Chapter 5: Receivables and Revenue

Revenue Recognition

Revenue is recognized when a company satisfies its performance obligation, meaning it has provided goods or services to the customer. Recognition does not occur when an order is placed or payment is received, but only when the company has given up something in exchange.

• Performance Obligation: The duty to deliver goods or services as promised in a contract.

• FOB Shipping Point: Title passes to the buyer when goods are shipped.

• FOB Destination: Title passes to the buyer when goods are received.

• Sales Discounts: Discounts offered to customers for early payment, e.g., 2/10, net 30 means a 2% discount if paid within 10 days, otherwise full payment due in 30 days.

• Sales Returns & Allowances: Estimated future returns are recorded as a contra-revenue account, reducing gross revenue.

• Net Revenue Calculation:

  • Net Revenue = Gross Revenue - Sales Returns/Allowances - Sales Discounts

Types of Receivables

Receivables represent amounts owed to the company. They are classified as:

• Trade Receivables: Amounts due from customers for goods/services provided.

• Non-Trade Receivables: Amounts due from sources other than customers (e.g., interest, loans).

Accounting for Accounts Receivable

• Increase: Sales made on account.

• Decrease: Cash collections and write-offs.

• Allowance for Uncollectible Accounts: Contra-asset account with a credit balance, used to estimate receivables that may not be collected.

• Journal Entry for Allowance: Debit Uncollectible Account Expense, Credit Allowance for Uncollectible Accounts.

Net Realizable Value (NRV)

NRV is the amount expected to be collected from customers.

• Formula:

Allowance for Doubtful Accounts Methods

• Percent-of-Sales Method: Uncollectible expense is calculated as sales multiplied by the estimated uncollectible percentage.

• Aging-of-Receivables Method: Allowance is determined based on the age of receivables; expense is the adjustment needed to reach the calculated allowance.

Writing Off Uncollectible Accounts

• Journal Entry: Debit Allowance for Uncollectible Accounts, Credit Accounts Receivable.

• Effect: Write-offs do not affect NRV.

Notes Receivable: Interest and Maturity Value

• Interest Revenue Formula:

• Maturity Value: Principal plus all interest earned during the loan period.

• Accruing Interest: Records interest revenue in the correct period; failure to accrue understates revenue and assets.

Quick (Acid-Test) Ratio and Days' Sales Outstanding

• Quick Ratio Formula:

• Days' Sales Outstanding Formula:

• Interpretation: Higher quick ratio indicates better liquidity; lower DSO means faster collection.

Pivot Tables in Excel

• Purpose: Analyze collectability of accounts receivable by grouping and summarizing data.

Chapter 6: Inventory and Cost of Goods Sold

Inventory Cost Components

Inventory includes all costs necessary to acquire and prepare goods for sale.

• Included: Purchase price, freight-in, preparation costs.

• Excluded: Purchase returns and discounts decrease inventory.

Special Inventory Arrangements

• Consignment: Goods are held by the consignee but owned by the consignor; inventory remains on consignor's books.

Inventory Asset and Cost of Goods Sold (CoGS)

• Inventory Asset: Converts to CoGS when sold.

• CoGS: Expense reported on the income statement.

• Inventory System: Purchases increase inventory; sales require two entries: record sales and reduce inventory.

Periodic CoGS Calculation

• Formula:

Inventory Costing Methods

• FIFO (First-In, First-Out): Oldest inventory costs are assigned to CoGS.

• LIFO (Last-In, First-Out): Newest inventory costs are assigned to CoGS.

• Average Cost: CoGS and ending inventory are based on average cost per unit.

Effect of Costing Methods on Net Income and Inventory

• Rising Prices: FIFO yields lower CoGS (higher net income), LIFO yields higher CoGS (lower net income).

• Falling Prices: Opposite effects.

Lower-of-Cost-or-Market Rule

• Application: Inventory is written down to net realizable value if it will be sold at a loss.

Gross Profit and Gross Profit Percent

• Gross Profit Formula:

• Gross Profit Percent Formula:

Inventory Turnover

• Formula:

• Interpretation: Higher turnover indicates efficient inventory management.

Perpetual Inventory System

• Characteristics: Continuously updates inventory and CoGS with each transaction.

Chapter 7: Plant Assets, Natural Resources, and Intangibles

Capitalization of Costs

• Capitalized Costs: Costs classified as assets, not expensed immediately.

• Examples: Installation costs, improvements that add life or capacity.

Characteristics of Plant Assets

• Long-lived: Used for more than one year.

• Used in Operations: Not held for resale.

• Tangible: Physical presence.

Lump-Sum (Basket) Purchases

• Allocation: Total price is allocated to each asset based on relative fair values.

Capital Expenditure vs. Expense

• Capital Expenditure: Adds life, functionality, or capacity; capitalized.

• Expense: Regular repairs and maintenance; expensed immediately.

Depreciation

• Definition: Systematic allocation of asset cost to expense over its useful life.

• Depreciable Base Formula:

• Journal Entry: Debit Depreciation Expense, Credit Accumulated Depreciation.

• Accumulated Depreciation: Contra-asset account; sum of all depreciation recorded.

Depreciation Methods

• Straight-Line (SL):

• Unit-of-Production (UoP):

• Double Declining Balance (DDB): (for first year)

• Differences: DDB does not use residual value in calculation, uses book value, and adjusts ending book value to residual value.

Book Value

• Formula:

• Gain/Loss on Sale: Difference between proceeds and book value.

• Depreciation must be updated to date of sale.

Intangible Assets

• Characteristics: Long-lived, used in operations, intangible (no physical presence).

• Amortization: Intangibles are amortized on a straight-line basis.

• Examples: Patents and copyrights (amortized), trademarks and goodwill (not amortized).

Goodwill and Impairment

• Goodwill: Excess purchase price over fair value of identifiable assets; not amortized, tested for impairment.

• Impairment: Asset value is reduced if it cannot be recovered; loss is recognized.

Return on Assets Ratio

• Formula:

• Interpretation: Higher ratio indicates more efficient use of assets.

Excel Functions for Depreciation

• Purpose: Calculate straight-line and double declining balance depreciation.

ESG and Plant Assets

• ESG Issues: Environmental, social, and governance factors may affect asset valuation and accounting.

Appendix E: Investments

Initial Reporting Basis

• Cost Basis: Investments are recorded at cost on the purchase date.

Subsequent Reporting Basis

• Stock (Equity) Investments: Valuation depends on percentage ownership.

Accounting for Stock Investments

• Insignificant Influence: Adjust investment to fair value each period; unrealized gains/losses reported in income statement.

• Significant Influence: Use equity method; investment valued at adjusted cost basis.

• Controlling Influence: Consolidate financial statements; no separate investment account.

Accounting for Debt Investments

• Held to Maturity: Valued at amortized cost; interest revenue recognized.

Additional info: Some topics (e.g., global views, tax advantages, advanced investment accounting) are not tested in this course, as noted in the original guide.