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Illustration: Gross Method vs. Net Method

Illustration: Gross Method vs. Net Method

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LO7-3



Gross Method vs. Net Method



(Illustration continued)



The Hawthorne Manufacturing Company offers credit customers a 2% cash discount if the sales price is paid within 10 days.

Any amounts not paid within 10 days are due in 30 days. These repayment terms are stated as 2/10, n/30. On October 5,

2016, Hawthorne sold merchandise at a price of $20,000. The customer paid $13,720 ($14,000 less the 2% cash discount) on

October 14 and the remaining balance of $6,000 on November 4.



Journal Entry-October 14, 2016



Debit



Credit



Gross Method

13,720



Cash

Sales discounts



280



Accounts receivable



14,000



Net Method

13,720



Cash

Accounts receivable



13,720



LO7-3



Gross Method vs. Net Method



(Illustration continued)



The Hawthorne Manufacturing Company offers credit customers a 2% cash discount if the sales price is paid within 10 days.

Any amounts not paid within 10 days are due in 30 days. These repayment terms are stated as 2/10, n/30. On October 5,

2016, Hawthorne sold merchandise at a price of $20,000. The customer paid $13,720 ($14,000 less the 2% cash discount) on

October 14 and the remaining balance of $6,000 on November 4.



Journal Entry-November 4, 2016



Debit



Credit



Gross Method

6,000



Cash

Accounts receivable



6,000



Net Method

6,000



Cash

Accounts receivable

Interest revenue



5,880

120



LO7-3



Gross Method vs. Net Method



(Illustration continued)



The Hawthorne Manufacturing Company offers credit customers a 2% cash discount if the sales price is paid within 10 days.

Any amounts not paid within 10 days are due in 30 days. These repayment terms are stated as 2/10, n/30. On October 5,

2016, Hawthorne sold merchandise at a price of $20,000. The customer paid $13,720 ($14,000 less the 2% cash discount) on

October 14 and the remaining balance of $6,000 on November 4.



Sales

Less: Sales discounts

Net sales revenue

Interest revenue

Total revenue



Gross Method



Net Method



$20,000



$19,600



(280)



-0-



19,720



19,600



0



120



$19,720



$19,720



LO7-4



Subsequent Valuation of Accounts Receivable



Two situations could cause the cash ultimately collected to be less than the initial valuation of

the receivable:



1)

2)



Returns: The customer could return the product

Bad Debts: The customer could default and not pay the agreed-upon sales price.



LO7-4



Sales Returns











Situation when merchandise is returned for a refund or for credit to be applied to other

purchases

Special price reduction, called an allowance, may be given as an incentive for the

customer to keep the merchandise rather than returning it

We need to accrue sales returns and allowances at the time of sale.



– Otherwise, recognizing sales returns when they occur could result in overstated

income in the period of sale and understated income in the return period



LO7-4



Illustration: Accounting for Sales Returns

During 2016, its first year of operations, the Hawthorne Manufacturing Company sold merchandise for $2,000,000. This

merchandise cost Hawthorne $1,200,000 (60% of the selling price). Industry experience indicates that 10% of all sales will be

returned, which in this case equals $200,000 ($2,000,000 × 10%). Customers returned $130,000 of sales during 2016.

Hawthorne uses a perpetual inventory system.



Sales of $2,000,000 occurred in 2016, with cost of goods sold of $1,200,000



Assuming Hawthorne received cash at the time of sales:



Assuming Hawthorne recorded accounts receivable at the time of sales

that have not yet been collected:



Cash



2,000,000



Sales revenue



COGS

Inventory



Acc. receivable

2,000,000



1,200,000



Sales revenue



COGS

1,200,000



2,000,000

2,000,000



1,200,000

Inventory



1,200,000



LO7-4



Accounting for Sales Returns



(Illustration continued)



During 2016, its first year of operations, the Hawthorne Manufacturing Company sold merchandise for $2,000,000. This

merchandise cost Hawthorne $1,200,000 (60% of the selling price). Industry experience indicates that 10% of all sales will be

returned, which equals $200,000 ($2,000,000 × 10%) in this case. Customers returned $130,000 of sales during 2016.

Hawthorne uses a perpetual inventory system.



Sales returns of $130,000 occurred during 2016. The cost of returned inventory is $78,000 ($130,000 × 60%)



Assuming Hawthorne received cash at the time of sales:



Assuming Hawthorne recorded accounts receivable at the time of sales

that have not yet been collected:



Sales returns



130,000



Cash



Inventory

COGS



Sales returns

130,000



78,000



Acc. receivable



Inventory

78,000



130,000



COGS



130,000



78,000

78,000



LO7-4



Accounting for Sales Returns



(Illustration continued)



During 2016, its first year of operations, the Hawthorne Manufacturing Company sold merchandise for $2,000,000. This

merchandise cost Hawthorne $1,200,000 (60% of the selling price). Industry experience indicates that 10% of all sales will be

returned, which equals $200,000 ($2,000,000 × 10%) in this case. Customers returned $130,000 of sales during 2016.

Hawthorne uses a perpetual inventory system.



At the end of 2016, an additional $70,000 of sales returns are expected. The cost of the inventory expected to be returned is

$42,000 ($70,000 × 60%)

Assuming Hawthorne recorded accounts receivable at the time of sales

Assuming Hawthorne received cash at the time of sales:

Sales returns



70,000



Refund Liability



Inventory–est. returns

COGS



that have not yet been collected:

Sales returns



70,000



42,000



Allow. for S. returns



Inventory–est. returns

42,000



70,000



COGS



70,000



42,000

42,000



LO7-4



Accounting for Sales Returns



(Illustration continued)



During 2016, its first year of operations, the Hawthorne Manufacturing Company sold merchandise for $2,000,000. This

merchandise cost Hawthorne $1,200,000 (60% of the selling price). Industry experience indicates that 10% of all sales will be

returned, which equals $200,000 ($2,000,000 × 10%) in this case. Customers returned $130,000 of sales during 2016.

Hawthorne uses a perpetual inventory system.



Sales returns of $70,000 occurred during 2017. The cost of returned inventory is $42,000.



Assuming Hawthorne recorded accounts receivable at the time of sales

Assuming Hawthorne received cash at the time of sales:

Refund Liability



70,000



Cash



Inventory

Inventory–est. returns



that have not yet been collected:

Allow. for S. returns



70,000



42,000



Acc. receivable



Inventory

42,000



70,000



Inventory–est. returns



70,000



42,000

42,000



LO7-4



Sales Returns (Damaged or Defective)



Sales Returns









Merchandise unable to satisfy the



Defective or damaged during



customer’s needs



shipment



Should be included in a company’s estimate of returns

To be valued at the lower of cost and net realizable value



LO7-4



Accounting Treatment for Merchandise Returns







If the estimate of future sales returns turns out to be wrong, the new estimate is

incorporated into accounting determinations in the next period



Suppose in our illustration that in 2017 actual returns from 2016 sales are $60,000 instead of $70,000.



Journal Entry-2017

Allowance for sales returns



Debit

10,000



Sales returns

Cost of goods sold

Inventory—estimated returns



Credit



10,000

6,000

6,000



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Illustration: Gross Method vs. Net Method

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