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Cornerstones of Financial & Managerial Accounting
Rich/Jones/Heitger/Mowen/Hansen
Chapter 5
Learning Objectives
LO1. Explain the criteria for revenue recognition.
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
Revenue is recognized when it is:
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realized or realizable
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earned
The terms “realized” and “realizable” mean that the selling price is fixed and
determinable and collectibility is reasonably assured.

Revenue is considered earned when delivery has occurred or services have
been provided.
LO2. Measure net sales revenue.
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The appropriate amount of revenue to recognize is generally the cash received
or the cash equivalent of accounts receivable.
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However, companies often induce customers to buy by offering:
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sales discounts
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sales returns
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sales allowances
Sales discounts are reductions of the normal selling price to encourage prompt
payment.
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Sales returns occur when a customer returns goods as unsatisfactory.
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Sales allowances occur when a customer agrees to keep goods with minor
defects if the seller reduces the selling price.

These events are recorded in contra-revenue accounts that reduce gross sales
to net sales.
LO 3. Describe internal control procedures for merchandise sales.

Since sales revenues have a significant effect on a company’s net income,
internal control procedures must be established to ensure that the amounts
reported are correct.
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Typically sales are not recorded until a three-way match is performed between
the:
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customer purchase order (which indicates that the customer wants the
goods)
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the shipping document (which indicates that the goods have been shipped
to the customer)
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the invoice (which indicates that the customer has been billed
LO4. Describe the principal types of receivables.
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Receivables are classified along three different dimensions:
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accounts and notes receivable
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trade and non-trade receivables
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current and noncurrent receivables
LO5. Measure and interpret bad debt expense and the allowance for doubtful
accounts.
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The primary issues in accounting for accounts receivable are when and how to
measure bad debts (i.e., accounts that will not be paid).
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GAAP requires receivables to be shown at net realizable value on the balance
sheet.
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Further, the matching principle says that an expense should be recognized in
the period in which it helps generate revenues.

Consequently, we must estimate and recognize bad debt expense in the period
the sale is made—even though we do not know which accounts will be
uncollectible.
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The estimate is made by using either:
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the credit sales method or
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the aging method
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The credit sales method estimates the bad debt expense directly.
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The aging method estimates the ending balance needed in the allowance for
doubtful accounts, and bad debt expense follows.
LO6. Describe the cash flow implications of accounts receivable.

Companies can increase the speed of cash collection on receivables by
factoring, or selling, their receivables.
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The buyer of the receivables will charge a fee to compensate themselves for
the time value of money, the risk of uncollectability, and the tasks of billing
and collection.

Receivables may also be packaged as financial instruments or securities and
sold to investors. This is referred to as securitization.

A special case of selling receivables is accepting credit cards like MasterCard
and Visa.
LO7. Account for notes receivable from inception to maturity.

Notes receivable are recognized for the amount of cash borrowed or
goods/services purchased.

This is the principal amount of the note receivable.

Any excess of amount repaid over principal is recognized as interest revenue
in the period the interest was earned.
LO8. Analyze profitability and asset management using sales and receivables.
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Because sales revenue is such a key component of a company’s success,
analysts are interested in a large number of ratios that incorporate sales.
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Many of these ratios attempt to measure how much the company is making on
sales. These are called profitability ratios.
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Gross profit percentage
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Operating margin percentage
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Net profit margin
Analysts are also concerned with asset management. Asset management refers
to how efficiently a company is using the resources at its disposal.

One of the most widely-used asset management ratios is accounts receivable
turnover.