Recognizing Revenue, Cash Collection, Sales Discount, SRA

When Should Revenue Be Recognized?
Revenue recognition is the phrase that accountants use to refer to the recording of a sale through a
journal entry in the formal accounting records. Revenue is usually recognized when two important
criteria have been met.
1. Th e work has been substantially completed (the company has done something).
2. Cash, or a valid promise of future payment, has been received (the company has received something
in return).
As a practical matter, most companies record sales when goods are shipped to customers. Credit sales
are recognized as revenues before cash is collected, and revenue from services is usually recognized
when the service is performed, not necessarily when cash is received.
ILLUSTRATION
Farm Land Products sells 30 sacks of fertilizer for cash and 20 sacks on credit, all at P10 per sack. Given
these data, the P500 of revenue is recorded as follows:
Cash 300
Accounts Receivable 200
Sales Revenue 500
Sold 30 sacks of fertilizer for cash and 20 sacks on credit
Although the debit entries are made to different accounts, the credit entry for the full amount is to a
revenue account. Th us, accrual-basis accounting requires the recognition of P500 in revenue instead of
the P300 that would be recognized if the focus were merely on cash collection
Using the revenue recognition criteria, when would the following companies recognize revenues?
1 Groceries sold to customers at Wal-Mart V
2 A plane ticket sold by Delta for a trip to be taken in six months
3 A 30-year mortgage issued by Bank of America
SOLUTION
1 Revenue related to groceries sold to customers at Wal-Mart would be recognized at the point of sale.
At that moment, the customer has possession of the groceries and has either paid or, using a credit
card, promised to pay.
2 Delta will recognize revenue when the plane has flown, thus six months from the date of the ticket
sale. While V Delta receives cash in advance of providing the service, it cannot recognize revenue until it
has provided the service.
3 Bank of America will earn interest on the mortgage over its 30-year life. It will recognize a portion of
each payment as interest income each month for the next 30 years
CASH COLLECTION
Subsequent collection of the P200 accounts receivable is recorded as follows:
Cash 200
Collected cash for P200 credit sale
Th e following T-accounts show that the net result of these two transactions is an increase in Cash and
Sales Revenue of P500
Sales Discounts
In many sales transactions, the buyer is given a discount if the bill is paid promptly. Such incentives to
pay quickly are called sales discounts, or cash discounts, and the discount terms are typically expressed
in abbreviated form. For example, 2/10, n/30 means that a buyer will receive a 2% discount from the
selling price if payment is made within 10 days of the date of purchase, but that the full amount must be
paid within 30 days or it will be considered past due. A 2% discount is a strong incentive for a customer
to pay within 10 days because it is equivalent to paying an annual interest rate of about 36% to wait and
pay after the discount period.
If the P200 in Farm Land credit sales were made with discount terms of 2/10, n/30, and if the customer
paid within the discount period, the entry to record the receipt of cash is:
Cash 196
Sales Discounts (P200 × 0.02) 4
Collected cash within the discount period for P200 credit sale
Sales Discounts is a contra account (specifically, a contra-revenue account), which means that it is
deducted from sales revenue on the income statement. Th is account is included with other revenue
accounts in the general ledger, but unlike other revenue accounts, it has a debit balance rather than a
credit balance.
Contra account An account that is offset or deducted from another account
Sales Returns and Allowances

Customers often return merchandise, either because the item is defective or for a variety of other
reasons. Most companies generally accept merchandise returns in order to maintain good customer
relations. When merchandise is returned, the company must make an entry to reduce revenues and to
reduce either Cash (a cash refund) or Accounts Receivable (an adjustment to the customer’s account). A
similar entry is required when the sales price is reduced because the merchandise was defective or
damaged during shipment to the customer.
Farm Land customers return goods costing P150; P100 in returns were made by cash customers, and
P50 in returns were made by credit customers. The entry to record the return of merchandise is:
Sales Returns and Allowances 150

Cash 100
Received P150 of returned merchandise; P100 from cash customers and P50 from credit
customers
The credit customers will be sent a credit memorandum for the return, stating that credit has been
granted and that the balance of their accounts (in total) is now P150 (P200 original credit purchase less
P50 returns). Like Sales Discounts, Sales Returns and Allowances is a contra account that is deducted
from sales revenue on the income statement.
INCOME STATEMENT
Sales Revenue 500
Less: Sales Discount (3)
Less: Sales Return and Allowances (150)
Net Sales Revenue 347
Net sales can be calculated as follows:
Gross Sales
– Sales Discounts
– Sales Returns and Allowances
= Net Sales

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When Should Revenue Be Recognized?

Subsequent collection of the P200 accounts receivable is recorded as follows:

Contra account An account that is offset or deducted from another account

Sales Returns and Allowances

Sales Returns and Allowances 150

Net sales can be calculated as follows:

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