chap05 1 auditing text and cases

Revenue and Monetary

Assets

Part One: Financial Accounting

5

The Business Operating Cycle

^{Slide 5-1}

Purchase materials

Convert materials into a finished

product

Inspect the product Receive an order

for the product Ship the product

and send the customer an

invoice

Customer acknowledges receipt of the item

Collect cash from the customer

1. Sales order received no none

2. Deposit or advance no none

payment received

3. Goods being produced For certain long- percentage of term contracts completion

4. Production completed; For precious metals production

goods stored and certain agri- cultural products 5. Goods shipped or usually delivery

6. Customer pays account collection is installment

receivable uncertain

Timing of Revenue Recognition

^{Slide 5-2}

Typical

Revenue Recognition Revenue Recognition Event at This Time Method

dr. Inventory on consignment 1,000

cr. Merchandise inventory 1,000

Consignment Shipments

^{Slide 5-3}

Goods costing $1,000 were Goods costing $1,000 were shipped out on consignment.

shipped out on consignment.

Goods costing $1,000 were Goods costing $1,000 were shipped out on consignment.

shipped out on consignment.

dr. Cost of goods sold 1,000

cr. Inventory on consignment 1,000

dr. Accounts receivable 1,400

cr. Sales revenue 1,400

Consignment Shipments

^{Slide 5-4}

These goods are sold by the These goods are sold by the

consignee for $1,400.

consignee for $1,400.

These goods are sold by the These goods are sold by the

consignee for $1,400.

consignee for $1,400.

Customer Project Year-End Payments Costs Percent

Year Received Incurred Complete Revenues Expenses Income

1 $120,000 $160,000 20 $ 0 $ 0 $ 0

2 410,000 400,000 70 0 0 0

3 370,000 240,000 100 900,000 800,000 100,000 Total $900,000 $800,000 $900,000 $800,000 $100,000

Completed-Contract Method

^{Slide 5-5}

If the amount of income to be earned on the contract cannot be reliably estimated, then

revenue is to be recognized only when the project has been completed.

If the amount of income to be earned on the contract cannot be reliably estimated, then

revenue is to be recognized only when the project has been completed.

1 $120,000 $160,000 20 $180,000 $160,000 $ 20,000 2 410,000 400,000 70 450,000 400,000 50,000 3 370,000 240,000 100 270,000 240,000 30,000 Total $900,000 $800,000 $900,000 $800,000 $100,000

Customer Project Year-End Payments Costs Percent

Year Received Incurred Complete Revenues Expenses Income

Percentage-of-Completion Method

^{Slide 5-6}

GAAP assumes that the percentage-of-

completion method will be used to account for long-term contracts.

GAAP assumes that the percentage-of-

completion method will be used to account for long-term contracts.

Bad Debts

^{Slide 5-7}

Check out the aging schedule in

Illustration 5-4.

Check out the aging schedule in

Illustration 5-4.

The firm expects bad debts of

$7,132 .

The firm expects bad debts of

$7,132 .

The accounts receivable section of the December 31, 1997 balance sheet would appear as follows:

Accounts receivable $262,250less: allowance for doubtful accounts 7,132accounts receivable, net

$255,118

dr. Bad Debts Expense 7,132

cr. Allowance for Doubtful 7,132

Bad Debts

^{Slide 5-8}

The adjusting entry would be:

Bad Debts

^{Slide 5-9}

If sometime in 1998 the Essel Company decided that James Johnson was never going to pay his bill of

$250, the following entry would be made:

dr. Allowance for Doubtful Accounts 250

cr. Accounts Receivable 250

The accounts receivable section of the balance sheet immediately after the write-off entry would show-- Accounts receivable $262,000less: allowance for doubtful accounts 6,882 accounts receivable, net $255,118

Note the the net Note the the net amount of accounts amount of accounts receivable is unchanged.

receivable is unchanged.

Note the the net Note the the net amount of accounts amount of accounts receivable is unchanged.

receivable is unchanged.

Sales Discounts

^{Slide 5-10}

Sold $1,000 of merchandise on credit

terms of 2/10, net/30.

Sales Discounts

^{Slide 5-10}

Sold $1,000 of merchandise on credit terms of 2/10, net/30.

dr. Accounts Receivable 980

cr. Sales Revenue 980

If payment is made within the discount period:

dr. Cash 980

cr. Accounts Receivable 980

Sales Discounts

^{Slide 5-11}

If payment is made after the discount period:

dr. Cash 1,000

cr. Discounts Not Taken 20

Accounts Receivable 980

The 2 percent discount really amounts to an annual rate of 32 percent.

The 2 percent discount really amounts to an annual rate of 32 percent.

Credit Card Sales

^{Slide 5-12}

Bank plan (MasterCard and Visa) Bank plan (MasterCard and Visa)

dr. Cash 970

Sales Discounts (Credit Cards) 30

cr. Sales Revenue 1,000

Other plans (American Express and Discover) Other plans (American Express and Discover)

dr. Accounts Receivable 970

Sales Discounts (Credit Cards) 30

cr. Sales Revenue 1,000

Interest Revenue

^{Slide 5-13}

On September 1, 1997, a bank loaned $10,000 for one year at 9 percent interest, the interest and

principal to be paid on August 31, 1998. The bank’s entry on September 1, 1997 is:

dr. Loan Receivable 10,000

cr. Cash 10,000

On December 31, 1997, an adjusting entry is made to record the fact that interest for one-third of a year,

$300, was earned in 1997:

dr. Loan Receivable 300

cr. Interest Revenue 300

Interest Revenue

^{Slide 5-14}

On September 1, 1997, a bank loaned $10,000 for one year at 9 percent discounted.

dr. Loan Receivable 10,000

cr. Cash 9,100

Unearned Interest Revenue 900

On December 31, 1997, an adjusting entry is made to record the fact that $300 of interest was earned in 1997.

dr. Unearned Interest Revenue 300

cr. Interest Revenue 300

Interest Revenue

^{Slide 5-15}

On August 31, 1998, when the loan is repaid, the entry is:

dr. Cash 10,000

cr. Loans Receivable 10,000

After repayment by the borrower, an adjusting entry is also made by the bank to record the fact that $600 interest was earned in 1998.

dr. Unearned Interest Revenue 600

cr. Interest Revenue 600

Current Ratio

^{Slide 5-16}

Current assets Current liabilities Current Ratio =

$1,245.1

$1,214.6 Current Ratio =

Current Ratio = 1.03

Slide 5-17

Acid-Test Ratio

Cash, temporary investments, and accounts

receivable (net)

Monetary Current assets Current liabilities

Acid-Test Ratio =

$634.9

$1,214.6 Acid-Test

Ratio = Acid-Test 0.52

Ratio =

Slide 5-18

Cash Cost Per Day

Expenses (net of depreciation) 365

Cash Cost Per Day =

$5,348.0 365 Cash Cost

Per Day =

$14.65 per day Cash Cost

Per Day =

Slide 5-20

Days’ Cash

Cash

Cash costs per day Days’ Cash =

$98.1

$14.65 Days’ Cash =

7 days

Days’ Cash =

Chapter 5

The End