CHAPTER 7 CONTROL OF SALES AND ACCOUNTS RECEIVABLES INTRODUCTION ------------ Sales, or revenue, result from the sale of merchandise or from the rendering of some kind of service. This revenue is ordinarily recognized (entered into the accounting information system ) when the customer is billed, that is , when a sales invoice is prepared. Or, if the sale is for cash, the revenue is recognized at the time of the sale when the cash is received. If the cash is not received at the time of the sale, the sale is made on account. That is an account receivable entry is recorded indicating that the customer will pay the bill at a later time. These activities raise the following questions? 1. When do we record the sale? 2. Should we allow the customer credit? Should we let the customer take the merchandise and pay for it later? 3. Should we allow the customer a discount (reduction in price ) if he or she buys in large quantities? 4. Should we allow the customer a discount if the customer pays before his account is due? 5. How do we know that all sales are recorded? 6. How do we know that all accounts receivables are recorded? 7. How do we know what each customer owes us? 8. How do we know that the customer was charged correctly for the merchandise? RECOGNITION OF REVENUE ---------------------- When we are legally entitled to the revenue from a sale of merchandise, or the rendering of a service, we should immediately enter the information into the AIS System. We are legally entitled to the revenue when we have given up title to the merchandise (delivered possession to the customer) or completed the rendering of the service. In a Retail System ------------------ When a sale is recorded on the cash register in a retail store and the merchandise given to the customer, the revenue from the sale is earned and recorded. The optical scanner reads the code on the package and automatically sends the information to the computer system. The code on the package is an inventory code that tells the computer which inventory item has been sold. The computer system automatically sends back to the register the description of the item sold and the price. Thus in a retail system, the computer system automatically records the sale, increasing the cash balance and the sales account immediately. In the INVENTORY chapter we will see how the computer system also automatically keeps track of the quantity on hand , the retail price and the cost of each inventory item. So when the optical scanner reads the code on the package,it sends the inventory code to the computer, and the computer sends back the description of the item and the price to the cash register. This system has a tremendous advantage over a manual system because we do not have to worry if the employee at the cash register has entered the price of the item correctly. Possibly the greatest potential for human input errors has be controlled. Which means that many dollars have been saved. You should recognize that errors can still occur. For example, the cashier may miss running the package over the optical scanner. In this case the customer will not be charged for the merchandise. The company will then not only lose the gross profit (difference between the sales price and cost of goods sold) but also the full cost of the merchandise. Many sales will have to be made just to recover this loss. You have probably already discovered that when you are checking out at the grocery store that in many cases you are charged the regular price even though the store has advertised a reduced price. This happens so frequently that you wonder if it was planned that way. If you ask for the correct price they will be happy to make the correction, but they may indicate that it was a computer error. Obviously, this is not a computer error. This is a human error. THEY HAVE NOT ENTERED THE SPECIAL SALES PRICE INTO THE COMPUTER SYSTEM. Have they done this on purpose? It certainly will increase their profits. Make sure you know your prices and watch that the computer system charges you correctly. In a Wholesale System -------------------- A wholesaler is a business that is selling to other businesses for resale to their customers. To ensure that a good system of internal control is maintained for the purchase and sale of goods, it is important that clearly defined procedures be implemented and followed. The following is an example of a set of clearly defined procedures for recording sales. A sale will be recorded as of the invoice date and payments from customers will be recorded on the date received. A. The buyer's retail store forwards a purchase requisition to the purchasing department requesting the purchase of merchandise. B. The buyer's purchasing department prepares a purchase order (original and 3 copies): - The original is mailed to the seller; - Copy 1 goes to the buyer's receiving department; - Copy 2 is filed; - Copy 3 goes to the buyer's accounting department. C. When the purchase order is received by the seller, the buyer's credit is approved before the order is processed. D. The seller's accounting department prepares a sales invoice (original and 3 copies): - The original and copy 3 is held by the seller's accounting department; - Copy 1 and Copy 2 go to the seller's shipping department. E. The seller's shipping department packs the goods and encloses Copy 1 (packing slip). Copy 2 is sent back to the seller's accounting department listing the items shipped. F. The seller's accounting department completes the original invoice and Copy 3 using information entered on Copy 2 by the shipping department. THE SALE IS THEN RECORDED USING COPY 3 AS THE SOURCE DOCUMENT. G. The original sales invoice is dated and mailed by to the buyer. This date begins the discount period. CASH DISCOUNTS -------------- As an incentive to the buyer for early payment, a seller can offer a discount, which is a reduction in the amount due if payment is made within a specified time period. Several sample cash discount terms are listed below: Code Terms Explanation ---- ------ ----------- 1 n/30 The invoice price is due within 30 days of the invoice date. (no discount) 6 2/10,n/30 A 2% discount is given if payment is made within 10 days of the invoice date, otherwise the invoice price (or unpaid balance is due within 30 days of the invoice date. TRADE DISCOUNTS --------------- Buyers who order in large quantities will receive a trade discount, that is, a reduced price because they are reselling the merchandise to their customers. Obviously, for a wholesaler to make a profit he or she must be able to buy merchandise at a lower price than the retail price. The trade discount may be 10%, 20% or 50% of the retail price, depending upon the industry and the quantity of the order. ACCOUNTS RECEIVABLE ------------------- An accounts receivable, an asset, is the result of selling merchandise on credit. We give up inventory items but receive an account receivable (a right to receive payment at a later time). SUBSIDIARY ACCOUNTS RECEIVABLES ------------------------------- What ever system we use we must keep track of exactly how much each customer owes us. We must keep track of each sales invoice of each customer as well as each payment received from each customer. The computer file that holds all the information in regard to the transactions by customer is called the SUBSIDIARY ACCOUNTS RECEIVABLE FILE. When printed out this report for each customer will list all invoices of the respective customer and all payments and the resulting balance owed. At the end of each month this report will be sent to the customer to remind to that this is, or is not. a balance due. This is called the monthly billing or monthly statements. When a sale on account is entered into the SALES JOURNAL we must not only enter the sale amount and accounts receivable amount but also the customer's account number. This information instructs the computer system to add this information the customer's subsidiary account receivable file. UNCOLLECTIBLE ACCOUNTS ---------------------- If we are going to extend credit to customers, we must recognize that some customers will not pay their bills when due. Some customers will be late in payment and some customers will end up not paying at all. If the customer does not pay his invoices the seller has not only lost his profit, but the seller has paid for merchandise and has not even recovered his cost. So we know from experience that there will be some bad debts. There are at least two methods of estimating the amount of uncollectible accounts receivable, the ALLOWANCE METHOD and the AGING METHOD. THE ALLOWANCE METHOD OF ESTIMATING BAD ACCOUNTS ----------------------------------------------- The allowance method, or percentage-of-net-sales method, compares the amount of uncollectible accounts expense with the net credit sales of prior years and calculates the percentage of prior losses. This percentage is then used to estimate the amount of uncollectible accounts. For example: Year Credit Net Sales Losses-uncollectible ---- ---------------- -------------------- 1984 $ 120,000 $ 3,300 1985 160,000 4,900 1986 180,000 5,300 1987 210,000 6,100 1988 230,000 6,900 1989 260,000 7,900 1990 300,000 9,300 1991 350,000 11,000 1992 400,000 12,300 ---------- -------- 2,210,000 67,000 67,000 ---------- = .0303 = 3 % 2,210,000 Therefore if we wish to estimate our losses from un collectible accounts receivable we can use our past experience and say that we expect our losses to be 3 %. If we want our Balance Sheet and Income Statement to be correct, we must recognize this loss of uncollectible accounts receivable as an expense and a reduction in the value of the accounts receivable (an asset). ADJUSTING ENTRY --------------- If the net sales on credit for the month was $36,000, we would make the following ADJUSTING ENTRY in the general journal: Debit Credit Uncollectible Accounts Expense 1080 Allowance for Uncollectible Accounts 1080 The Uncollectible Accounts Expense is an expense account shown in the Income Statement resulting in a decrease in Net Income of $1,080. The Allowance for Uncollectible Accounts appears in the Balance Sheet as a subtraction from the Accounts Receivable Account. When an account is a subtraction from another account we refer to it as a CONTRA ACCOUNT. So the Allowance for Uncollectible Accounts is a Contra Account. We must use these estimate accounts because we know from past experience that 3 % of Accounts Receivables (in this example) will not be collected, but we do not know at this time which ones will be uncollectible. We cannot make the entry directly to the accounts receivable account because when ever we change the accounts receivable account we must also show the effect on a specific customer's account (THE SUBSIDIARY ACCOUNT RECEIVABLE). What should we do when we determine that a specific customer's account is uncollectible? Then we can write off the specific customer's account and decrease the accounts receivable, and reduce the allowance for uncollectible accounts since we have now used up part of the estimate. For Example: If the account receivable for John Smith of $1,000 is determined to be uncollectible, the following entry would be made in the General Journal: Debit Credit Allowance for Uncollectible Accounts 1000 Accounts Receivable (John Smith) 1000 In summary, if we use the Percentage-of-net-sales Method we will add 3 % of net sales for each month to the Allowance for Uncollectible Accounts , a credit. In the Balance Sheet we will show the Accounts Receivable less the Allowance for Uncollectible Accounts and the difference, the Net Accounts Receivable. The Net Accounts Receivable should represent the estimate by management as the amount of accounts receivable that will be collected. THE AGING METHOD ---------------- The Aging Method is an alternative method to determine the losses from uncollectible accounts receivable. This method estimates what the balance of the Allowance for Uncollectible Accounts should be. This method recognizes that a larger percentage of older accounts receivables will not be collected. The older the account receivable the less the chance of collecting it. Therefore the method of analysis of accounts receivables involves sorting out all the accounts receivables by age, that is, by groups such as 0- 30 days old, 31-60 days old, 61-90 days old, 91-120 days old and over 121 days. The computer system will print out an Aging Report that might look like the following: The ABC COMPANY AGING OF ACCOUNTS RECEIVABLE November 30,1992 Age Of Accounts Receivables 31-60 61-90 91-120 Over120 Customer Total Current Days Days Days Days -------- ------- ------- ------ ------ ------- ----- Stout Stores 40000 30000 10000 0 0 0 Northridge Ins. 3600 2000 1600 Mutual of Northridge 1300 0 0 0 300 1000 Sunny Country Club 2900 2000 900 Valley Mall 1100 0 0 100 0 1000 Kaput Pharmacy 2600 2200 400 0 0 0 ------ ------ ----- ----- ----- ---- 51500 36200 12900 100 300 2000 Percentage Estimate to be Uncollectible 2 % 5 % 10% 30 % 75 % Estimated Uncollectible Amount 724 645 10 100 1500 Total amount required in Allowance Account 2979 Balance in the Allowance for Uncollectible Accounts 2100 ----- Adjustment amount + 879 ----- In this example, the firm has studied its losses in previous years and concluded that 2 % of the current accounts, 5 % of the 31-60 day old accounts, 10 % of the 61-90 day old accounts, 30 % of the 91-120 day old accounts and 75% of accounts that are over 120 old. This estimating method calculates what the balance of the Allowance for Uncollectible Accounts should be. So the difference between this calculated figure and the actual balance in the account is the adjustment amount. The ADJUSTING ENTRY would be as follows: Debit Credit Uncollectible Accounts Expense 879 Allowance for Uncollectible Accounts 879 The PERCENTAGE-OF-NET-SALES estimating method determines how much to add to the allowance account. The AGING METHOD estimates what the balance in the allowance account should be. An adjustment is the difference between the actual balance of the Allowance for Uncollectible Accounts and the amount that the AGING METHOD calculates the balance should be. THE SALES JOURNAL ----------------- The Sales Journal is used to record all sales on account (on credit). Cash sales are recorded in the Cash Receipts Journal. An example of a Sales Journal follows: ================================================================ SALES JOURNAL Enter Date as X to EXIT, or C to CANCEL Sales A/R Tax Subs. A/R Sales Payable Ln# Date Ref. Customer Invoice # Debit Credit Credit -- ---- ---- ---------------- ------- ------ ------- ----- 1 12/9 4 Sunny Country Club 3900 12420.00 11500.00 920.00 2 12/11 2 Northridge Insurance 3901 8446.00 7820.40 625.60 3 12/12 1 Stout Stores 3902 21600.00 20000.00 1600.00 4 12/15 6 Kaput Pharmacy 3903 10800.00 10000.00 800.00 ------- ------- ----- 53266.00 49320.40 3945.60 ================================================================= CONTROL ------- The totals of the debit and credit columns in the sales journal must equal zero. If not an error has occurred, and must be corrected. The computer system will post (transfer) the total accounts receivable ($53266.00) to the accounts receivable account as an increase (debit). The computer system will post each entry in the A/R Debit column to the respective subsidiary accounts receivable (the respective customer ledger) account. The total accounts receivable must always equal the total of all the subsidiary accounts receivable accounts. The computer system will post the total of the Sales Credit column to the Sales Account and the total of the Sales Tax Payable Credit column to the liability, Sales Tax Payable Account. An invoice is prepared for all sales and the invoices are pre-printed with consecutive numbers. All invoices must be accounted for by number. Even a void invoice will be recorded in the sales journal with zero amounts, so that all invoice numbers will appear in the sales journal. THE ACCOUNTS RECEIVABLE SYSTEM ------------------------------ The typical Accounts Receivable System consists for four sub- systems as follows: 1. The Customer Master File Maintenance System. 2. The Sales Order Entry/Invoice System. 3. The Cash Receipts System. 4. The Monthly Billing System. THE CUSTOMER MASTER FILE MAINTENANCE SYSTEM ------------------------------------------- The Customer Master File Maintenance System must be run first to set up at least your company's name and address in it and at least one customer. As you run the Sales Order Entry System you can add new customers to the Customer Master File. Or if you prefer you can add all your customer names and addresses to the Customer Master File initially by employing Option 7 of the Customer Master File Maintenance System. The Customer Master File Maintenance Menu appears as follows: ================================================================= A C C O U N T S R E C E I V A B L E S Y S T E M SELECT OPTION 1 CUSTOMER MASTER FILE MAINTENANCE 2 SALES ORDER ENTRY/INVOICE SYSTEM 3 A/R CASH RECEIPTS SYSTEM 4 PRINT MONTHLY STATEMENTS 5 EXIT ENTER OPTION (1-5)? 1 CUSTOMER MASTER FILE MAINTENANCE SELECT OPTION 1 OR 7 FIRST 1 = TO LOAD INTO MEMORY CUSTOMER MASTER FILES 2 = TO ADD NEW INVOICES TO CUST. MASTER FILE IN MEMORY 3 = TO LIST RECORDS IN MEMORY 4 = TO CHANGE RECORD IN MEMORY 5 = PRINT LABELS 6 = TO PRINT CUSTOMER MASTER FILE 7 = TO CREATE CUSTOMER MASTER FILE 8 = TO WRITE UPDATED CUSTOMER MASTER FILE FROM MEMORY TO DISK 9 EXIT ENTER OPTION (1-9) ? 7 INSERT DISK WITH DATA FILES CREATE NEW CUSTOMER MASTER FILE YOUR CO. NAME ? ON GUARD INC. ADDRESS ? 1811 NORTH ST. CITY ? NORTHRIDGE STATE ? CA ZIP ? 91330 TELEPHONE ? (213) 349-8349 ENTER INVOICE COMMENT LINE #1 ?THANK YOU FOR YOUR ORDER ENTER INVOICE COMMENT LINE #2 TERMS ARE 2/10,N/30 ENTER INVOICE COMMENT LINE #3 ? ================================================================ ================================================================ CUSTOMER MASTER FILE CREATION ENTER INVOICE DATE (MM/DD/YY) ? 10/05/92 ENTER INVOICE NO. ? 1001 ENTER CUSTOMER ID (1-9998, NOT 99) ? 1 ENTER CUSTOMER NAME ? Stout Stores ENTER ADDRESS LINE 1 ? ATT:DICK SMITH ENTER STREET ADDRESS ? 1258 HILL ST. ENTER CITY ? BURBANK ENTER STATE ? CA ENTER ZIP CODE ? 91220 ENTER BALANCE DUE ? 00 CORRECT INPUT (Y/N)? Y ENTER ANOTHER CUSTOMER (Y/N)? N ================================================================= THE SALES ORDER ENTRY/INVOICE SYSTEM ------------------------------------ The Sales Order Entry/Invoice System print customer invoices, an Invoice Register and mailing labels for this batch of customer orders. The system will allow the user to obtain an Invoice as the information is entered or wait until a later time to print out all the invoices of a batch of entries. The system will display the invoice of the screen as the data is entered to verify input. The system will allow the user to print the number of copies of the invoice he desires at the time of data entry or later or both. If the respective customer is included in the Customer Master File, the user does not have to enter the customer name and address. If the user enter the customer number, the computer will search the Customer Master File and display the customer's name and make the address available for the invoice. The user will select Option 7 to add this Invoice file to the Outstanding Invoice File. The Outstanding Invoice File is used in the Cash Receipts System and Monthly Billing System. The MENU for the Sales Order Entry/Invoice System appears as follows: ============================================================ S A L E S O R D E R E N T R Y S Y S T E M SELECT OPTION 1 = ENTER INVOICE DATA 2 = PRINT INVOICES 3 = PRINT INVOICE REGISTER 4 = PRINT INVOICE FILE, CUSTOMER NAME, ADDRESS, BALANCE 5 = PRINT CUSTOMER MAILING LABEL OR ENVELOPE 6 = WRITE JOURNAL ENTRIES FOR GENERAL LEDGER SYSTEM 7 = TO ADD THIS INVOICE FILE TO OUTSTANDING INVOICE FILE 8 = EXIT ENTER OPTION (1-8) ? 1 ============================================================== THE ACCOUNTS RECEIVABLE-CASH RECEIPTS SYSTEM -------------------------------------------- The Cash Receipts System enables the user to verify that the cash received from customers on account matches the Invoice # and Invoice amount. More important it provides a control so that cash received is credited to the correct customer's account. The Cash Receipts System load into the computer's memory the Outstanding Invoice File and the old Cash Receipts File for reference. When the user enters a cash receipt from a customer, the computer will display on the video screen the outstanding invoices and previous cash payment of that customer. Thus providing information to verify that the cash receipt is correctly applied to the invoice and to the customer's account. This system also prints a Cash Receipts Journal which list all cash receipts entered into the system. An aged Accounts Receivable Report is also available. The Cash Receipts System MENU appears as follows: ================================================================= C A S H R E C E I P T S S Y S T E M SELECT OPTION 1 FIRST SELECT OPTION 1 = LOAD OUTSTANDING INVOICE FILE & CASH RECEIPTS FILE 2 = ADD NEW OUTSTANDING INVOICES TO FILE 3 = ENTER CASH RECEIPTS FROM CUSTOMERS 4 = PRINT CASH RECEIPTS JOURNAL 5 = WRITE JOURNAL ENTRIES FOR GENERAL LEDGER SYSTEM 6 = WRITE UPDATED CASH RECEIPTS FILE FOR NEXT RUN 7 = PRINT AGEING OF ACCOUNTS RECEIVABLE REPORT 8 = CREATE INITIAL CUSTOMER OUTSTANDING INVOICE FILE 9 = LIST OUTSTANDING INVOICES IN MEMORY 10= EXIT ENTER OPTION (1-10)? 1 ================================================================= Then we would select option 3 to enter customer's cash payment on account as follows: ================================================================ CASH RECEIPTS ENTRY ENTER CUSTOMER ID (1-9998) or 0 to exit ? 2 THE FOLLOWING INVOICES ARE OUTSTANDING INV# DATE CUST. ID CUSTOMER NAME INVOICE AMT PAID AMT 1002 10/10/92 2 ALLEN JONES 129.50 0.00 1004 10/12/92 2 ALLEN JONES 152.04 0.00 1006 10/12/92 2 ALLEN JONES 141.92 0.00 ENTER INVOICE # OR 0=EXIT? 1004 CASH AMOUNT RECEIVED OR 0=EXIT? 152.04 ENTER DATE (MM/DD/YY)? ? 10/20/92 ENTER DISC. ALLOWED ? 0 ENTER INVOICE # PAID OR 0=EXIT ? 0 If the customer does not pay the correct amount the invoice remains as an outstanding invoice indicating the paid amount. THE MONTHLY BILLING SYSTEM -------------------------- Monthly billing can be done on a BALANCE FOREWORD METHOD or the OUTSTANDING INVOICES METHOD. The Balance Forward Method presents a statement with the balance as the first of the month and lists all new outstanding invoices for the month. This is similar to a bank statement balance forward method. The OUTSTANDING INVOICE METHODS list all outstanding invoices as the beginning of the month and all new invoices and all payments made by the customer during the month. This method requires larger date files but provides more information for the customer in case he has any questions or disagreements. The following MENU presents a Monthly Billing System that uses the Outstanding Invoice Method. ================================================================= = MONTHLY BILLING SYSTEM SELECT OPTION 1 7 2 FIRST SELECT OPTION 1 = LOAD INTO MEMORY OUTSTANDING INVOICE FILE 2 = ADD CASH RECEIPTS TO FILE 3 = PRINT MONTHLY STATEMENTS 4 = LIST OUTSTANDING INVOICES IN MEMORY 5 = PURGE PAID INVOICES 6 = EXIT ENTER OPTION (1-6) ? 1 ================================================================= Having and using a monthly billing system is extremely important to facilitate cash flow. If you do not bill your customers they will not send you cash to run your business. Your monthly statement should be scheduled to be in the mail by or before the first of the month to receive prompt payment. END