M4L2V1: Accounts Receivables: Cash Discounts

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From the course by University of Illinois at Urbana-Champaign

Financial Accounting: Foundations

969 ratings

University of Illinois at Urbana-Champaign

Financial Accounting: Foundations

969 ratings

Course 1 of 7 in the Specialization Financial Management

In this course, you will learn foundations of financial accounting information. You will start your journey with a general overview of what financial accounting information is and the main financial statements. You will then learn how to code financial transactions in financial accounting language. In the meantime, you will learn about the most important concept in contemporary financial accounting: accrual accounting. You will then critically analyze how firms recognize revenues. Finally, you will finish the course with an analysis of accounting for short-term assets where you will go into detail on how firms account for accounts receivables and inventories. Upon successful completion of this course, you will be able to: • Understand main financial statements and the financial information they provide • Write a financial transaction in financial accounting language and understand how this impacts main financial statements • Understand how accrual accounting and fundamental accounting concepts work • Understand revenue recognition principles and how they impact main financial statements • Account for accounts receivables and inventories. This course is part of the iMBA offered by the University of Illinois, a flexible, fully-accredited online MBA at an incredibly competitive price. For more information, please see the Resource page in this course and onlinemba.illinois.edu.

From the lesson

Module 4: Short-Term Assets

One of the major components of a balance sheet is short-term assets, which are assets that can be converted into cash within a year. Accounts receivables and inventories constitute a major part of short-term assets. Understanding accounting for these accounts will help you uncover how these accounts change over time, their valuation, and their usefulness in managerial decision making.

M4L2V1: Accounts Receivables: Cash Discounts3:31

Meet the Instructors

Oktay Urcan
Associate Professor of Accountancy
Department of Accountancy, College of Business

The first group of short term assets we are going to talk about in this class is

accounts receivables.

So what's an example here?

For example, there is a firm which is making a sale of let's say $1,000, but

it doesn't collect the money from the customer at the time of sale.

Then this $1000 will be recorded as an account receivable on the balance sheet.

So the question now is how do we label account receivables?

Account receivables are not valued at their face value.

In the example that I just gave you, it's quite possible that the value that you see

for the account receivable balance on the sheet the balance may not be $1000.

Instead account receivables are valued in terms of their net realizable value.

Net realizable value is equal to face value,

in the example I just gave you it is $1000, minus three things.

These are cash discounts, sales returns, and bad debts.

Now we will spend some time on these three terms.

The first term that we have just mentioned is cash discounts.

What's a cash discounts?

These are discounts given to customers, over sale price,

if they pay within a certain time period.

The main purpose of the cash discounts is to encourage customers to pay early.

Let's give an example.

Here I have Illini supermarket which sells goods worth $2,000 to customer on credit,

that's why it is accounts receivable, on January 1, 2016, based on some terms.

These are 3/15 and n/30.

So let me just explain, let me must stop with the second one, enter the means.

This receivable needs to be collected within 30 days.

The first term 3/15 means, on the other hand if the customer

pays within 15 days customer will get 3% cash discount.

And it turns out that customer makes the payment on January 10th 2016, in other

words, customer pays within 15 days and customer's entitled to this cash discount.

So how do we do the accounting for this?

First of all, we record the sale.

So on the income statement IS column, there is an increase of $2000.

This is the amount of sales.

And at the same time on the account receivable column, AR,

we have $2000 increase.

This is on January 1st, 2016.

On January 10th 2016 what happens is that customers pay all of this receivables but

since the customer pay early he is entitled to a certain amount of discount.

What is the size of this discount, which is the last column here?

It is $2,000 times 3%, which is 60.

And the 60 is recorded as a negative, as a minus, from income statement column.

In general, we consider the $60 of cash discount as a reduction from sales.

Second of all,

all of the account receivable disappears because the customer makes the payment.

And finally, what is the amount of total cash collection?

It is $2,000,

which is the amount of face value of the receivable minus $60 of cash discounts.

So as you can see here,

the value of the account receivable that on the balance sheet may not be $2,000.

It is $2,000 minus cash discounts.

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