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Chapter 6Reporting and Interpreting Sales
Revenue, Receivables, andCash
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What are we going to learn?
How to apply revenue principle
How to analyze credit card sales, sales
discount and sales return (net sales)?
Bad debts and write-offs
Ratios Gross Profit Percentage and Receivable
Turnover
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Revenue and Net Sales
Revenue Recognition Principle: revenues arerecognized as earned when
Delivery is occurred or services have been rendered There is a persuasive evidence of an arrangement for
customer payment
The price is fixed or determinable
Collection is reasonably assured
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Review of Recognition Principle
For sellers of goods: the criteria for revenuerecognition often meet when title and risks of
ownership transfer to buyer. FOB (free on board) shipping
FOB destination
For service companies: when they have provided
services to the buyer, they recognize revenues.
Revenue Recognition Rule : in the footnote to the
financial statements
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Reporting Net Sales5
Companies record credit card discounts,sales discounts, and sales returns andallowances separately to allow management
to monitor these transactions.
(Gross) Sales revenueLess: Credit card discounts
Sales discountsSales returns and allowances
Net Sales Revenue
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Credit Card Sales6
Companies accept credit cards for several reasons:
1. To increase sales.
2. To avoid providing creditdirectly to customers.
-To avoid losses due tofraudulent credit card sales.
-To receive payment quickly.
3. To avoid losses due to badchecks.
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Credit Sales
When credit card sales are made, the company mustpay the credit card company a fee for the service itprovides .
Example: Sears sold a washer and the customercharged the $1,000 sales price on her Master card.Master card charges a 2% credit card fee.Cash 980Credit card discount 20
Sales Revenue 1,000
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Contrarevenue
account
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Sales Discounts
When companies allow customers topurchase merchandise on an open account ,the customer promises to pay the company
for the purchase in the future.
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When customers purchase on open
account, they may be offered a salesdiscount to encourage early payment .
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Sales Discounts (Credit Terms)9
2/10, n/30Discount
Percentage# of Days in
DiscountPeriod
Otherwise,the Full
Amount IsDue
MaximumDays inCreditPeriod
Pay 98% if payment is made within 10 days,otherwise pay the full amount within 30 days
Read as: Two ten, net thirty
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To Take or Not Take the Discount?10
With discount terms of 2/10,n/30, a customersaves $2 on a $100 purchase by payingon the 10 th day instead of the 30 th day.
$2$98
= 2.04%Interest Rate for 20 Days =
Interest Rate for 20 Days = Amount Saved Amount Paid
So, should the customer take the discount?
Annual Interest Rate = 365 Days20 Days 2.04% = 37.23%
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Example: Sales Discount On 2/1/09, OfficeMax sold a copier to a customer at an
invoice price of $2,000, terms 3/10, n/60. Purchase cost ofthe copier was $1,500.
Accounts Receivable 2,000Sales Revenue 2,000
Cost of Goods Sold 1,500Inventory 1,500 The customer paid the full amount on 2/4/09.
Cash 1,940Sales Discount 60
Accounts Receivable 2,000 Implicit annual interest rate in the sales discount?
Interest rate for 50 days: 60/(2,000-60) = 3.09% Annual interest rate: 3.09%*365/50 = 22.56%
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Contrarevenueaccount
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Sales Returns and Allowances Sales returns and allowance account Contra revenue account
Debited for damaged merchandise Debited for returned merchandise
See Chapter 6 Supplement A Recording Credit Card Sales, Sales Discount and Returns
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Credit Card Sales13
On January 2, a Deckers factory stores credit card saleswere $3,000. The credit card company charges a 3%service fee. Prepare the Deckers journal entry
Date Description Debit Credit
Jan. 2 Accounts Receivable (+A) 2,910
Credit Card Discounts (+XR, - R, -SE) 90
Sales Revenue (+R, +SE) 3,000
$3,000 3% = $90 Credit Card Fee
GENERAL JOURNAL
Credit Card Discounts are reported
as a contra-revenue account.
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Sales Discounts14
On January 6, Deckers sold $1,000 of merchandise oncredit with terms of 2/10, n/30 . Prepare the Deckers journalentry.
Date Description Debit Credit
Jan. 6 Accounts Receivable (+A) 1,000Sales Revenue (+R, +SE) 1,000
GENERAL JOURNAL
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Sales Discounts15
On January 14, Deckers receives the appropriate paymentfrom the customer for the January 6 sale. Prepare theDeckers journal entry
Date Description Debit Credit
Jan. 14 Cash (+A) 980
Sales Discounts (+XR, -R, -SE) 20
Accounts Receivable (-A) 1,000
GENERAL JOURNAL
$1,000 2% = $20 sales discount
$1,000 - $20 = $980 cash receipt
Contra-revenue account
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Sales Discounts16
If the customer remits the appropriate amount on January20 instead of January 14, what entry would Deckers make?
Date Description Debit Credit
Jan. 20 Cash (+A) 1,000
Accounts Receivable (-A) 1,000
GENERAL JOURNAL
Since the customer paid outside of the discountperiod, a sales discount is not granted .
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Sales Returns and Allowances17
On July 8, before paying, a customer returns $500 ofsandals originally purchased on account from Deckers. Thesandals originally cost Deckers $300. Prepare the Deckers
journal entry.
Date Description Debit Credit
July 8 Sales Returns and Allowances (+XR, -R, -SE) 500
Accounts Receivable (-A) 500
July 8 Merchandise Inventory (+A) 300
Cost of Goods Sold (-E, +SE) 300
GENERAL JOURNAL
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Reporting Net Sales
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(Gross) Sales revenue $6,000
Less: Credit card discounts 90Sales discounts 20Sales returns and allowances 500
Net Sales Revenue 5,390
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Concept Quiz
What are the three common contra-revenueaccounts?
What is the meaning of 2/10, n/30?
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Sales Revenue
Less: ( )( )( )
Net Sales
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More Challenging Example1. Target offers its customers who use its store credit card 5%
off all transactions.2. Wal-Mart allows customers to use other credit cards and
then pays 3% to the credit card company.3. Starbucks has a rewards card which gives customers a
cash back reward online of $1 for every $100 spent. Assuming the customer pays using the above form of
payment, what amount would each company record in netrevenue for a $100 transaction.
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Classification of Receivables21
Accounts
Receivable
Trade receivables are amountsowed to the business for credit
sales of goods, or services.
Nontrade receivables are amountsowed to the business for other
than business transactions.
NotesReceivable
A promise in writing (a formaldocument) to pay (1) principal and
(2) interest at future dates
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Receiving Payment for Goods and Services
On credit through Accounts Receivable
Bad debts are possible Credit cards
Least risky method for a firm
Must pay service charge to credit card company Cash
Control of cash is a major issue
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Considerations of Receipt ofRevenue Payment
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Accounts Receivable
Accounts receivable ( AR ) are the expected futurecash receipts of a company for sales made on account
Receivables are reported at their face value less an
allowance for accounts which are likely to beuncollectible.
The amount which is actually expected to be collected iscalled the net realizable value (NRV). GAAP requires that AR be reported at NRV.
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Bad Debts (Uncollectible Accounts)
When customers default , account becomesvalueless and must be removed .
Could be considered a reversal of revenue,however, it is considered a cost of business (an expense ) and gross revenue remains.
An uncollectible account is written-off (asset
removed ) and an expense is recognized .
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Bad debts (uncollectible accounts) resultfrom credit customers who will not pay thebusiness the amount they owe, regardless
of collection efforts.
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Accounting for Bad Debts25
MatchingPrinciple
Bad DebtExpense
SalesRevenue
Record in sameaccounting
period.
Most businesses record an estimate ofthe bad debt expense by an adjusting
entry at the end of the accounting period .
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Accounting Process for Bad Debt
Step 1: Record estimated bad debts expense At end of period in which sales are made(Matching principle)
Expense goes up , Allowance for doubtful accounts
(contra asset) goes up Step 2: Identify and write off actual bad debts
Throughout the period as bad debts becomeknown
Accounts Receivable go down , Allowance fordoubtful accounts goes down .
No effect on Net Income and Assets in the
second step !!!
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Step 1: Recording of Estimated Bad Debtsexpense
Journal EntryBad Debt Expense (+E, -SE) xxx Allowance for Doubtful Accounts (+XA,-A) xxx
Allowance Account: a contra-asset on the balance sheet Bad Debt Expense: is normally classified as a selling
expense and is closed at year-end .
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Balance Sheet Disclosure Accounts Receivable (Gross) 500,000
Less: Allowance for doubtful accounts (25,000)
Accounts Receivable (Net) 475,000
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Step 2: Actual Write-off of an UncollectableAccount
Journal Entry Allowance for Doubtful Accounts(-XA,+A) xxx Accounts Receivable(-A) xxx
Uncollectable accounts are written off against theallowance account
No effect on Net Income and Assets !!!
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Example: Deckers29
Date Description Debit Credit
Dec. 31 Bad Debt Expense (+E, -SE) 27,567
Allowance for Doubtful Accounts (+XA, -A) 27,567
GENERAL JOURNAL
Deckers estimated bad debt expense for 2008 to be
$27,567. Prepare the adjusting entry (at the end ofDecember 2008)
Deckers total write -offs for 2008 were $25,216. Prepare a
summary journal entry for these write-offs.Date Description Debit Credit
Allowance for Doubtful Accounts (-XA, +A) 25,216
Accounts Receivable (-A) 25,216
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Example: Deckers30
Assume that before the write- off, Deckers Accounts
Receivable balance was $300,000 and the Allowance forDoubtful Accounts balance was $30,000.Lets see what effect the total write -offs of $25,216 had onthese accounts.
Before Write-Off
After Write-Off
Accounts Receivable 144,051$ 118,835$Less: Allow. for doubtful accts. 35,922 10,706 Accounts receivable (Net) 108,129$ 108,129$
Notice that the total write-offs of $25,216 did not change the AccountsReceivables (net) nor did it affect any income statement accounts .
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Quick Review Net Sales Revenue
Record by creating a contra-revenue account
Recording Bad Debt Expense
Bad Debt Expense (+E, -SE) xxx Allowance for Doubtful Accounts (+XA,-A) xxx
Record Write-Offs Allowance for Doubtful Accounts(-XA,+A) xxx
Accounts Receivable -A xxx
(Gross) Sales revenueLess: Credit card discounts
Sales discounts
Sales returns and allowancesNet Sales Revenue
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More Challenging ExampleWhat is the January 31 st Net Accounts Receivable and Net
Sales Revenue Balance for Proctor and Gamble? (assume 0beginning balances)
January 3 rd P&G sold $500,000 in cleaning supplies to Target with terms1/10, n/30 (the cleaning supplies cost P&G $300,000). On January 5 th Target paid $396,000 of the balance. On January 30 th
Target paid the remainder of the balance ($100,000). On January 17 th Target notified P&G that it received the wrong size of
$8,000 worth of cleaning supplies and that it has sent them back(inventory cost $5,000). Assume this $8,000 merchandise had not yetbeen paid for.
On January 28 th, P&G shipped $100,000 in personal care products to Boand Mos family shop.
On January 31 st , P&G estimates based on past experience that $2,000 of
the Bo and Mo sale will be uncollectable .
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Solution
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Methods for Estimating Bad Debts
Percentage of credit sales or
Aging of accounts receivable
????
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Percentage of Credit Sales A company estimates the percentage of credit sales that will
prove uncollectable . Bad debt percentage is based on actual uncollectable accounts from
prior years credit sales
The focus is on determining the amount to record as BadDebt Expense on the i n c o m e s t a t em en t The bad debt expense for the period = the percentage * Credit Sales for the period This amount is used in an adjusting journal entry
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Example: Percentage of Credit Sales
Date Description Debit Credit
Dec. 31 Bad Debt Expense (+E) 6,000
Allowance for Doubtful Accounts (+ XA, -A) 6,000
GENERAL JOURNAL
In 2009, Kids Clothes had credit sales of $600,000. Past
experience indicates that bad debts are one percent ofcredit sales . What is the estimate of bad debts expense for2006?
$ 600,000 * 0.01 = $ 6,000
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Aging of Accounts Receivable
A company estimates the percentage ofaccounts receivable that will proveuncollectable . Adjust net account receivable up or down to this
number The difference goes to bad debt expense
The focus is on determining the desiredbalance in the Allowance for Doubtful
Accounts on the b al an c e s h eet
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Aging of Accounts ReceivableAccounts Receivable
% Estimated UncollectibleDesired Balance in Allowance Account
- Allowance Account Cr ed i t Balance
Amount of Journal Entry
Accounts Receivable % Estimated Uncollectible
Desired Balance in Allowance Account- Allowance Account C r e d i t Balance
Amount of Journal Entry for Bad Debt Expense
Focus is on determining the ( ending )
desired balance in the Allowance forDoubtful Accounts on the balance sheet.
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Example: Aging Schedule
Each customers account is aged bybreaking down the balance byshowing the age (in number of days)
of each part of the balance. An aging of accounts receivable for
Kids Clothes in 2009 might look likethis . . .
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Example: Aging Schedule
Days Past Due
Customer Not Yet
Due 1-30 31-60 61-90 Over 90
TotalA/R
BalanceAaron, R. 235$ 235$
Baxter, T. 1,200$ 300 1,500 Clark, J. 50$ 200$ 500$ 750
Zak, R. 325 325 Total 3,500$ 2,550$ 1,830$ 1,540$ 1,240$ 10,660$
Based on past experience, the businessestimates the percentage of uncollectible
accounts in each time category.
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Example: Aging Schedule
Days Past Due
Customer Not Yet
Due 1-30 31-60 61-90 Over 90
TotalA/R
BalanceAaron, R. 235$ 235$
Baxter, T. 1,200$ 300 1,500 Clark, J. 50$ 200$ 500$ 750
Zak, R. 325 325 Total 3,500$ 2,550$ 1,830$ 1,540$ 1,240$ 10,660$% Uncollectible 0.01 0.04 0.10 0.25 0.40
These percentages are then multipliedby the appropriate column totals.
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Example: Aging Schedule
Days Past Due
Customer Not Yet
Due 1-30 31-60 61-90 Over 90
TotalA/R
BalanceAaron, R. 235$ 235$
Baxter, T. 1,200$ 300 1,500 Clark, J. 50$ 200$ 500$ 750
Zak, R. 325 325 Total 3,500$ 2,550$ 1,830$ 1,540$ 1,240$ 10,660$% Uncollectible 0.01 0.04 0.10 0.25 0.40 EstimatedUncoll. Amount 35$ 102$ 183$ 385$ 496$ 1,201$
The column totals are then added toarrive at the total estimate of
uncollectible accounts of $1,201.
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Example: Aging Schedule
After posting, the Allowance
account wouldlook like this . . .
Date DescriptionPost.Ref. Debit Credit
Dec. 31 Bad Debt Expense 1,151
Allowance for Doubtful Accounts 1,151
GENERAL JOURNAL
1,201 Desired Balance- 50 Credit Balance
1,151$ Adjusting Entry
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Example: Aging Schedule
Allowance for Doubtful Accounts50 Balance at
12/31/2009before adj.
1,151 2009 adjustment1,201 Balance at
12/31/2009after adj.
Notice that the balanceafter adjustment is equal
to the estimate of $1,201based on the aginganalysis performed
earlier.
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Difference between the Two Methods
Percentage of CreditSales Aging of Account
Focus Estimate thebad debt expense(Income Statement )
Estimate the endingbalance of allowancefor doubtful accounts
(Balance Sheet )
Calculationof bad debt
expenseDirect Indirect
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Concept Quiz What is the difference between Accounts Receivable and
Notes Receivable?
What are Bad Debts?
By ( ) principle, a company must recognize baddebt expenses in the same period when it recognizes salesrevenue.
What are the two steps to account for bad debts?
What are the two methods for estimating bad debt expenses?How do they differ?
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Two Ratios
Gross Profit PercentageGross Profit=
Net Sales
All other things remaining equal,a higher gross profit percentage
higher net income Used to assess profitability
Receivable TurnoverNet Sales
=
Average AccountsReceivable
A measure of how many times averagereceivables are recorded and collectedfor the year
The higher ratio the faster thecollection of receivables
Used to assess liquidity of receivables(a companys management ofreceivables)
whereAverage Accounts Receivable
= Beginning Balance + Ending Balance
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Example: Deckers Data from the 2006 financial statement (dollars in
thousands) Gross Sales: $ 314,423 Credit Card Discounts: $10,000 Cost of Sales: $163,224 Net Accounts Receivable:
Beginning balance $39,683Ending balance $49,571
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Example: Deckers
Gross Profit = Net Sales Cost of Sales
Gross Profit Margin = Gross Profit / Net Sales
Average Accounts Receivable
Receivable Turnover= Net Sales / Average Accounts Receivable
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Reporting and Safeguarding Cash Cash Equivalents: Short-term investments with original
maturities of three months or less that are readily convertibleto cash. Examples? Certificates of Deposit (
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Safeguarding Cash Internal Controls: processes by which a company safeguards
its assets and provides reasonable assurance regarding thereliability of the companys financial reporting, theeffectiveness and efficiency of its operations, and compliancewith applicable laws and regulation
Effective Internal Control: Separation of duties
Separate physical handing of cash and accounting for cash Separate receiving and dispersing cash
Prescribed policies and procedures Require daily deposits Certain individuals are required to approve expenditures (sign checks) Includes monthly bank reconciliation
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Balance per Bank
+ Deposits in Transit
- Outstanding Checks
Bank Errors
= Correct Balance
Balance per Book
+ Deposits by Bank
(credit memos)
- Service Charge
- NSF Checks
Book Errors
= Correct Balance
Bank ReconciliationExplains the difference between cash reported on bankstatement and cash balance on companys books and
provides information for reconciling journal entries.
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Bank Reconciliation ExamplePrepare a July 31 bank reconciliation statementand the resulting journal entries for the SimmonsCompany. The July 31 bank statement indicateda cash balance of $9,610, while the cash ledgeraccount on that date shows a balance of $7,430.
Additional information necessary for thereconciliation is shown on the next page.
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Bank Reconciliation Example Outstanding checks totaled $2,417. A $500 check mailed to the bank for deposit had not
reached the bank at the statement date. The bank returned a customers NSF check for $225
received as payment of an account receivable. The bank statement showed $30 interest earned on the
bank balance for the month of July. Check 781 for supplies cleared the bank for $268 but was
erroneously recorded in our books as $240. A $486 deposit by Acme Company was erroneously
credited to our account by the bank.
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Bank ReconciliationEnding bank balance, July 31 9,610$Additions: Deposit in transit 500 Deductions: Bank error 486$
Outstanding checks 2,417 2,903 Correct cash balance 7,207$
Ending book balance, July 31 7,430$Additions:
Interest 30 Deductions: Recording error 28$
NSF check 225 253 Correct cash balance 7,207$
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Take-aways of Chapter 6 Revenue and Net Sales
How to record credit card sales, sales discount, and salesreturns?
How to compute the implicit annual interest rate of salesdiscount?
Bad Debts and Uncollectible Accounts How to account for bad debt? (Recording allowance and
writing off bed debt?)
How to estimate bad debt expense? (Percentage of Creditsales vs. aging of accounts)
Gross profit margin and receivable turnover Cash control & bank reconciliations