Accounting for managers

1
Accounting for managers

• An introduction to financial accounting
• doc. dr. Aljoa Valentincic

2
Recognition of revenue

• Revenue gross inflow of economic benefits
• Only on its own account (i.e., excluding all
  agent-type transactions)
• Operating cycle of a company
• Recognise revenue when (IAS 4)
• it is probable that economic benefits will flow
  to the firm
• the amount of revenue (and associated costs) can
  be measured reliably
• the firm has transferred to the buyer the
  significant risks and rewards of ownership
• does not apply to services

3
Revenue Recognition and Accounting Manipulations?

• A major source of accounting manipulations
• also see Box 10.2 in the book

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Valuation of receivables (1)

• Account receivable when revenue is not paid
  immediately in cash (or settled in with some
  other type of good / service)
• remember the definition of an asset
• Why do companies want to sell on credit?
• They expect to earn more this way rather than
  just by selling on cash
• Bad debt losses are matched against sales they
  help to produce in the period

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Valuation of receivables (2)

• At what amount should receivables be recorded
  (initially, when revenue is recognised)?
• At cost fair value of consideration given,
  i.e., normally amount on the invoice
• Adjustments to initial value (later)?
• as time goes by economic circumstances may change
• e.g., a customer goes bankrupt
• write down receivables to its recoverable amount
• recoverable amount expected future cash flow

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Complication 1 discounts (1)

• Cash discounts
• often, trade terms offer a cash discount if paid
  within a certain number of days, e.g. 2/10 net 30
• e.g., if paid within 10 days, you only pay 98 of
  the amount, or else the full amount (100) within
  30 days
• all else equal, less cash makes the owners worse
  off
• Dr. Accounts receivable (A) 100
• Cr. Sales revenue (OE) 100
• Dr. COGS (OE-) 80
• Cr. Inventory (A-) 80
• Customer pays on day 8
• Dr. Cash (A) 98
• Sales discount (OE-) 2
• Cr. Accounts receivable(A-) 100

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Complication 1 discounts (2)

• What would the customer account in its books?
• Dr. Inventory (A) 100
• Cr. Accounts payable (L) 100
• Then, when they pay within the 10 day period
• Dr. Accounts payable (L-) 100
• Cr. Cash (A-) 98
• Purchase discount (OE) 2

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Complication 1 discounts (3)

• Cash discount alternatively
• Dr. Accounts receivable (A) 98
• Cr. Sales revenue 98
• Dr. COGS (OE-) 80
• Cr. Inventory (A-) 80
• Customer pays on day 26
• Dr. Cash (A) 100
• Cr. Accounts receivable (A-) 98
• Discount revenue (OE) 2
• What is the difference between the two approaches
  from the perspective of an user of financial
  statements?

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Complication 2 VAT

• The company acts as an agent between the (final)
  customer and the government
• hence VAT not revenue, but included in receivable
• continue parallel to previous example, assume VAT
  rate 20, the firm first buys a machine for 80
  (incl. VAT) and sells it at 100 (incl. VAT)
• Dr. Inventory (A) 66.67
• VAT receivable (A) 13.33
• Cr. Accounts payable (L) 80
• Dr. Accounts receivable (A) 100
• Cr. Sales revenue (OE) 83.33
• VAT payable (L) 16.67

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Complication 3 bad debts (1)

• Customers go bankrupt, disputed receivables,
• partially or wholly unrecoverable receivables
• In principle, simple
• when you find out that a customer has gone
  bankrupt, you directly write-off the amount
• Dr. Bad debt expense (OE-) 20
• Cr. Accounts receivable (A-) 20
• Where do you think the problem is with this
  method?

11
Complication 3 bad debts (2)

• The allowance method
• at the end of or during) every financial period
  uncollectible accounts are estimated
• receivables ageing schedule
• become doubtful, but we really do not know
  whether these accounts will ever be paid or not
• but we should allow for it in the financial
  statements

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Complication 3 bad debts (3)

• Two accounts are used
• Allowance for doubtful accounts
• a balance sheet contra-asset account for A/R
• a separate account paired with a related
  account
• shown as a deduction from the related account
• has opposite balance
• reduces the A/R to the amount expected to be
  realised (collected in cash) indirectly
• remember the definition of an asset
• original expectations and new (revised)
  expectations regarding the receivables are
  preserved
• Uncollectible accounts axpense
• an account on the income statement
• an operating expense (quite normal in most
  businesses)

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Complication 3 bad debts (3)

• Assume the Allowance for doubtful accounts
  account has a credit balance of 30
• It comes from previous adjusting entries
• A normal balance of a contra-asset account is a
  credit balance
• Determine that the 67 of the 1,000 of gross
  receivables outstanding will not be collected
  (see ageing schedule)
• Need to account for 67 (need) 30 (already done)
  37 additional
• Dr. Uncollectible accounts expense (OE-) 37
• Cr. Allowance for doubtful accounts (CA) 37

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Complication 3 bad debts (4)

• Assume the Allowance for doubtful accounts
  account has a debit balance of 30
• It comes from previous adjusting entries
• But this time a non-normal debit balance ?
  amount actually written-off is less than
  estimated allowances
• Determine that the 67 of the 1,000 of gross
  receivables outstanding will not be collected
  (see ageing schedule)
• Need to get to 67 from a start of -30 97
• Dr. Uncollectible accounts expense (OE-) 97
• Cr. Allowance for doubtful accounts (CA) 97

15
Complication 3 bad debts (5)

• Write-off an uncollectible account receivable
• when it becomes clear the receivable is not only
  doubtful but it never will be collected
• For example Customer D, who owes company C 250,
  is declared bankrupt on January 15.
• Dr. Allowance for doubtful accounts (CA-) 250
• Cr. Accounts receivable (A-) 250
• Note
• Net Realisable Value of A/R remains the same.
  Why?
• Account and Contra Account are deducted with the
  same amount!
• Also note that the uncollectible amount was
  already expensed in the past the period C got
  suspicious D will not pay.

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Complication 3 bad debts (6)

• Recovery of Accounts receivable written-off
• On September 1 D notifies after its bankruptcy
  that it would be able to pay 100. D also sends
  a cheque for 50 (of the 100 to be paid)
• Dr. Accounts receivable (A) 100
• Cr. Allowance for uncollectible accounts
  (CA) 100
• Dr. Cash (A) 50
• Cr. Accounts receivable (A-) 50

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Complication 4 sales returns and allowances

• We had two situations in Soncek, d.o.o.,
• a customer returns goods and the company gives
  money (or cancels liability) a sale return
• a customer returns the goods and the company
  gives a voucher a sale allowance
• Prudently at the point of sale
• Dr. Estimated sales returns (OE-) 300
• Cr. Allowances for sales returns (CA) 300
• Then, when returns actually happen
• Dr. Allowances for sales returns (CA-) 300
• Cr. Accounts receivable (A-) 300
• Assuming the goods are resealable
• Dr. Inventory 180
• Cr. Cost of goods sold 180