recognition principle requires bad debt expenses to be recorded in the same period the related sales are made.
• The Bad Debt Allowance Method bases bad debt expense on an estimate of uncollectible accounts.

  1. An adjusting entry records the estimated bad debt expense
  2. Specific accounts deemed uncollectible during the period are written off
• When the adjusting entry in the Bad Debt Allowance Method is made, the bad debt expense is debited, but it is impossible to know which customers’ accounts receivables are involved, so instead, a contra-asset account, Allowance for Bad Debts, is credited.
• The Allowance for Bad Debts contra-asset account balance is subtracted from Accounts Receivable.
• The write-off of bad debts using the allowance method decreases the asset Accounts Receivable and the contra-asset Allowance for Doubtful Accounts by the same amount. Consequently, net income and net accounts receivable are unaffected. This is different from recording a bad debt expense, which would have a negative effect on income and assets.
• An individual journal entry is recorded when it is determined that a customer will not pay their debt. This means that at the end of the period, the Allowance for Bad Debts contra-asset account is removed by debiting the account with the total true (not estimated) bad debt value and crediting accounts receivable.
• If a company receives payment on an account after it has already been written off, the reverse transaction takes place: accounts receivable are debited, and Allowance for Bad Debts are credited.
• Percentage of Credit Sales Method: Divide total bad debt losses by total credit sales to determine the bad debt loss rate. Multiply credit sales by this rate to allocate the bad debt expense.
• Ageing of Accounts Receivable Method: Estimates the uncollectible accounts based on the age of each account receivable. For example, not yet due: 1%; 1 to 90 days past due: 6%; over 90 days: 30%. The longer a debt is not paid, the higher the likelihood it will never be.
• Bad Debt Expense Estimate (using ageing method) = Balance in the Allowance for Bad Debts at the End of Period - Beginning of Period + Write-Offs
• Converting the related receivables from the sales volume is important. Otherwise, they will not add to the bottom line. Bad debts can be minimised by:

  • Requiring approval of customers’ credit history
  • Periodically age accounts receivable and contact those with overdue payments
  • Reward sales and connection personnel for speedy collections
• Receivables Turnover Ratio = Net Sales / Average Net Trade Accounts Receivable
• Average Net Trade Accounts Receivable = (Beginning Balance + Ending Balance) / 2
• The Receivables Turnover Ratio reflects how many times trade receivables are recorded and collected during the period. The higher the ratio, the faster the collection of receivables. A sudden decline in this ratio might mean a company is extending payment deadlines to prop up lagging sales.
• Average Collection Period (in days) = 365 / Receivables Turnover Ratio
• When net accounts receivables decrease for the period, cash collected from customers is more than revenue and vice versa. A decrease in accounts receivables needs to be added to cash flows from operations, and an increase needs to be subtracted.
• Cash is money or any instrument banks will accept for deposit or immediate credit.
• Cash equivalents are short-term investments with original maturities of three months or less that are readily convertible to cash and whose value is unlikely to change (i.e. not sensitive to interest rate changes).
• Examples of cash equivalents include bank certificates of deposit and Treasury bills.
• Cash management involves accurate reporting, ensuring volumes meet current operating needs, maturing liabilities & unexpected emergencies, and preventing the accumulation of idle cash.
• Internal cash control involves separating duties (receiving and distributing) and prescribed policies.
• Bank Reconciliation is the process of verifying the accuracy of a business's bank statement and cash accounts.
• The most common reasons for differences between the bank statement and cash account ending balances are outstanding checks, deposits in transit, bank service charges, bad checks, interest and errors.