Chapter 6 Flashcards
Revenue Recognition Principle (ASPE)
Recognize revenues when - earnings process is complete or substansially complete.”
- Risk and rewards have been transferred
- Performance is complete, and the required significant acts have been performed.
- Transaction/consideration can be measured
- Collection is reasonably assured
Net sales is…
Sales revenue
(Credit card discounts)
(Sales discounts)
(Sales returns and allowances)
Why do companies accept credit card discount?
- Increase sales
- Avoid providing credit directly to customers
- Avoid losses due to bad cheques
- Receive payment quicker
Sales returns and allowances are..
- Used to debit for damaged or returned merchandise significant $.
- Contra revenue account
The Matching Principles
- Cost of goods sold related to revenue should be recognized in the same period as the sales revenue
- if revenue is deferred, all expenses should also be deferred
- if revenue is recognized in the current period, but expenses are yet to be incurred, liability must be created.
Measuring Accounts Receivable
- Canadian practice
– Show receivable at the net realizable value
– Net realizable value should be an approximation of
the cash collected - Net Realizable value adjusts for things like:
– Cash discounts
– Sales returns
– Allowances for uncollectible account (bad debt)
– (consistent with the disclosure of “Net Sales”)
Bad Debts are…
Regardless of collection efforts, bad debts result from customers who will not pay for what they owe.
Reported as part of selling expense
Governed by the Matching Principle- bad debt is recorded in the same accounting period as revenue
2 Methods of Calculating Bad Debt
- Allowance Method:
– Income Statement approach
* Percent of sales
– Balance Sheet approach
* Aging method - Direct Method of writing bad debt:
- Not GAAP
- Does not comply with matching principle
- Can be used, if amount is not material
AFDA Method 1: Credit Sales Method
Income Statement
approach
* Emphasizes the matching principle
* Average % of bad debt to sales is determined based
on historical information
* Percent is applied to current period net credit
sales to determine bad debt expense
AFDA Method 1: Credit Sales Method
Bad debt percentage is based on the actual uncollectible accounts from prior years’ (historical rates) credit sales.
The focus is on determining the amount to record on the income statement as Bad Debt Expense.
Net Credit Sales
× % Estimated Uncollectible
Amount of Journal Entry
AFDA METHOD 2: AGING METHOD
- Based on past experience, the business estimates the percentage of uncollectible accounts in each time category.
- These percentages are then multiplied by the appropriate column totals.
- The column totals are then added to arrive at the the total estimate of uncollectible accounts of $1,201.
- Record the Dec. 31, 2020, adjusting entry assuming that the Allowance for Doubtful Accounts currently has a $50 credit balance.
Allowance vs Direct Write-Off Method
Allowance
Methods
Direct Write-Off
Method
Year end
adjustment
Dr: Bad debt
Cr: AFDA
No entry
Write Off DR: AFDA
CR A/R- ABC Co.
DR: Bad Debt
CR: A/R – ABC Co.
Recovery DR: A/R- ABC Co.
CR: AFDA
DR: Cash
CR: A/R- ABC Co.
DR: A/R- ABC Co.
CR: Bad Debt
DR: Cash
CR: A/R- ABC Co.
Receivable Turnover (IMPORTANT)
Receivable Turnover = Net Sales / Average Net Trade Receivables
Internal Control (Definition and Purpose)
Defined as organization plan and all related measures adopted by an entity to ensure orderly and efficient
conduct of business
- Purpose of internal control
– Discharge statutory responsibilities, maintain accountability to owners
and adherence to managerial policies
– Profitability and minimization of cost- EVALUATE PERFOMRANCE
– Safeguard of assets- protect assets from waste, fraud and theft
– Ensure accurate, reliable and timely accounting data
Internal Control - Overview (5 Primary Components and Limitations)
Good I/C systems have five
primary components:
– Control environment
– Risk assessment
– Control activities
* Authorization of transactions
* Segregation of duties
* Documentation
* Physical control
* Independent checks
– Information and communication
– Monitoring
Limitation of I/C
- Reasonable
assurance
- Cost/benefit
- Human element
- Collusion
- Size of business
