Revenue and Receivables

Question 1

What are revenues?

Answer 1

Revenues result from delivering goods or services as part of an entity’s core operations.

Question 2

When does recognition of revenues occur?

Answer 2

Recognition occurs at a single point in time when the control of a good or service is transferred to the customer on a specific date.

Question 3

What are some indicators that a transfer has occurred and revenue should be recognized?

Answer 3

The seller has the right to receive payment
Customer having legal title
The customer having physical possession of the asset
The customer formally accepts an asset
The customer assuming the risks and rewards of ownership

Question 4

What are the five steps of revenue recognition?

Answer 4

Step 1: Identify a contract with the customer
Step 2: Identify the performance obligations in the contract
Step 3: Determine the transaction price
Step 4: Allocate the transaction price to each performance obligation
Step 5: Recognize revenue when (or as) each performance obligation is satisfied.

Question 5

Nordstrom sells a skirt to a customer for $75 that was previously purchased from a wholesaler for $40. How would Nordstrom account for the sale?

Answer 5

Balance Sheet:
+$75 Cash
- $40 Inventory
+35 Retained Earnings

Income Statement:
+75 Sales Revenue
+40 COGS
+35 Net Income

Question 6

What is the core principle of revenue recognition?

Answer 6

Companies recognize revenue when goods or services are transferred to customers for the amount the company expects to be entitled to receive in exchange for those goods and services.

When: upon TRANSFER to customers
How Much: amount the seller is ENTITLED to recieve

Question 7

What are the ways to know that the performance obligation is likely satisfied?

Answer 7

The customer:
Has an obligation to pay the seller
Receive legal title to the good or received the service
Physical Possession of the asset
Assumed the risk and reward of ownership to the good or receiving the service
Accepted the goods or service

Question 8

What do we do if we receive cash before performing our performance obligation?

Answer 8

We have to recognize a liability called deferred revenue or unearned revenue.

Question 9

When do we recognize revenue over a period of time?

Answer 9

3 Criteria

The customer consumes the benefit of the seller’s work as it is performed (i.e. cleaning service)

The customer controls the asset as it is created (constructing a building extension)

The seller is creating an asset that has no alternative use to the seller, and the seller has the legal right to receive payment for progress to date (i.e. an order of jets customized for the Airforce)

Question 10

How do we recognize revenue over a period of time?

Answer 10

We recognize it in proportion to the amount of performance obligation that has been satisfied.

Question 11

What are the steps of revenue recognition for contracts that contain multiple performance obligations?

Answer 11

Identify the performance obligations
- Ask “Are the goods or services in question capable of being distinct?

Allocate the transaction price to each performance obligation

Question 12

What does it mean for goods or services to be distinct?

Answer 12

Separately identifiable from other goods or services in the contract (i.e. capable of being sold separately)

Question 13

What are examples of discounts or guarantees that companies make to reduce the amount of cash the company is entitled to receive from customers?

Answer 13

Sales Returns
Trade Discounts
Sales Discounts

Question 14

What are sales returns?

Answer 14

Product that is returned by the customer.

Question 15

Trade Discounts

Answer 15

Discounts that are offered to incentivize the sale of products.

Question 16

Sales Discounts

Answer 16

Early Payment discounts that incentivize cash receipt.
A reduction in the amount to be received from a credit customer if collection on account occurs within a specified period.

I.e. 2/10, n/30
[ Discount percentage/number of days discount is available, otherwise, Net (or all) is due in 30 Days/Credit Period]

Question 17

What is net revenue?

Answer 17

Total revenues minus any amounts of returns and discounts.

Question 18

What are credit sales?

Answer 18

Credit sales transfer goods or services toa customer today while bearing the risk of collecting payment from that customer in the future.

Question 19

What is recorded by a company at the time of a credit sale?

Answer 19

Accounts receivable
Revenue

Question 20

How is Accounts Receivable affected by a credit sale?

Answer 20

Record the amount owed to the company from the sale of goods or services on account. This number is located under ASSETs and it increases as a customer purchases product.

Question 21

How is Revenue affected by a credit sale?

Answer 21

Even though no cash is received during a credit sale, the seller records revenue immediately once goods or services are provided to the customer, and future collection is probable.

Question 22

What is a subsidiary ledger?

Answer 22

A subsidiary ledger contains a group of individual sub-accounts associated with a particular account.

• for example, the subsidiary ledger for accounts receivable keeps track of all increases and decreases to individual customers’ accounts.

The balances of all individual accounts then sum to the balance of total accounts receivable reported in the balance sheet.

Question 23

What is the Allowance Method (GAAP)

Answer 23

GAAP requires that companies account for uncollecible accounts using an allowance method.

Question 24

What are the two steps of the allowance method?

Answer 24

Estimate the amount of current accounts receivable that will prove to be uncollectible in the future.

Report this estimate as a contra asset to its accounts receivable

Question 25

How much does the company report in its accounts receivable under the allowance method?

Answer 25

A company reports its accounts receivable for the net amount EXPECTED to be collected.

Question 26

Bad Debt Expense

Answer 26

Bad Debt Expense refers to the portion of receivables that a company or individual is unable to collect from debtors. It represents the amount of credit sales that are expected to remain uncollectible and is considered as an expense for the business.

Part of Operating Expense

Question 27

When is bad debt recorded as an adjustment?

Answer 27

At the end of the period.

Question 28

What is the result of a bad debt expense adjustment?

Answer 28

Increase allowance for uncollectible accounts and INCREASE bad debt expense.

Question 29

What are the three steps of applying the allowance method?

Answer 29

1. At the end of the year, establish an allowance by estimating future uncollectible accounts
2. During the subsequent year, write off actual bad debts as uncollectible
   - Note. Actual write-offs may differ from the previous year’s estimate.
3. At the end of the subsequent year, once again, estimate future uncollectible accounts.

Question 30

What happens when we finally decide that a specific customer won’t pay?

Answer 30

“Write-Off”

Question 31

What is a write-off

Answer 31

It is what we call a specific customer’s account that we determine is not collectible.

Question 32

When do we write off accounts recievable?

Answer 32

When it becomes clear that the customer will not pay, the company will write off their account balance as uncollectible.

Question 33

How does the Write-Off play out on the balance sheet?

Answer 33

• Decreases the balance of accounts receivable
• Decrease the balance of the contra account Allowance for Uncollectible Accounts

Question 34

What effect does the write-off have on total assets or total expenses?

Answer 34

No effect

Question 35

What are the two methods for calculating the ending allowance for uncollectible accounts.

Answer 35

Percentage of Receivables
Aging

Question 36

What does the method of Percentage of Receivables entail?

Answer 36

Based on the percentage of accounts receivable expected not to be collected.

For this method, the percentage may be estimated using current economic conditions, company history, and industry guidelines.

I.e. If Accounts Receivable is $30 million and we estimate, based on
history, that 23% of AR will not be collected then we would calculation our ending Allowance to be $7 million ($30 million * 23%)

Question 37

What does the method of Aging entail?

Answer 37

Estimates future bad debts on the various ages of individual accounts receivable, using a higher percentage for “old” accounts than for “new” accounts.

The older the account, the less likely it is to be collected.

I.e. Similar approach to Percentage of Receivables, except a bit more
sophisticated, because we have %s for each ‘aging bucket’. Add up the uncollectible estimate by ‘bucket’ and that is the needed ending
Allowance.