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Auditing Practice I Third Term, AY 2013-2014

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UNIT3
AUDITOFRECEIVABLES,RELATEDREVENUES
ANDCREDITLOSSES
EstimatedTime:6.0HOURS
*UseLouwers4
th
edition

Discussionquestions3-1
1. Whataccountbalancesareincludedintherevenueandcollectioncycle?
2. Howshouldaccountsreceivablebemeasuredinitially?Subsequently?
3. What are the audit working papers related to receivables? Provide an example for
each.
4. When should a client recognize impairment of receivables? How should the client
reflectsuchimpairmentinthefinancialstatements?

Discussionquestions3-2Substantiveproceduresintherevenueandcollectioncycle
RefertoLouwers7-15,7-16and7-19.

Problem3-1Analysisandclassificationofreceivables
Your audit disclosed that on December 31, 2012, the accounts receivable control
account of CCC Company had a balance of P1,432,000. An analysis of the accounts
receivableaccountshowedthefollowing:

Accountsknowntobeworthless P18,200
Advancepaymentstocreditorsonpurchaseorders 75,000
Advancestoaffiliatedcompanies 187,500
Customers accounts reporting credit balances arising
fromsalesreturn (112,500)
Interestreceivableonbonds 75,000
Othertradeaccountsreceivableunassigned 375,000
Subscriptionsreceivableduein30days 412,500
Trade accounts receivable assigned (CCC
CompanysequityinassignedaccountsisP75,000) 187,500
Trade installment receivable due 1-18 months,
includingunearnedfinancechargesofP15,000 165,000
Tradereceivablesfromofficersduecurrently 11,500
Trade accounts on which post-dated checks are held
(noentriesweremadeonreceiptsofchecks) 37,300
Total P1,432,000

1) WhatistheadjustedtradeaccountsreceivableasofDecember31,2012?
2) What is the adjusted net current trade and other receivables as of December 31,
2012?

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Problem3-2Analysisandclassificationofreceivables
When examining the accounts of CLOVER COMPANY, you ascertain that balances
relating to both receivables and payables are included in a single controlling account
(calledreceivables),whichhasaP23,050debitbalance.Ananalysisofthedetailsofthis
accountrevealedthefollowing:

Items Debit Credit


Accountsreceivablecustomers P40,000
Accountsreceivable-officers(current
collectionexpected) 2,500
Debitbalancescreditors 450
Expenseadvancestosalespersons 1,000
Sharecapitalsubscriptions
receivable 4,600
Accountspayableformerchandise P19,250
Unpaidsalaries 3,300
Creditbalanceincustomeraccounts 2,000
Cashreceivedinadvancefromcustomers
forgoodsnotyetshipped 450
Expectedbaddebts,cumulative 500

1. Give journal entry to eliminate the above account and to set up the appropriate
accountstoreplaceit.
2. HowshouldtheitemsbereportedonCloverCompanysbalancesheet?

Problem3-3Confirmationofreceivables
LawrenceCompanymaintainsitsaccountsonthebasisofafiscalyearendingOctober
31.AssumethatyouwereretainedbythecompanyinAugusttoperformanauditforthe
fiscalyearendingOctober31,2012.Youdecidetoperformcertainauditingprocedures
in advance of the balance sheet date. Among these interim procedures is the
confirmationofaccountsreceivable,whichyouperformatSeptember30.

TheaccountsreceivableatSeptember30consistedofapproximately200accountswith
balances totaling P956,750. Seventy-five of these accounts with balances totaling
P650,725 were selected for confirmation. All but 20 of the confirmation requests have
been returned; 30 were signed without comments, 14 had minor differences that have
beenclearedsatisfactorily,and11confirmationshadthefollowingcomments:

1. Wearesorry,butwecannotansweryourrequestforconfirmationofouraccount
becauseMossCompanyusesacomputerizedaccountspayablevouchersystem.
2. ThebalanceofP1,050waspaidonSeptember23,2012.
3. TheabovebalanceofP7,750waspaidonOctober5,2012.
4. Theabovebalancehasbeenpaid.
5. We do not owe you anything at September 30, 2012, since the goods
represented by your invoice dated September 30, 2012, Number 25,050, in the
amountofP11,550,werereceivedonOctober5,2012,onFOBdestinationterms.
6. AnadvancepaymentofP2,500madebyusinAugust2012shouldcoverthetwo
invoicestotalingP1,350shownonthestatementattached.
7. Weneverreceivedthesegoods.
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8. We are contesting the propriety of the P12,525 charge. We think the charge is
excessive.
9. Amount okay. As the goods have been shipped to us on consignment, we will
remitpaymentuponsellingthegoods.
10. TheP10,000,representingadepositunderlease,willbeappliedagainsttherent
duetousduring2012,thelastyearofthelease.
11. YourcreditintheamountofP440,datedSeptember5,2012,cancelstheabove
balance.

Whatstepswouldyoutaketoclearsatisfactorilyeachoftheabove11comments?

Problem3-4Analysisofaccountsreceivableandrelatedlosses
InyourauditofASTERCorporationfortheyearendedJanuary31,2012,youobtained
thefollowinginformationdirectlyfromtheclient:

Sales(cashandcredit) P591,050
Cashreceivedfromcreditcustomers,allofwhomtook
advantageofthediscountfeatureofthecorporationscredit
terms4/10,n/30
303,800
Cashreceivedfromcashcustomers 210,270
Accountsreceivablewrittenoffasworthless 5,250
Creditmemorandaissuedtocreditcustomersforsalesreturns
andallowances 63,800
Cashrefundsgiventocashcustomersforsalesreturnsand
allowances 13,318
Recoveriesonaccountsreceivablewrittenoffasuncollectible
inpriorperiods(notincludedincashamountstatedabove) 8,290

ThefollowingbalancesweretakenfromtheJanuary31,2011ledger:

Accountsreceivabletrade P95,842
Allowancefordoubtfulaccounts(creditbalance) 9,740

The corporation provides for its net uncollectible account losses by crediting Allowance
fordoubtfulaccountsfor2.5%ofnetcreditsalesforthefiscalperiod.

1) PreparethejournalentriestorecordthetransactionsfortheyearendedJanuary31,
2012.
2) Prepare the adjusting journal entry for estimated uncollectible accounts on January
31,2012.

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Problem3-5Analysisofaccountsreceivableandrelatedlosses
Your audit client, GRYFFINDOR Corporation, provided for uncollectible accounts
receivableundertheallowancemethodsincethestartofitsoperationstoDecember31,
2012. Provisions were made monthly at 2 percent of credit sales; bad debts written off
were charged to the allowance account; recoveries of bad debts previously written off
were credited to the allowance account; and no year-end adjustments to the allowance
accountweremade.Gryffindorsusualcredittermsarenet30days.

The credit balance in the allowance for doubtful accounts was P260,000 at January 1,
2012. During 2012, credit sales totaled P18,000,000, interim provisions for doubtful
accountsweremadeat2percentofcreditsales,P180,000ofbaddebtswerewrittenoff,
and recoveries of accounts previously written off amounted to P30,000. Gryffindor
installedacomputersysteminNovember2012andanagingofaccountsreceivablewas
prepared for the first time as of December 31, 2012. A summary of the aging is as
follows:

ClassificationsbyMonthofSale BalanceinEach
Category
Estimated%
Uncollectible
NovemberDecember2012 P2,460,000 2%
JulyOctober2012 1,450,000 15%
JanuaryJune2012 750,000 25%
PriortoJanuary1,2012 260,000 75%

Based on the review of collectibility of the account balances in the prior to January 1,
2012 aging category, additional receivables totaling P120,000 were written off as of
December 31, 2012. Effective with the year ended December 31, 2012, Gryffindor
adoptedanewaccountingmethodforestimatingtheallowancefordoubtfulaccountsat
theamountindicatedbytheyear-endaginganalysisofaccountsreceivable.

1. Howmuchistheadjustedbalanceoftheallowancefordoubtfulaccountsasof
December31,2012?
2. Howmuchisthedoubtfulaccountsfortheyear2012?
3. Howmuchistheincreaseinallowancefordoubtfulaccounts?

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Problem3-6Analysisofaccountsreceivableandrelatedlosses
InyourauditofKNIGHTCompany,awholesaler,fortheyearendedDecember31,2012,
youobtainedthefollowingscheduleofagedaccountsreceivable.

AgeofAccounts Amount
0-30days P561,600
31-60days 196,100
61-90days 88,400
91-120days 18,500
Over120days 9,600
P874,200

The following schedule shows the year-end receivables balances and uncollectible
accountsexperienceforthepreviousfouryears.
Year
Year-end
receivables
0-30days
31-60
days
61-90
days
91-120
days
Over120
days
2011 P780,700 0.7% 1.0% 10.2% 49.1% 78.2%
2010 750,400 0.6 1.1 10.0 51.2 77.3
2009 681,400 0.8 1.2 11.0 51.7 79.0
2008 698,200 0.7 0.9 10.1 52.3 78.5

Additionalinformation:
1. Thecompanyusestheagingmethodtoestimatedoubtfulaccountlosses.
2. TheunadjustedallowancefordoubtfulaccountsbalanceonDecember31,2012
isP31,364.

1) Compute the correct balance for the allowance for doubtful accounts based on the
averagelossexperienceforthelastfouryears.
2) Basedonthefirstrequirement,preparetheappropriateend-of-yearadjustingentry.

Problem3-7Analysisofaccountsreceivableandrelatedlosses
Youareauditingtheaccountsreceivableandtherelatedallowancefordoubtfulaccounts
of Singer Company. The control account of the aforementioned accounts had the
followingbalances:

Accountsreceivable P1,270,000
Less:Allowancefordoubtful
accounts
78,000
Netrealizablevalue P1,192,000

Uponyourinvestigation,youfoundoutthefollowinginformation:
a. Thecompanysnormalsalestermisn/30.
b. Theallowancefordoubtfulaccountshadthefollowingdetailsinthegeneralledger:
Jan1BalanceP30,000CR
July31Write-off24,000DR
December31Provision72,000CR

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c. ThesubsidiaryledgerbalancesofthecompanysaccountsreceivableasofDecember
31,2012containedthefollowinginformation:

Debitbalances Credit
balances

Underonemonth P540,000 PopCo. P12,000


Onetosixmonths 552,000 JazzCorp. 21,000
Oversixmonths 228,000 RnBInc. 27,000
P1,320,000 P60,000

Additionalinformation:
ThecreditbalancewithPopCo.wasforanoverpaymentfromthecustomer.The
company delivered additional merchandise to Pop Co. on January 3, 2013 to
coversuchoverstatement.
The credit balance of Jazz Corp. was due to a posting error, the amount should
havebeencreditedtoJezzCorp.fora60-dayoutstandingreceivable.
ThecreditbalancefromRnBInc.wasacashadvanceforadeliverytobemade
onJanuary15,2013.

Moreover, it was estimated that 1 percent of accounts under one month is doubtful of
collection while 2% percent of accounts one to six months are expected to require an
allowance for doubtful of collection. The accounts over six months are analyzed as
follows: definitely uncollectible, P72,000; doubtful (estimated to be 50% collectible),
P36,000;andapparentlygood,butslow(estimatedtobe90%collectible),P120,000.

1. Whatistheentrytoadjustanyunlocateddifferencebetweenthecontrolaccount
andthesubsidiaryledger?
2. DeterminetheadjustedaccountsreceivablebalanceonDecember31,2012.
3. Determine the required balance of the allowance for doubtful accounts on
December31,2012.
4. Whatistheadjustingentrytocorrecttheallowancefordoubtfulaccounts?

Problem3-8Analysisofaccountsreceivableandrelatedlosseswithsubsequent
recovery
RAINCompanystartedoperationsin2008.Thecompanyhasnoallowancefordoubtful
accounts. Uncollectible receivables were expensed as written off and recoveries were
creditedtoincomeascollected.Datafromcompanysrecordsforfiveyearsisasfollows:

Year CreditSales AmountWritten


Off
Recovery
2008 P3,000,000 P30,000 P0
2009 4,500,000 76,000 5,400
2010 5,900,000 104,000 5,000
2011 6,600,000 130,000 9,600
2012 8,000,000 166,000 10,000

Balances of accounts are P3,000,000 as of December 31, 2011 and P3,500,00 as of


December31,2012.

OnMarch1,2012,rightafterthe2011financialstatementswerereleased,management
realizedthatthecompanyspolicyregardingtreatmentofuncollectibleaccountswasnot
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correct, and decided that an allowance method must be followed. A policy was
established to set-up an allowance for doubtful accounts based on the companys
historical uncollectible accounts loss percentage to be applied to year-end AR. The
historicallossshallberecomputedeachyearbasedontheaverageofallavailablepast
yearsuptoamaximumoffiveyears.

1. Computefortheamountofallowancefordoubtfulaccountsthatshouldbeset-upas
ofJanuary1,2012.
2. Compute for the average percentage of net doubtful accounts to credit sales that
shouldbeusedinsettingupthe2012allowance.
3. ComputeforthecorrectbalanceofallowancefordoubtfulaccountsasofDecember
31,2012.
4. Computeforthecorrectdoubtfulaccountsexpensefor2012.

Problem3-9Analysisofreceivablesusedassourceofcash
CHRIS Trading required additional cash for its operation and used accounts receivable
toraisesuchneededcash,asfollows:
1) On December 1, 2012, Chris assigned on a nonnotification basis accounts
receivable of P5,000,000 to bank in consideration for a loan of 90% of the
receivableslessa5%servicefeeontheaccountsassigned.Chrissignedanote
forthebankloan.OnDecember31,2012,Chriscollectedassignedaccountsof
P3,000,000lessdiscountofP200,000.Chrisremittedthecollectionstothebank
inpartialpaymentfortheloan.Thebankappliedfirstthecollectiontotheinterest
andthebalancetotheprincipal.Theagreedinterestis1%permonthontheloan
balance.
2) Chris sold P1,550,000 of accounts receivable for P1,340,000. The receivables
had a carrying value of P1,470,000 and were sold outright on a nonrecourse
basis.
3) ChrisreceivedanadvanceofP300,000fromMetrobankbypledgingP360,000of
accountsreceivable.
4) OnJune30,2012,ChrisdiscountedatabankacustomersP600,000,6-month,
10%notereceivabledatedApril30,2012.Thebankdiscountedthenoteat12%
onthesamedate.

Basedontheinformationyougatheredandtheresultofyouraudit,answerthefollowing:
1) Whatshouldbetheentrytorecordthesaleofaccountsreceivable?
2) HowmuchisChrisequityinaccountsreceivableassigned?
3) HowmuchnotepayableshouldChrisreportasacurrentliability?
4) HowmuchisproceedsfromthenotereceivablediscountedonJune30,2012?

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Problem3-10Analysisofnotesreceivableandrelatedaccounts
You are engaged in your fifth annual examination of the financial statements of LEE
Corporation. Your examination is for the year ended December 31, 2012. The client
preparedthefollowingschedulesofTradeNotesReceivableandInterestReceivablefor
you at December 31, 2012. You have agreed the opening balances toyour prior years
auditworkpapers.

LEECORPORATION
TRADENOTESRECEIVABLEANDRELATEDINTEREST
RECEIVABLE
TradeNotesReceivable

Maker Date Terms Int


Rate
Balance
12/31/11
2012
Debits
2012
Credits
Balance
12/31/12
ABC
DEF
GHI
EDL
NOP

QRS
TUV

040/1/11
05/01/12
07/01/12
08/03/12
10/02/12

11/01/12
11/01/12
1year
90days
60days
Demand
60days

90days
90days
Total

12%

12%
12%
12%

8%
12%
P60,000

P60,000

P30,000
6,000
15,000
50,000
50,000
42,000
32,000
P225,000
P60,000
29,375

50,000

35,000

P174,375

P625
6,000
15,000
------
50,000
7,000
32,000
P110,625

InterestReceivable
Balance 2012 Balance
DueFrom 12/31/11 Debits Credits 12/31/12
ABC P5,400 P1,800 P7,200
GHI 120 P120
EDL 400 400
NOP 1,000 660 340
QRS 560 560
TUV _______ 640 ______ 640
Totals P5,400 P4,520 P7,860 P2,060

Yourexaminationrevealsthisinformation:
1. Interest is computed on a 360-day basis. In computing interest, it is the
corporationspracticetoexcludethefirstdayofthenotestermandtoincludethe
duedate.
2. The DEF Companys 90-day non-interest bearing note was discounted on May
16 at 10%, and the proceeds were credited to the Trade Notes Receivable
account.Thenotewaspaidatmaturity.
3. GHI Industries became bankrupt on August 31, and the corporation will recover
75centsonthepeso.AllofLeesnotesreceivableprovideforinterestatarateof
12%onthematurityvalueofadishonorednote.
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4. EDL, president of Lee Corporation, confirmed that he owed Lee Corporation
P15,000 and that he is expected to pay the note within six months. You are
satisfiedthatthenoteiscollectible.
5. NOP Companys 60-day note was discounted on November 1 at 8%, and the
proceeds were credited to the Trade Notes Receivable and Interest Receivable
accounts. On December 2, Lee Corporation received notice from the bank that
NOP Co.s note was not paid at maturity and that it had been charged against
Leescheckingaccountbythebank.Uponreceivingthenoticefromthebank,the
bookkeeper recorded the note and the accrued interest in the Trade Notes
Receivable and Interest Receivable account. NOP Company paid Lee
CorporationthefullamountdueinJanuary2012.
6. QRS, Inc. 90-day note was pledged as collateral for P35,000, 60-day 10% loan
fromthePhilippineNationalBankonDecember1.
7. On November 1, the Corporation received four, P8,000, 90-day notes from TUV
Co.OnDecember1,thecorporationreceivedpaymentfromTUVCo.foroneof
the P8,000 notes with accrued interest. Prepayment of the notes is allowed
without penalty. The bookkeeper credited the TUV Co.s Accounts Receivable
accountforthecashreceived.

Prepare the adjusting journal entries that you would suggest at December 31, 2012.
ReclassifyallpastduenotesandrelatedcarryingcoststoAccountsReceivable.

Problem3-11Analysisofnoncurrentreceivablesandrelatedaccounts
The WEBLINK Company included the following in its notes receivable as of December
31,2012:
Notesreceivablefromsaleofplant P880,000
Notesreceivablefromwebdevelopmentservices 1,200,000
Notesreceivablefromsaleofmachine 1,600,000
Total P3,680,000

In connection with your audit, you were able to gather the following transactions during
2012andotherinformationpertainingtothecompanysnotesreceivable:

1) On January 1, 2012, Weblink Company sold a plant to three engineers as an


investment. The plant constructed five years ago is being depreciated using
straight-line for 25 years without any residual value. It was carried on Weblinks
books at a value of P500,000. Weblink received a noninterest-bearing note for
P880,000 from the engineers. The note is due on December 31, 2013. There is
no readily available market value for the plant, but the current market rate of
interestforcomparablenotesis12%.
2) On January 1, 2012, Weblink Company finished web development services and
acceptedinexchangeapromissorynotewithafacevalueofP1,200,000,adue
date of December 31, 2014, and a stated rate of 5%, with interest receivable at
the end of each year. The fair value of the services is not readily determinable
and the note is not readily marketable. Under the circumstances, the note is
consideredtohaveanappropriateimputedinterestrateof12%.
3) On January 1, 2012, Weblink Company sold a machine with a carrying value of
P1,600,000 to M-Zet Company. As payment, M-Zet gave Weblink a P2,400,000
note. The note bears an interest rate of 4% and is to be repaid in three annual
installments of P800,000 (plus interest on the outstanding balance). The first
paymentwasreceivedonDecember31,2012.Themarketpriceofthemachine
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is not readily determinable. The prevailing interest rate for notes of this type is
13%.

Basedontheinformationyougatheredandtheresultofyouraudit,answerthefollowing
(use four significant figures for PV and round-off final answers to the nearest whole
peso):
1) Webdevelopmentservicesrevenuethatshouldberecognizedin2012.
2) Gainonsaleofplantandmachinethatshouldberecognizedin2012.
3) NoncurrentnotesreceivableasofDecember31,2012.
4) Currentportionoflong-termnotesreceivableasofDecember31,2012.
5) Interestincometoberecognizedin2012.

Problem3-12Impairmentofreceivables
On January 1, 2012, POWER Company, a calendar-year firm, gave a loan to ABC
Enterprises amounting to P200,000 and received a two-year, 9%, P200,000 note. The
note calls for annual interest to be paid each December 31. Power collected the 2012
interestonschedule.

At December 31, 2013, however, based on ABCs recent financial problems, Power
expects that the 2013 interest will not be collected and that only P120,000 of the
principaldueDecember31,2013willbecollected.

The P120,000 principal amount is expected to be collected in two installments (first


installmentisP50,000)onDecember31,2015andDecember31,2017.

Powerbelievesthat12%isthemarketsassessmentofthetimevalueofmoney.

Required:
1. What entries should be made in the records of Power Company on December 31,
2013?
2. Assume that Power Company collects the expected payments from ABC. What
entriesshouldbemadeonDecember31,2014;December31,2015;December31,
2016;andDecember31,2017?

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Case3-1Ethicscase
YouareanassistantauditorwithZaird&Associates,CPAs.UniversalAir(UA),yourfifth
auditclientinyoureightmonthswithZaird,isanationalairlinebasedinyourhometown.
UAhascontinuedtogrowwhileremaininghealthyfinanciallyovertheeightyearsofits
existence. Indeed, as you start the audit you notice that (unaudited) sales are up 30
percentthisyear(2012),withearningsup40percent.Yourfirm,Zaird&Associates,has
beenUAsonlyauditor.

During the audit you noticed that UA records sales when tickets are sold debit
receivable (or cash), credit sales. In performing substantive procedures relating to
receivables you also found that some of the sales are for 2013 flights generally in
JanuaryandearlyFebruary.Youbroughtupthismattertoyourin-chargeseniorandshe
indicatedthatshealsowonderedaboutthislastyearwhensheworkedontheaudit.She
suggested that she concluded that this isnt likely to be a problem for at least three
reasons(anyoneofwhichwouldbesufficienttoallowthecurrentmethod):
1. The company has been using this approach since its inception eight years ago.
Thus,anyoverstatementofthisyearssalesatyear-endislikelytobeaveraged
out by an understatement at the beginning of the year, since the company
followedthesamepolicylastyear(andtheyearsbefore).
2. Valid reasons exist for including the sales when booked. The small airlines
earnings process is probably best considered about complete when the sale is
made because this is the toughest part of the revenue generation process. The
planes are scheduled to fly for the first six months of next year, and will fly,
regardlessofwhethertheserelativelyfewpassengerswhopaidbeforeyear-end
for next years flights are on them; there are virtually no variable costs incurred
forthesepassengers,exceptforafewverysmallbagsofpeanutsandafewcans
ofsoda.
3. Imagine what a nightmare it would be to have to record an entry when a
passengerbuysaticket,andthenanotheronewhentheflightoccurs.

Shesayssheiswillingtodiscussthiswithyouifyoudisagree,butatthispointshethinks
itisntaproblem.

1. Discusswhetheryouagreeordisagreewitheachofherreasons.
2. Now assume that you potentially agree with her first justification. You think that
maybe a journal entry could be made at year-end to estimate the liability for next-
yearflights.Yet,thiswouldntbenecessaryifeverythingdoesaverageoutandany
year-endliabilityis immaterial. Giventhissituation,wouldyouexpecttheprocedure
toaverageoutovertheyear?
3. Howmightonedeterminewhetheritdoesaverageoutovertheyear?