Classnotes 6 Flashcards
Income Recognition before the Sale
Generally applies to long-term projects (construction of planes,
ships and buildings; consulting services):
Production covers several periods
Firms can reasonably estimate future costs
Price set in advance and periodic payments are often made
Income Recognition after the sale
- Customer purchases product or service prior to
delivery
Examples:
sales of subscriptions by publisher or online merchant
gift card sales
sale of an insurance policy
» Results in an unearned or deferred revenue (liability) until goods delivered or services performed
2) Multiple element arrangements - two or more products or services sold as a ‘package’ or bundle
Examples
Software with upgrades privileges
Software with future customer support
» Revenue related to future services is recognized over the agreed upon future service period
Multiple Software Deliveries
Year 1: A customer purchases an “anti-virus” product from Symantec for cash $100. The customer is entitled for free upgrades through the end of Year 2. Symantec estimates that the value of future upgrades is $20.
Year 2:
Symantec provides free upgrades from Year 1.
Sells another “anti-virus” product for cash $110, estimated value of future upgrades = $40.
Year 1
Cash (+A) 100
Sales revenue (+R, +SE) 80
Unearned revenue (+L) 20
Year 2 Unearned revenue (-L) 20 Sales revenue (+R, +SE) 20
Cash (+A) 110
Sales revenue (+R, +SE) 70
Unearned revenue (+L) 40
Bundling various components, then you would allocate the sales price pro rata based on the market value
Suppose the software and upgrades are collectively worth $120, but you sell for $100, you would allocate the $100 pro rata based on the sales price
Accounting for expected sales returned
Sales returns is a common occurrence in certain
industries
– e.g., retail, publishing
- Revenue amount should be recorded net of estimated sale returns
- Recording estimated sales returns
two contra accounts:
Debit: Sales allowance XX
Credit: Reserve (or allowance) for sales returns XX
*Revenue contra account included on the I/S
Methods of accounting for uncollectible accounts
Direct write-off method – bad debt expense is recognized in the period in which a specific account is deemed
uncollectible
Poor matching of expense timing with related revenue
Allowance method – bad debt expense is matched to the
revenue by recognizing an estimate of the expense in the same
period as the credit sale
Required method under GAAP
Both approaches involve judgment and estimation
Balance sheet presentation of the allowance method
Accounts receivable (@ gross amount of sale )
Less: Allowance for estimated uncollectible amounts
Net accounts receivable «_space;Amount on balance sheet
Allowance account is a contra asset account
Often the allowance is disclosed as supplemental information on the
face of the balance sheet:
Uncollectible receivables - the allowance method
Time of Sale Sale to customer Dr A/R (+A)
Cr Sales Revenue (+R, +SE)
Period of Sale Adjusting entry Dr Bad Debt Expense (+E, -SE)
Cr Allowance for Uncollectible Accounts (+XA)
Later Collection Dr Cash (+A)
Cr A/R (all who pay) (-A)
Yet later Write-off Dr Allowance for Uncollectible Accounts (-XA)
Cr A/R (written off)
Balance Sheet for T-Accounts for Receivalbes
Balance Sheet T-Accounts for Receivables
Accounts receivable
Record sale to a credit customer:
DR Accounts receivable CR Revenue
Record the collection of cash from a credit customer:
DR Cash
CR Accounts receivable
Record the recognition of bad debt expense:
DR Bad debt expense
CR Allowance for doubtful accounts
Note: This is an estimate determined at the time of sale
Record write-off of uncollectible accounts:
DR Allowance for doubtful accounts CR Accounts receivable
Note: This will not impact expense accounts, as an estimate has already been expensed
