Apply the revenue principle to determine the accepted time to record sales revenue for typical retailers, wholesalers, manufacturers, and service companies.
Revenue recognition policies are widely recognized as one of the most important determinants of the fair presentation of financial statements. For most merchandisers and manufacturers, the required revenue recognition point is the time that title changes to the buyer (shipment or delivery of goods). For service companies, it is the time that services are provided.
Analyze the impact of credit card sales, sales discounts, and sales returns on the amounts reported as net sales.
Both credit card discounts and sales or cash discounts can be recorded either as contra-revenues or as expenses. When recorded as contra-revenues, they reduce net sales. Sales returns and allowances, which should always be treated as a contra-revenue, also reduce net sales.
Analyze and interpret the gross profit percentage.
Gross profit percentage measures the ability to sell goods or services for more than the cost to produce or purchase. It reflects the ability to charge premium prices and produce goods and services at lower cost. Managers, analysts, and creditors use this ratio to assess the effectiveness of the company's product development, marketing, and production strategy.
Estimate, report, and evaluate the effects of uncollectible accounts receivable (bad debts) on financial statements.
When receivables are material, companies must employ the allowance method to account for uncollectibles. These are the steps in the process:
The end-of-period adjusting entry to record bad debt expense estimates.
Writing off specific accounts determined to be uncollectible during the period. The adjusting entry reduces net income as well as net accounts receivable. The write-off affects neither.
Analyze and interpret the accounts receivable turnover ratio and the effects of accounts receivable on cash flows.
Accounts receivable turnover ratio—Measures the effectiveness of credit-granting and collection activities. It reflects how many times average trade receivables were recorded and collected during the period. Analysts and creditors watch this ratio because a sudden decline in it may mean that a company is extending payment deadlines in an attempt to prop up lagging sales or even is recording sales that later will be returned by customers.
Effects on cash flows—When a net decrease in accounts receivable for the period occurs, cash collected from customers is always more than revenue, and cash flows from operations increases. When a net increase in accounts receivable occurs, cash collected from customers is always less than revenue. Thus, cash flows from operations declines.
Report, control, and safeguard cash.
Cash is the most liquid of all assets, flowing continually into and out of a business. As a result, a number of critical control procedures, including the reconciliation of bank accounts, should be applied. Also, management of cash may be critically important to decision makers who must have cash available to meet current needs yet must avoid excess amounts of idle cash that produce no revenue.
Closely related to recording revenue is recording the cost of what was sold. Chapter 7 will focus on transactions related to inventory and cost of goods sold. This topic is important because cost of goods sold has a major impact on a company's gross profit and net income, which are watched closely by investors, analysts, and other users of financial statements. Increasing emphasis on quality, productivity, and costs have further focused production managers' attention on cost of goods sold and inventory. Since inventory cost figures play a major role in product introduction and pricing decisions, they also are important to marketing and general managers. Finally, since inventory accounting has a major effect on many companies' tax liabilities, this is an important place to introduce the effect of taxation on management decision making and financial reporting.
