Module - Receivables.docx

FINANCIAL ASSET – ACCOUNTS RECEIVABLE Nature of receivables – Receivables are financial assets arising from a contractual right to receive cash or another financial asset from another company. Classes of Receivables A. For Manufacturers or retailers: Trade receivables – are claims arising from sale of merchandise or service in the ordinary course of business operations; such as: (a) Accounts receivable – are open accounts or those not supported by promissory notes. Other names for accounts receivable are customers’ accounts, trade debtors, and trade accounts receivable. (b) Notes receivable – are those supported by formal promises to pay in the form of notes. Non-trade receivables – are claims arising from sources other than from sale of goods or services in he normal course of business; such as the following: (a) Advances to officers and employees (b) Advances to subsidiaries/affiliates (c) Dividends and interest receivable (d) Deposits as a guarantee of performance or payment (e) Deposits to cover potential losses or damage (f) Claims for: insurance, tax refunds, lawsuits, merchandise damaged or lost in transit, returnable items, etc. B. For banks and other financial institutions Loans – are claims arising primarily for providing loans to heterogenous customers and the repayment periods are frequently longer or over several years. Presentation of receivables Receivables are disaggregated into amounts receivable from trade customers, receivables from related parties, prepayments and other amounts. (PAS 1 paragraph 75b) Trade receivables and nontrade receivables which are currently collectible shall be presented on the face of the statement of financial position as one line item called trade and other receivables. However, the details of the total trade and other receivables shall be disclosed in the notes to financial statements.

Customers’ credit balance – are balances in accounts receivable resulting from overpayments, returns and allowances, and advance payments from customers. These credit balances are classified as current liabilities and are not offset against the debit balances in other customers’ accounts, except when the amount is deemed immaterial. Illustration 1. Apollo Company’s accounts receivable controlling account reports a balance of P500,000. You examined the subsidiary ledgers and discovered the following details in Apollo’s customers’ accounts: Sales Debit balance

CUSTOMER A P 800,000 Collections 400,000

400,000

Sales Debit balance

CUSTOMER B 600,000 Collections 150,000

450,000

Sales

CUSTOMER C 500,000 Collections Returns Credit balance

450,000 100,000 50,000

Question: How much should be presented as accounts receivable on the financial statements? Initial Measurement of receivables PFRS 9, paragraph 5.1.1, provides that a financial asset shall be recognized initially at fair value plus transaction costs that are directly attributable to the acquisition. The fair value of a financial asset is usually the transaction price, meaning, the fair value of the consideration given. For short term receivables, the fair value is equal to the face value or original invoice amount. For long term receivables that are interest-bearing, the fair value is equal to the face value For long term receivables that are not interest bearing, the fair value is equal to the present value of all future cash flows discounted using the prevailing market rate if interest for similar receivables (effective interest rate).

Accounts Receivable – are open accounts arising from sale of merchandise or services in the ordinary course of business. Again, accounts receivable shall me initially measured at face value or original invoice amount. However, subsequently the accounts receivable shall be measured at net realizable value, meaning the amount of cash expected to be collected or the estimated recoverable amount. The initial amount shall be reduced by adjustments which in the ordinary course of business will reduce the amount recoverable from the customer. Accordingly, in estimating the net realizable value of trade accounts receivable, the following deductions are made: a. b. c. d.

Allowance for freight charge Allowance for sales return Allowance for sales discount Allowance for doubtful accounts

Problem 1. On December 31, 2018, the “Receivables” account of Boreas Company showed a debit balance of P2,000,000. The allowance for doubtful accounts has a credit balance of P50,000. Subsidiary details revealed the following: Trade accounts receivable Trade notes receivable Installments receivable, normally due in one (1) year to two (2) years Customers’ accounts reporting credit balances arising from sales returns Advance payments for purchase of merchandise Customers’ accounts reporting credit balances arising from advance payments Cash advance to subsidiary Claim from insurance entity Subscriptions receivable due in 60 days Accrued interest receivable

P 775,000 100,000 300,000 (30,000) 150,000 (20,000) 400,000 15,000 300,000 10,000 2,000,000

Questions: 1. How much should be presented as “trade and other receivables” under current assets? 2. How should the other items excluded from the answer in no. 1 be classified and presented?

Problem 2. The following T-account summarizes the transactions affecting the accounts receivable of Circe Company for the current year: Jan. 1 balance Credit sales Shareholders’ subscriptions Deposit on contract Claim against common carrier for damages IOUs from employees Cash advance to affiliates Cash advance to supplier

Accounts Receivable 600,000 Collection from customers 6,000,000 Write-off 200,000 Merchandise returns 120,000 Collection on carrier claims 100,000 Allowances to customer for shipping damages 10,000 Collection on subscriptions 100,000 500,000

5,300,000 35,000 40,000 40,000 25,000 50,000

Required: 1. Compute the correct amount of accounts receivable. 2. Prepare one compound entry to adjust the accounts receivable. 3. Compute the amount to be presented as “trade and other receivables” under current assets 4. Indicate the classification and presentation of the other items. Accounting for freight charge: Terms related to freight charge: a. b. c. d.

FOB Destination FOB Shipping Point Freight Collect Freight Prepaid

Sometimes goods are sold “FOB Destination” but shipped “freight collect” with the understanding that the buyer will pay for the freight charge and deduct the same when remittance is made by him. On the part of the seller, the freight charge is recorded by debiting Freight Out and crediting Allowance for freight charge. Problem 3. Dionysus Company sold merchandise on account for P500,000. The terms are 2/10. n/30. The related freight charge amounted to P10,000. The account was collected within the discount period. Required: Prepare the journal entries to record the above transactions under the following freight terms: 1. FOB destination and freight collect 2. FOB destination and freight prepaid 3. FOB shipping point and freight collect 4. FOB shipping point and freight prepaid

Allowance for sales returns – the measurement of accounts receivable shall also recognize the probability that some customers will return goods that are unsatisfactory or will make other claims requiring reduction in the amount due as in the case of shipment shortages and defects. Accounting for sales discount – entities usually offer cash discounts to credit customers. A cash discount is a reduction from an invoice price by reason of prompt payment. A cash discount is known as sales discount on the part of the seller and a purchase discount on the part of the buyer. Methods of recording credit sales 1. Gross method – the accounts receivable and sales are recorded at gross amount of the invoice. This is the common and widely used method because it is simple to apply. 2. Net method – the accounts receivable and sales are recorded at net amount of the invoice, meaning the invoice price minus the cash discount. Problem 4. Estes Company engaged in the following transactions during the month of November: Nov.

1 3 12 30

Sold merchandise to A Company for P50,000, 2/10, n/30 Sold merchandise to B Company for P200,000, 2/10, n/30. Received payment from B Company for the November 3 sale. Received payment from A Company for the November 1 sale.

Required: a. Prepare the journal entries using the gross method b. Prepare the journal entries using the net method Allowance for sales discount – if customers are granted cash discounts from prompt payment, then, conceptually estimates of cash discounts on open accounts at the end of the period based on past experience shall be made. For example, of the accounts receivable of P1,000,000 at the end of the period, it is reliably estimated that discounts to be taken will amount to P50,000. The adjustment to record the expected sales discount is: Sales discount Allowance for sales discount

50,000

50,000

The adjustment may be reversed at the beginning of the next period in order that discounts can the be charged normally to sales discount account.

ACCOUNTING FOR BAD DEBTS When an account becomes uncollectible, the entity has sustained a bad debt loss. This loss is simply one of the costs of doing business on credit. Two methods are followed in accounting for this bad debt loss, namely: 1. Allowance method 2. Direct write-off method ALLOWANCE METHOD The allowance method requires recognition of a bad bet loss if the accounts are doubtful of collection. The journal entry to recognize the doubtful accounts is: Doubtful accounts expense Allowance for doubtful accounts

xx xx

If the doubtful accounts are subsequently found to be worthless or uncollectible, the accounts are written off as follows: Allowance for doubtful accounts Accounts receivable

xx

xx

Generally accepted accounting principles require the use of the allowance method because it conforms with the matching principle. Recoveries of accounts written off If a collection is made on account previously written off as uncollectible, the customary procedure is first to recharge the customer’s account with the amount collected and possibly with the entire amount previously charged off. Accounts receivable Allowance for doubtful accounts

xx

xx

The collection is then recorded normally as follows: Cash

Accounts receivable

xx

xx

DIRECT WRITEOFF METHOD The direct write-off method requires recognition of a bad debt loss only when the accounts proved to be worthless or uncollectible. The entry to recognize the worthless or uncollectible account is as follows:

Doubtful accounts Accounts receivable

xx

xx

This approach is often used by small businesses because it is simple to apply. As a matter of fact, the BIR recognizes this method for tax purposes. Illustration 1: Allowance method vs. Direct write-off method Give the journal entries for each transaction under the two methods 1. Accounts receivable worth P10,000 is found to be doubtful of collection. Allowance method Direct method

2. The P10,000 doubtful account is deemed worthless and needs to be written off Allowance method Direct method

3. The P10,000 account previously written off is subsequently recovered. Allowance method Direct method

METHODS OF ESTIMATING DOUBTFUL ACCOUNTS Doubtful accounts are recognized only when the loss is probable and the amount can be estimated reliably. There are three methods, namely: 1. Aging the accounts receivable or “statement of financial position approach” 2. Percent of accounts receivable or also SFP approach 3. Percent of sales or “income statement approach” Aging of accounts receivable The aging of accounts receivable involves an analysis where the accounts are classified into not due or past due.

a. b. c. d.

Not due 1 to 30 days past due 31 to 60 days past due 61 to 90 days past due

e. f. g. h.

91 to 120 days past due 121 to 180 days past due 180 to 365 days past due More than 1 year past due

The allowance is then determined by multiplying the total of each classification by the rate or percent of loss experienced by the company for each category. Illustration 2: Aging based on days past due Papasa Ako Company sells to wholesalers on terms 2/15, net 30. An analysis of the company’s trade receivable balances at December 31, 2018 revealed the following: Age in days 0-15 16-30 31-60 61-90 91-120 121-150 Total accounts receivables

Receivable balances 100,000 60,000 50,000 40,000 30,000 20,000 300,000

Papasa Ako uses the aging of receivables method. The estimated percentages of collectability based on past experience are shown below: Accounts which are overdue for less than 31 days Accounts which are overdue 31 – 60 days Accounts which are overdue 61 – 90 days Accounts which are overdue 91 – 120 days Accounts which are overdue for over 120 days

97% 90% 85% 65% 40%

The allowance for doubtful accounts has a balance of P8,000 as of January 1, 2018. No writeoffs or recoveries were made during the year. Required: 1. Compute for the (a) balance of allowance for doubtful accounts on December 31, 2018 and (b) the doubtful accounts expense for the year. 2. When is an account past due? Percent of accounts receivable A certain rate is multiplied by the open accounts at the end of the period in order to get the required allowance balance. The rate is usually determined from past experience of the entity.

Illustration 3 The balance of Magiging CPA Ako Company’s accounts receivable is P2,000,000 and the credit balance in the allowance for doubtful accounts is P10,000. It is estimated that 3% of the accounts receivable are doubtful for collection. Required: Give the journal entry to record the allowance Percent of Sales The amount of sales for the year is multiplied by a certain rate to get the doubtful accounts expense. The rate may be applied on credit sales or total sales. Theoretically, the rate to be used is computed by dividing the bad debt losses in prior years by the charge sales of prior years. The rate thus obtained is multiplied by the current year’s charge sales to arrive at doubtful accounts expense Practically, however, there is no substantial difference if in the computation of the rate, the basis is total sales of the prior periods. In such a case, the rate thus obtained is multiplied by the current year’s total sales to get the doubtful accounts expense. Illustration 4 The following accounts are gathered from the ledger of Lance Company Accounts receivable Sales Sales returns Allowance for doubtful accounts

1,000,000 5,050,000 50,000 20,000

Required: Give the journal entry to record the doubtful accounts for the period. Correction in allowance for doubtful accounts The percent of sales method has the disadvantage of the allowance for doubtful accounts being inadequate or excessive. Aging the accounts is then necessary to test the reasonableness of the allowance. Accordingly, an inadequate allowance is adjusted as follows: Doubtful accounts Allowance for doubtful accounts

xx

xx

An excessive allowance is recorded as follows: Allowance for doubtful accounts Doubtful accounts

xx

xx

When the allowance is excessive, there is a corollary problem when the discrepancy is more than the debit balance in the doubtful accounts expense account. For example, if the amount of correction due to excessive allowance is P30,000 and the doubtful accounts expense account has a debit balance of P20,000, following the above procedure will result to a credit balance in the doubtful accounts expense account of P10,000. Such balance is obviously abnormal. It is believed that in such a case, the P10,000 difference shall not be treated as a prior period error but included in the determination of the income for the current period. Journal entry Allowance for doubtful accounts Doubtful accounts expense Other income

30,000

20,000 10,000

Debit balance in allowance account The allowance for doubtful accounts normally has a credit balance. However, in certain instances, it may have a debit balance because it may be the policy of the entity to adjust the allowance at the end of the period and record accounts written off during the year. Illustration 5 Guinevere Company reported the following data at year-end Sales Accounts receivable Allowance for doubtful accounts – January 1 Accounts written off Recovery of accounts written off

8,000,000 2,000,000 100,000 130,000 20,000

Required: Prepare the adjusting entry for doubtful accounts under each of the following methods: a. Percentage of sales – the estimate is 3% b. Percentage of accounts receivable – the estimate is 8% c. Aging – the estimate was computed to be P200,000.