Chapter 5: Motivating Sales and Collections

Question 1

Core Principle of Revenue Recognition

Answer 1

Definition: Revenues are recorded when a company transfers goods and services to customers, in the amount it expects to receive.

Determining Expected Entitlement: Commonly the contracted price for items, but may be reduced by incentives like discounts or rebates.

Question 2

Determining Transfer of Risks and Benefits

Answer 2

Contract Terms: Specifies when risks and benefits of ownership transfer from seller to customer.

Shipping Point: FOB (free on board) shipping point - title changes at shipment, buyer pays for shipping.

Destination Point: FOB destination point - title changes on delivery, seller pays for shipping.

Revenue Recognition: Goods sold FOB shipping point recognized at shipment, FOB destination point recognized at delivery.

Question 3

Revenue Recognition for Service Companies

Answer 3

Recognition Criteria: Service companies record sales revenue when obligations to the buyer under the agreed contract are fulfilled.

Disclosure: Specific revenue recognition policies are disclosed in financial statements under “Significant Accounting Policies.”

Question 4

Variable Consideration in Contracts

Answer 4

Types: Sales discounts, sales returns, refunds, and credits.

Effect: Variable consideration affects the expected amount to be received from the customer.

Complex Contracts: For complex contracts with multiple performance obligations, a five-step process is applied for revenue recognition.

Question 5

Impact of Credit Card Sales on Net Sales

Answer 5

Practice: Gildan allows all customers to use credit cards for purchases.

Impact: Increases convenience, potentially boosts sales, but may involve processing fees that affect net sales figures.

Question 6

Impact of Sales Discounts on Net Sales

Answer 6

Practice: Business customers receive discounts for early payment.

Impact: Encourages prompt payment, reduces accounts receivable turnover time, affects net sales positively.

Question 7

Impact of Sales Returns on Net Sales

Answer 7

Practice: Gildan allows returns under specific circumstances.

Impact: Can decrease net sales if products are returned and refunded, impacting revenue figures.

Question 8

Impact of Sales of Bundled Items on Net Sales

Answer 8

Practice: Gildan sells bundled items to both business and individual customers.

Impact: Can increase sales through bundled offers, potentially boosting revenue; however, careful accounting is needed to calculate net sales accurately.

Question 9

Reasons for Accepting Credit Cards

Answer 9

Convenience: Enhances customer traffic by offering credit card payment options.

Cost Avoidance: Eliminates expenses related to providing credit directly to customers, such as recordkeeping and debt collection.

Risk Mitigation: Reduces losses due to insufficient funds in customer accounts and minimizes losses from fraudulent credit card sales.

Faster Transactions: Accelerates cash flow as credit card receipts are directly deposited, enabling quicker access to funds.

Question 10

Credit Card Company Fees

Answer 10

Charges: Credit card companies charge a fee for their services.

Example: If a seller processes a $3,000 credit card payment and receives credit for 97% ($2,910), the credit card discount is 3%.

Calculation: Credit Card Discount = 3% of Gross Sales = 0.03 x $3,000 = $90.

Net Sales Calculation: Gross Sales - Credit Card Discount = Net Sales ($3,000 - $90 = $2,910).

Question 11

Impact on Net Sales Reporting

Answer 11

Calculation of Net Sales: Gross sales minus credit card discounts equals net sales.

Reporting: Net sales, reflecting credit card discounts, are reported on the statement of earnings.

Uniformity: Similar accounting principles apply when consumers use contactless mobile payment apps like Google Pay or Apple Pay.

Question 12

Credit Sales and Credit Terms

Answer 12

Definition: Most of Gildan’s sales are credit sales on open account, with no formal promissory note.

Credit Terms Notation: Credit terms, like n/30 (due within 30 days), are indicated on sales documents. ‘n’ means sales amount net of any returns.

Sales Discount Option: Gildan offers sales discounts to encourage prompt payment from business customers.

Question 13

Sales Discount Terms

Answer 13

Example: Standard credit terms of 2/10, n/30 mean a 2% discount is available if cash payment is made within 10 days; otherwise, the full invoice amount is due within 30 days.

Purpose: Encourages quick payment, benefits seller by improving cash flow and ensuring timely payments.

Calculation: Sales Discount = 2% of Gross Sales = 0.02 x $1,000 = $20.

Question 14

Impact on Net Sales Reporting (Discounts)

Answer 14

Calculation of Net Sales: Gross sales minus sales discounts equals net sales.

Reporting: Net sales, reflecting deducted sales discounts, are reported on the statement of earnings.

Additional Consideration: Any other price concessions, such as quantity discounts or rebates, also impact the computation of net sales.

Question 15

Significance of Early Payment Discounts

Answer 15

Savings Impact: Customers pay within the discount period to save substantially.

Example: With terms of 2/10, n/30, 2% is saved by paying 20 days early, equivalent to an annual interest rate of 37%.

Calculation: Annual interest rate is obtained by first computing the interest rate for the discount period.

Question 16

Discount Calculation

Answer 16

Discount Period: Customer pays 98% of the gross sales amount when a 2% discount is taken.

Example: On a $100 sale with terms of 2/10, n/30, $2 is saved, and $98 is paid 20 days early.

Interest Rate Calculation: (Amount saved + Amount paid) / Interest rate for 20 days = 2.04% for 20 days, or 0.102% per day.

Question 17

Annual Interest Rate Calculation

Answer 17

Formula: Annual interest rate = (Interest rate for 20 days) × 365 days = 37.23%.

Benefit to Customers: Even with borrowing from a bank at a high interest rate (e.g., 15%), customers save money by taking advantage of cash discounts.

Bank’s interest rate is typically lower than the high rate associated with failing to take cash discounts.

Question 18

Importance of Prompt Delivery

Answer 18

Significance: Essential for customer satisfaction and maintaining good relations.

Impacts of Poor Delivery: Late or incorrect deliveries can lead to lost sales, damage reputation, and strain relationships.

Customer Rights: Customers can return unsatisfactory or damaged merchandise for a replacement, refund, or bill adjustment.

Question 19

Sales Returns Management

Answer 19

Estimation Process: Gildan estimates expected product returns based on past experience.

Calculation: Estimated sales returns are subtracted from gross sales to determine net sales revenue.

Example: If a customer bought $2,000 worth of T-shirts and 5% is expected to be returned, net sales would be $1,900.

Reporting: Net sales, after deducting estimated sales returns, are reported on the statement of earnings.

Question 20

Handling of Sales Returns

Answer 20

Options: Customers can return products for credit, refund, or replacement within a specified period.

Management Approach: Gildan manages sales returns to ensure accurate accounting of net sales revenue.

Regulation: Accounting for sales returns follows specific guidelines discussed in detail in related appendices.

Question 21

Computation of Net Sales

Answer 21

Calculation: Net sales on the statement of earnings are computed by deducting credit card discounts, sales discounts, and estimated sales returns from gross sales.

Example: Gross sales of $6,000, minus $90 (credit card discounts), $20 (sales discounts), and $100 (estimated sales returns) result in net sales of $5,790.

Question 22

Components of Net Sales

Answer 22

Deductions: Credit card discounts, sales discounts, and estimated sales returns are subtracted to compute net sales.

Disclosure Practices: Companies often do not disclose these components in annual reports to prevent revealing their credit policies to competitors.

Confidentiality Concerns: External users may find it challenging to accurately assess the effects of these deductions on net sales and net earnings.

Question 23

Bundle of Goods and Services

Answer 23

Definition: Refers to a sales contract involving both goods and services.

Nature: Enforceable agreement creating rights and obligations between parties.

Examples: Smartphone purchases with service contracts, car sales with warranties and maintenance, iPad sales with future software upgrades.

Question 24

Implicit Contracts in Daily Purchases

Answer 24

Example: Purchasing food in a food court involves implicit contracts based on purchasing norms.

Distinctiveness: Smartphone purchases involve paying for the device and signing a service contract, often with discounts and legally enforceable obligations.

Question 25

Legal Enforceability and Obligations

Answer 25

Contracts: Rights and obligations between service providers and customers are legally enforceable.

Warranty and Maintenance: Examples include Jaguar bundling a five-year warranty and scheduled maintenance, and Apple including future software upgrades in iPad contracts.

Question 26

Definition of Contract

Answer 26

An agreement between two or more parties that creates enforceable rights and obligations.

Question 27

Five-Step Revenue Recognition Process (IFRS 15)

Answer 27

Step 1: Identify the contract between the company and the customer.

Step 2: Identify the performance obligations (promised goods and services).

Step 3: Determine the transaction price.

Step 4: Allocate the transaction price to the performance obligations.

Step 5: Recognize revenue when each performance obligation is satisfied (or over time if a service is provided over time).

Question 28

Gross Profit Percentage

Answer 28

Formula: Gross profit percentage = (Gross profit / Net sales) × 100.

Purpose: Measures the effectiveness of selling goods and services above their production or purchase costs.

Interpretation: Reflects the ability to charge premium prices and produce goods and services efficiently.

Effect on Earnings: Higher gross profit often leads to higher net earnings, assuming other factors remain constant.

Question 29

Factors Influencing Gross Profit Percentage

Answer 29

Product Differentiation Strategy: Focus on product superiority and uniqueness allows premium pricing, leading to higher gross profit percentages.

Low-Cost Strategy: Efficient production management and economies of scale reduce costs, increasing gross profit percentage.

Analysis Uses: Helps assess product development, marketing, and production effectiveness. Important for managers, analysts, and creditors.

Question 30

Gildan’s Gross Profit Percentage Analysis

Answer 30

Trend: Gildan’s gross profit percentage decreased from 27.7% in 2018 to 12.6% in 2020.

Causes: Factors include the COVID-19 pandemic impact, unfavorable product mix, increased cost of sales due to new initiatives, inventory write-down, and hurricane-related costs.

Comparability Issue: Gildan’s inclusion of certain expenses in cost of sales, unlike competitors, affects ratio comparability.

Question 31

Cautions in Evaluating Gross Profit Percentage Changes

Answer 31

Source Analysis: Understand the sources of changes in gross profit percentage; e.g., seasonal high-margin sales versus new product introduction.

Sustainability Consideration: Increases in margin might require sustained higher expenses in research, development, and advertising, impacting net earnings.

Net Earnings Impact: Even a small decrease in gross profit percentage, if not offset by reduced operating expenses, can lead to significant drops in net earnings.