3-1 AE111 NOTES Unit-3

Unit 3: Trade and Other Receivables
RECEIVABLES, DEFINED
Receivables are financial assets that represent a contractual right to receive cash or another
financial asset from another entity. It is an asset designation applicable to all debts, unsettled
transactions or other monetary obligations owed to a company by its debtors or customers.
It represents collectible from customers and others, most frequently arising from sales of
merchandise, claims for money lent, or the performance of service
Loans and receivables have been defined by PAS 32/39 as non-derivative financial asset
with fixed or determinable payments that are not quoted in an active market.
CLASSIFICATIONS
Trade receivables are receivables due from customers for merchandise sold or services
performed in the ordinary or normal course of business. Trade receivables may further be
considered as an accounts receivable or notes receivable.
Accounts Receivables are receivables that are not supported by a promissory note.
Other terms used for accounts receivable are trade accounts receivable, customers’
accounts and trade debtors.
Notes Receivables is a formal, written promise to receive a specific amount of cash from
another party on one or more future dates. Overdue accounts receivable are
sometimes converted into notes receivable, thereby giving the creditor more time to
pay.
Nontrade receivables are amounts due for payment to an entity other than its normal
customer invoices for merchandise shipped or services performed.
Examples of Nontrade Receivables are:
➢ Claims Receivable (insurance claims, claims against carriers, claims for rebates and
tax refunds)
➢ Accrued Income (dividend receivable, accrued interest)
➢ Advances to supplier for future delivery of goods
➢ Advances to (receivable from) shareholders or employees
(Employees for loans or wage advances)
➢ Subscription Receivables
➢ Debit balance of creditors’ account as a result of overpayment or returns and
allowances (if it is immaterial an offset may be made against the creditors’ accounts
payable)
➢ Advances to affiliates
➢ Special deposits on contract bids
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For banks and other financial institutions, loans to customers are considered as Accounts
Receivable, since they are from the entity’s normal operation. On the other, hand retailers
or manufacturers classify receivables into trade receivables and nontrade receivables.
STATEMENT OF FINANCIAL POSITION CLASSIFICATION OR PRESENTATION:
PAS 1, Presentation of Financial Statements, paragraph 66 states that “An entity shall classify
an asset as current when the entity expects to realize the assets or intends to sell or consume
it in the entity’s normal operating cycle, or when the entity expects to realize the asset within
twelve months after the reporting period, otherwise it is to be classified as noncurrent asset”
CURRENT RECEIVABLES include the following:
➢ All trade receivables

➢ Nontrade receivables that are collectible within 12 months after the balance sheet
date (e.g. advances to supplier, subscription receivable, debit balance of creditors’
account, claims receivable, accrued income)
To 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 trade and other receivables shall
be disclosed in the notes to financial statements. The disclosure may be presented as follows:
Accounts Receivable 1,000,000

Allowance for bad debts (10,000)
Notes Receivable 200,000
Accrued interest on note 30,000
Dividend
receivableReceivable 500,000
Advances to supplier 100,000
Total trade and other receivable 1,820,000
NONCURRENT RECEIVABLES include:

➢ All nontrade receivables that are collectible beyond twelve months after the balance
sheet date. They are presented on the balance under any of the following caption:
• Long-term Investment (Advances to affiliates)
• Other long-term asset (Advances to Officers)
• Subscriptions Receivable to be presented in the Stockholders’ Equity section-
as a deduction from capitals stock subscribed
CREDIT BALANCE IN ACCOUNTS RECEIVABLE

A credit balance is a certain amount of money owed to a customer or client on his account
from a bank, creditor, utility company or investment service after all related debts have been
settled. Credit balances could be a result from overpayments, returns and allowances, and
advance payment from customer.
Credit balances are classified as CURRENT LIABILITIES and not offset against the debit
balances in other customers’ account, except when it is immaterial.
ILLUSTRATION
The accounts receivable of ABC Company reports a balance of P250,000 composing of the
following balances:
Accounts Receivable
Customer Erl 150,000 50,000 Customer Nes*
Customer Shai 150,000
Balance 250,000
*Credit balance of customer Nes is due from overpayment
The balances presented above are presented in each customer’s subsidiary ledgers:
Customer Erl
Sales 300,000 150,000 Payment
Balance 150,000
Customer Shai
Balance 150,000
Customer Nes
50,000 Balance
Observe that the credit balance of Customer Nes, which was from an overpayment, was
presented as a deduction from the total balance of the Accounts Receivable.
The total accounts receivable should be presented at P300,000 as part of the total current
asset representing the accounts of Customer Erl and Customer Shai. The credit balance of
customer Nes should be not be presented as an offset against the debit balances of
Customer Erl and Shai rather classified as a current liability.
Credit balances can either be considered as an advances from the customer (current
liability) or may be returned to the customer in the form of cash.
There is no entry required to recognize a customer’s credit balance because these are
eventually cancelled for sales and cash reimbursement, but an adjustment may be made
for worksheet purposes to bring the correct balance of the Accounts Receivable, as follows:
Accounts Receivable 50,000

Customers' credit balances 50,000
RECOGNITION OF RECEIVABLES
There are certain conditions that need to be met to be able to recognize Receivables. These
conditions are as follows:
1. It is probable that the future economic benefits associated with the receivables will
flow to the enterprise.
2. The receivables have value that can be measured reliably.
INITIAL MEASUREMENT OF RECEIVABLES
PAS 39, paragraph 43 states that “receivables are initially measured at fair value plus
transaction costs that are directly attributable to the acquisition”. Where, the fair value of
financial asset is usually the transaction price which is the fair value of the consideration
given.
For Short-Term Receivables, fair value is the face value or original invoice amount (Cash flows
relating to short-term receivable are not discounted because the effect of discounting is
immaterial).
For Long-term Interest-bearing Notes Receivables, fair value is the same as the face value of
the note.
On the other hand, for Long-Term Non-interest-bearing Notes Receivables, the fair value is
equal to the present value of all future cash flows discounted using the prevailing market
rate of interest for a similar receivable.
ACCOUNTS RECEIVABLE
Accounts receivable represents the amount to be collected from the customers who
purchased a company's products or services on credit and usually they are unsecured open
accounts.
Accounts receivable are initially measured at face value or original invoice price, but
subsequently measured at net realizable value (NRV). Net realizable value is the amount the
company expects to collect or the estimated recoverable amount.
NRV = face value of receivable less any allowance for estimated uncollectible amount
Based on the established basic principle that “assets shall not be carried at above their
recoverable amount”, the initial amount recognized for accounts receivable shall be
reduced by adjustments which in the ordinary course of business will reduce the amount
recoverable from the customer.
To be able to estimate the net realizable value of Accounts Receivable, the following
deductions are made:
➢ Allowance for freight charge
➢ Allowance for sales return
➢ Allowance for sales discount
➢ Allowance for doubtful accounts
ACCOUNTING FOR FREIGHT CHARGE
Freight charges carry specific classification in accounting. How you record freight charges
in your financial statements depends on why you incurred the charges. Freight charges may
be incurred for delivery of goods or products received, products delivered from you to your
customers or for the delivery of a plant asset. You may also collect freight charges from your
customers for delivery of products purchased. Each of these situations requires a different
entry to record freight charges.
Accountants typically label the charges as either FOB shipping point or FOB destination. FOB
stands for "freight on board." It is a traditional term commonly associated with freight charge
when delivering fixed assets, such as equipment. In order to give proper accounting
recognition to freight charge in relation to accounts receivable, it is important to understand
the terms FOB destination, FOB shipping point, freight collect and freight prepaid.
FOB destination means that transfer of ownership occurs at the point the inventory is
delivered to the receiver. Ownership of the goods is vested in the buyer upon receipt of the
goods. Accordingly, the seller shall be responsible for the freight charges up to the point of
destination.
FOB shipping point is an accounting term designating the point at which the ownership of
materials being shipped passes to the receiver, this means that the ownership of the goods
purchased is vested in the buyer upon shipment thereof. Thus, it is required upon the buyer
to pay for the transportation charge from the point of shipment to the point of destination.
Freight collect means that freight charge on the goods shipped is not yet paid and the
common carrier shall collect the freight charge from the buyer. Therefore, under this term,
the freight charge is actually paid by the buyer.
Freight prepaid means that freight charge on the goods shipped is already paid by the seller.
ILLUSTRATION: (Recording transaction under different freight terms)
On January 1, an entity sold merchandise on account for P300,000. The related freight
charge amounted to P20,000. The account was collected on January 7.
Assuming the freight terms are FOB destination and freight prepaid the entries to record the
sales and collection are as follows:
Jan 1 Accounts Receivable 300,000

Freight out 20,000
Sales 300,000
Cash 20,000
Jan 7 Cash 300,000

Assuming the freight terms are FOB destination and freight collect the entries to record the
sales and collection are as follows:

Freight out 20,000
Sales 300,000
Allowance for freight charge 20,000
Jan 7 Cash 280,000

Allowance for freight charge 20,000
Assuming the freight terms are FOB shipping point and freight prepaid the entries to record
the sales and collection are as follows:

Sales 300,000
Cash 20,000
Jan 7 Cash 320,000

Assuming the freight terms are FOB shipping point and freight collect the entries to record
the sales and collection are as follows:

Sales 300,000
Jan 7 Cash 300,000

ACCOUNTING FOR ALLOWANCE FOR SALES RETURN
Allowance for sales return is made for the probability that some customers will return
merchandise, usually for one of the following reasons:
➢ Excess quantity shipped

➢ Excess quantity ordered
➢ Defective goods
➢ Goods shipped too late
➢ Product specifications are incorrect
➢ Wrong items shipped
In accounting for sales returns, the seller records the return as a debit to a Sales Returns
account and a credit to the Accounts Receivable account. The Sales Returns account is
a contra account; the total amount of sales returns is considered a deduction from the total
reported amount of gross sales in a period, which results to the Net Sales. The credit to the
Accounts Receivable account reduces the amount of accounts receivable outstanding.
ILLUSTRATION
JRC Merchandising Co. estimates that P30,000 of the total accounts receivable at year-end
represents selling price of goods that will probably be returned. The entry to recognize the
probable return is:
Sales Return 30,000

Allowance for Sales Return 30,000
ACCOUNTING FOR SALES DISCOUNT
When goods are sold on credit, both parties should have an understanding as to the amount
and time of payment. These credit terms are usually printed on the sales invoice and
establish part of the sales agreement. The credit term includes the credit period, the cash
discounts available, and the discount period.
Credit period is the period during which a credit customer can pay or settle its account.
Cash discount is a reduction from the invoice price, when payment is made within the
discount period, it is also known as a sales discount on the part of the seller and purchase
discount on the part of the buyer.
A cash discount may be expressed as 5/10, n/30, which means that the customer is entitled
to a 5% discount if payment is made in 10 days from the invoice date. If the customer fails to
pay within the 10-day discount period, the gross amount of the invoice price must be paid
within 30 days from the invoice date.
A trade discount is granted as incentive to purchase of merchandise in large volume,

contrary to a cash discount which is granted as an incentive for prompt payment of account.
Methods of recording credit sales
There are two methods of recording credit sales, mainly
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.
NET METHOD the accounts receivable and sales are recorded at net amount for the
invoice, meaning the invoice price minus the cash discount
ILLUSTRATION
Sale of Accounts Receivable 200,000

GROSS
merchandise for Sales 200,000
P200,000, terms Accounts Receivable 190,000
5/10, n/30 NET
Sales 190,000
Cash 190,000
Assume collection GROSS Sales Discount 10,000
is made within the Accounts Receivable 200,000
discount period Cash 190,000
NET
Cash 200,000
GROSS
Assume collection Accounts Receivable 200,000
is made beyond Cash 200,000
the discount period NET Accounts Receivable 190,000
Sales discount forfeited 10,000
Observe that under the NET Method of recording credit sales, an account Sales Discount
Forfeited was used to record the sales discount that was not availed. This account is classified
as other income.
DISCOUNT ON PARTIAL COLLECTION
At the time of sale, the seller may receive an initial or down payment covering part of the
invoice price. If the terms of sale apply only to the uncollected balance of the invoice price,
a cash discount would not be allowed on the down payment.
After the sale, the customer may make several partial payments before the invoice
becomes fully paid. In this case, the seller usually allows the cash discount only if the account
is fully settled within the discount period. The discount would be computed on the balance
of the debtor’s open account before partial payments were received. In this way, the
customer would not lose the discount on the earlier payments he made.
ILLUSTRATION
Jet Company sold goods for P 25,000 with the following terms: P 5,000 down payment and
the balance of P 20,000 to be paid on terms 2/10, n/30.
The entry to record the sale is as follow:
Cash 5,000
Sales 25,000
Note that no discount was given to the P 5,000 initial or down payment, since the terms of
the sale is applicable to the unpaid balance of P 20,000.
Assuming the company received the payment within the discount period, the entry to
record the collection is:
Cash 19,600
Sales Discount 400
ACCOUNTING FOR ALLOWANCE FOR SALES DISCOUNT
If customers are granted cash discounts for prompt payment, then, theoretically estimated
cash discounts on open accounts at the end of the period based on past experience shall
be made. Then an adjustment may be necessary at year end to bring the value of the
Accounts Receivable to its net realizable value.
At the beginning of the next accounting year, in order for the company to charge the sales
discount account normally, a reversing entry must be made.
ILLUSTRATION
Of the accounts receivable of P500,000 at the end of the period, it is probable that discounts
to be taken will amount to P25,000. The adjustment to record the expected sale discount is:
Sales Discount 25,000

Allowance for sales discount 25,000
ACCOUNTING FOR BAD DEBT EXPENSE
Usually most business firms extend credit to attract more customers and sell more goods.
However, an element of risk is involved in rendering services or selling goods on credit.
Regardless of the care taken in investigating the credit worthiness of each customer, there
are times where a business may find it difficult to collect on some of its credit accounts. A
certain percentage of these collectibles are not collected. For this reason, the business
should provide for such losses for non-collection of credits. This loss from uncollectible
accounts is called bad debts, an operating expense which must appear on the financial
statements either as:
DISTRIBUTION COST – If the granting of credit and collection of accounts are under the
charge of the sales manager, doubtful accounts shall be considered as DISTRIBUTION COST
ADMINISTRATIVE EXPENSE – If the granting of credit and collection of accounts are under the
charge of an officer other than sales manager, doubtful accounts shall be considered as
ADMINISTRATIVE EXPENSE
In the absence of any contrary statement, doubtful accounts shall be classified as

administrative expense.
Bad debts arise from sales made on account. Under the matching principle, they should be
taken up as an expense of the period in which the related sale took place. The amount of
bad debts for each period is generally a mere estimate because the uncollectibility of
customers’ accounts related the current sales is usually verified in the later period. The
records of the business regarding uncollectible accounts in the past periods would be useful
in making this estimate.
TWO METHODS IN ACCOUNTING FOR BAD DEBTS:
1. ALLOWANCE METHOD.
The allowance method requires recognition of bad debt loss if the accounts are doubtful
of collection. This method of accounting for uncollectible accounts claims that in
accordance with the matching rule, a business should assume that losses from an
uncollectible account at the moment the sale is made to the customer.
Under this method an Allowance for Bad debts account is used because the company
does not know until after the sale that the customer will not pay. Since the amount of loss
must be estimated to be matched against the sales or revenue for the period, it is not
possible to credit the amount of any particular customer. Also, it is not possible to credit
the Accounts Receivable controlling account in the general ledger because doing so
would cause the controlling account to be out of the balance with the total customers’
accounts in the subsidiary ledger. The Allowance for Bad Debts accounts is considered
as a contra asset account and is treated as a deduction to the Accounts Receivable to
be able to determine its net realizable value.
The entry to recognize the bad debt loss if the accounts are doubtful of collection is:
Doubtful Account/ Bad debt expense xx

Allowance for doubtful accounts xx
Below is the balance sheet presentation of the Allowance Account:
Current Assets
Cash P xx
Account Receivable P xx
Less: Allowance for Bad
Debts xx
Net Realizable Value Pxx
2. DIRECT CHARGE-OFF METHOD/ DIRECT WRITEOFF METHOD.
In contrast with the allowance method, the direct charge-off method records doubtful
accounts by debiting expense and directly when bad debts are discovered. This method
is not in accordance with generally accepted accounting principles because it makes
no attempt to match revenues and expense. Uncollectible accounts are charged to
expenses in the accounting period in which they are discovered rather than in the period
of sale.
On the balance sheet the accounts receivable is shown at gross value, because there is
no Allowance for Bad Debts account. The direct write-off method requires recognition of
bad debt loss only when the accounts proved to be worthless or uncollectible
Only the direct charge-off method, however, is allowable in computing taxable income.
The allowance method is still used for financial reporting because it is better from the
standpoint of accounting theory.
The entry to recognize the worthless or uncollectible account as loss:
Doubtful Account/ Bad debt expense xx

Accounts Receivable xx
COMPUTATION OF BAD DEBTS/DOUBTFUL ACCOUNTS
When the loss is probable and the amount can be estimated reliably, Doubtful accounts are
recognized. This approach is parallel to the recognition of a “provision” which is both
“probable and measurable” in accordance with PAS 37. Because it is impossible to know
which accounts will be uncollectible at the time financial statements are prepared, it is
necessary to estimate the expense to cover the expected losses for the year and estimates
can vary widely. There are three methods of estimating doubtful accounts, namely:
1. Percent of accounts receivable or statement of financial position approach

2. Aging the accounts receivable or also statement of financial position approach
3. Percent of sales or income statement approach
PERCENT OF ACCOUNTS RECEIVABLE
Under this method, a rate of uncollectibility is usually determined based from past
experience of the company. The rate is multiplied by the open accounts at the end of the
period in order to get the required allowance balance.
This procedure has the benefit of presenting the accounts at net realizable value however,
the approach violates the principle of matching bad debt loss against the sales revenue,
since the allowance is based on the outstanding balance of accounts receivable.
Moreover, the loss experience rate may be difficult to obtain and may not be reliable, since
it is based on an estimated percentage on past experiences.
ILLUSTRATION
The following unadjusted December 31 account balances are available: Accounts

receivable at P720,000 and a credit balance in the allowance account of P5,000. Bad debts
are estimated to be 2% of accounts receivable at the end.
Computation
Required Allowance (2% x 720,000) P14,400
Less: Allowance Balance (credit) 5,000
Increase in allowance- Expense for the year P 9,400
When the accounts receivable is multiplied by the rate of percent, the resulting amount is
the required balance of the Allowance for Bad Debt account. Thus to determine the amount
of the adjustment, the balance before adjustment should be considered, if the balance
before adjustment is a credit, it is deducted from the required balance; however, if the
balance before adjustment is a debit, it is added to the required balance to arrive at the
amount of the adjustment.
The adjusting entry to record bad debt is as follows:
Doubtful Account/ Bad debt expense 9,400

Allowance for Bad Debts 9,400
If the allowance account has a debit balance, then the following computation and entry is
made for the bad debts expense:
Computation:
Required Allowance (2% x 720,000) P 14,400
Add: Allowance Balance (debit) 5,000
Increase in allowance- Expense P 19,400
Doubtful Account/ Bad debt expense 19,400

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 to the entity to adjust
the allowance at the end of the period and record accounts written off during the year. Is
a debit balance in allowance for doubtful account possible?
For instance, on January 1, the allowance account before adjustment has a credit balance
of P 30,000, and during the year certain accounts amounting to P 50,000 is written off having
an entry of:
Allowance for doubtful accounts 50,000
As a result, the Allowance for doubtful accounts now has a debit balance of P 20,000 before
adjustment.
The debit balance does not indicate that allowance is inadequate because the accounts
written off during the year and charged to the allowance may have arisen from the current
year sales.
Thus, the charge to the allowance account simply predates the recording of doubtful
accounts. At the end of the period when adjustments are made, the debit balance should
be considered.
ILLUSTRATION
January 1, Company X has a debit balance of P 20,000 in its Allowance for Doubtful
Accounts, before year-end adjustments. The company estimates that the Required
Allowance at the end of the year is P 25,000. The computation of expense for the year is as
follow:
Computation:
Required Allowance P 25,000
Less: Allowance Balance (debit) 20,000
The entry to record the expense for the year is:
Doubtful Accounts Expense 45,000

Allowance for Doubtful Accounts 45,000
Observe that a debit balance in the Allowance for Doubtful Accounts increases the amount
of Expense to be recognized for the current period.
AGING OF THE ACCOUNTS RECEIVABLE
Accounts receivable aging is a technique to estimate bad debts expense by classifying

accounts receivable of a business according to of length of time for which they have been
outstanding and then estimating the probability of noncollection for each category.
The classification of accounts receivable in the accounts receivable aging schedule also
helps the business to identify the customers who take longer to pay so that they can restrict
sales to those customers to reduce risk of bad debts.
Typically, receivables are categorized into periods which are multiples of payment terms. For
example, if company sells at payment terms of n/20, the typical classification in aging
schedule will be 0 to 20 days past due, 20 to 40 days past due, 40 to 60 days past due and
so on.
The next step is to establish the probability of non-collection for each of the above category
which is then multiplied with the sum of accounts receivable from each category. This returns
the amount of accounts receivable which are expected to become bad in each category.
The rate or probability of non-collection is based on the company’s past experience.
The sum of estimated uncollectible accounts receivable from each category is fixed as the
ending balance of allowance for bad debts account. Bad debts expense is calculated as
provided in percentage of receivables method of bad debts estimation.
ILLUSTRATION
The following data are gathered in aging the accounts at the end of the year.
Probability of Uncollectible
Age Category Amount Non-collection Amount
1-20 days P 640,200 2% P 12,804
20-40 days 110,900 4% 4,436
40-60 days 50,200 7% 3,514
60-80 days 3,500 12% 420
More than 80days and past
due 1,000 15% 150
TOTAL P 805,800 P 21,324
The amount computed by aging of accounts receivable represents the required allowance
for doubtful accounts at the end of the period. Thus, if the allowance for doubtful accounts
has a credit balance of P10,000 before adjustment, the doubtful accounts expense is
determined as follows:
Computation
Required Allowance (aging table) P 21,324
Less: Allowance Balance (credit) 10,000

PERCENT OF SALES
In this method, the amount of sales for the year is multiplied by a certain rate to get the bad
debt expense or doubtful account expense. The rate may be applied on credit sales or total
sales.
In percentage of sales method, the balance in the allowance for doubtful debts is ignored.
Bad debts expense is calculated via the following formula:
Bad Debts Expense = Estimated % × Credit Sales
After the estimation of bad debts, an adjusting entry is passed to recognize bad debts
expense. The entry involves a debit to bad debts expense account and a credit to
allowance for doubtful debts account.
ILLUSTRATION
Credit sales of Company A during the year ended December 31 were P304,930. The
company estimated that 3% of its credit sales will end up uncollected. The allowance for
doubtful accounts of the company had a credit balance of P1,418 on December 31. The
bad debts expense to be recognized at the end of the period and the new balance of the
allowance for doubtful debts account will be as follows:
Computation:
Credit Sales P 304,900
Multiply by 3%
Bad Debt Expense 9,147
The adjusting entry to record bad debt is as follow:

Then, Allowance for Bad debts would have a balance of:
Allowance for Bad Debts, beg. P 1,418

Add: Bad Debts Expense 9,147
Allowance for Bad Debts, end P10,565
If this method is used, the resulting amount of the computation is already the amount of the
doubtful accounts expense and not the required allowance, in contrast with the aging
method and the percent of accounts receivable method. The allowance for doubtful
account should have an adjusted balance of P10,565, the beginning allowance of P1,418
plus the adjustment of P9,147.
When the “percent of sales” method is used in computing doubtful accounts, proper
matching of cost against revenue is achieved. This is so because the bad debt loss is directly
related to sales and reported in the year of sale.
The main argument against this method is that accounts receivable may not be shown at
estimated realizable value because the allowance for doubtful accounts may prove
excessive or inadequate. Thus, it becomes necessary that from time the accounts should be
“aged” to ascertain the probable loss and as a consequence of which the rate applied on
sales should be revised accordingly.
HINT: When Doubtful accounts are based on Real Accounts (Accounts in the Balance
Sheet), the amount that is estimated is considered as the required allowance or ending
balance of the Allowance for Doubtful Accounts.
On the other hand, when Doubtful accounts are based on a Nominal Account (Accounts in
the Income Statement), the amount that is estimated is considered as the expense/loss for
the period.
WHEN IS AN ACCOUNT PAST DUE?
The term “past due”, refers to the period beyond the maximum credit term. For example, if
the credit terms were 2/10, n/30, and the account is 45 days old, it is considered to be 15
days past due. Therefore, In the example, the credit term or credit period is 30 days and the
discount period is within 10 days.
CORRECTION IN ALLOWANCE FOR DOUBTFUL ACCOUNTS
Using the percent of sales method in estimating bad debt expense has disadvantage of
allowance for doubtful accounts being inadequate or excessive. Aging the accounts is then
necessary to test the reasonableness of the allowance. Where the allowance is inadequate
or excessive, a question arises as to the proper treatment of the discrepancy, whether to
consider it as an error or a component of profit or loss.
The correction is to be reported in the income statement either as an addition to or

subtraction from bad debt expense. The correction is the natural result of a change in
estimate. Changes in estimate are treated currently and prospectively.
Adjustment for INSUFFICIENT allowance
Doubtful Accounts Expense / Bad Debts Expense xx

Allowance for Doubtful Accounts xx
Adjustment for EXCESSIVE allowance
Allowance for Doubtful Accounts xx

Doubtful Accounts Expense / Bad Debts Expense xx
If the allowance is excessive, there is a problem when the discrepancy is more that the debit
balance of the bad debt expense account. For instance, if the amount of correction suitable
to excessive allowance is P15,000 and the bad debt expense has a debit balance of P10,000,
this would result to a credit balance of bad debt expense of P5,000 when adjusted, which is
abnormal.
The P5,000 discrepancy shall be treated as a part of miscellaneous income, a prior period
error added to the income of the current period. The adjusting entry to be made must be:

Doubtful Accounts Expense/ Bad Debt Expense 10,000
Miscellaneous income 5,000
WRITING OFF WORTHLESS ACCOUNTS
When it becomes clear that a specific account will not be collected, the amount is
considered worthless if any or a combination of the following condition exists:
➢ The customer cannot be located
➢ The customer is declared dead, extremely ill or bankrupt, or
➢ Legal efforts have been exerted, yet the customer refuses to pay his balance
After approval of the responsible officer or officers, the worthless accounts are written off by
reducing their balance in the records to zero. The entry to record the write-off of bad debts
is:

Remember that it was already accounted for as an expense when the allowance was
established before. The write off does not affect the estimated net realizable amount of
accounts receivable because there is no expense involved and because the related
allowance for bad debt account has already been deducted from the receivables. The
write off simply reduces the allowance for bad debts account and the gross accounts
receivable by similar amount.
RECOVERY OF ACCOUNTS RECEIVABLE WRITTEN OFF
If a collection is made on account previously written off as uncollectible, the customary

procedure is first to restore the customer’s account with the amount collected and possibly
with the entire amount previously charged of it is now expected that collection will be
received in full.
The collection is then recorded normally by debiting cash and crediting accounts
receivable. The collection is then recorded as follows:
Cash xx
The recharging of the customer’s account is usually followed because it is an evidence of
the attempt of the customer to re-establish his credit with the company. The accepted
procedure is to simply reverse the original entry of write-off regardless of whether the
recovery is during the year of write-off or subsequent thereto. The journal entry is:
ILLUSTRATION
On January 24 of the current year, JENRA, after his bankruptcy, notified the company that
he would be able to pay P1,000 of his account and send a check for P500. The entries to
record this transaction are as follows:

Cash 500
Accounts Receivable 500
DIFFERENCE ON ACCOUNTING BAD DEBT USING THE ALLOWANCE METHOD AND DIRECT
WRITEOFF METHOD
Presented in the table below is the difference between the Allowance Method and Direct
Write-off method of accounting for Bad Debts.
Transactions Method Entry

Accounts of Bad Debt Expense 60,000
P60,000 are Allowance
considered
doubtful of Direct
NO ENTRY
collection Write-off
Observe that in Direct Write-off method no entry is made if collection of an account
is only doubtful.
The accounts Allowance for Bad Debts 60,000
are Allowance
subsequently
discovered to Bad Debts Expense 60,000
Direct
be worthless or Write-off
uncollectible Accounts Receivable 60,000
Upon discovery that the accounts are already worthless, the Direct Write-off method
now establishes an expense and directly removes it from the Accounts Receivable.
The same Allowance for Bad Debts 60,000
accounts that Allowance
Cash 60,000
are previously
written off are
unexpectedly Accounts Receivable 60,000
recovered or Direct Bad Debts Expense 60,000
collected Write-off Cash 60,000
Note that the only difference between the two methods is on the entry to establish
the Accounts Receivable prior to collection, the Allowance Method charges it to
the Allowance for Bad Debts and the Direct Method reverses it to the Bad Debts
Expense.
The same Accounts Receivable 60,000
accounts that Allowance for Bad Debts 60,000
are previously Allowance
Cash 60,000
written off are
unexpectedly
recovered or Accounts Receivable 60,000
collected, Miscellaneous Income 60,000
Direct
subsequent to Write-off Cash 60,000
the year of
write-off Accounts Receivable 60,000
If collection was made in the year subsequent to the year of write-off, same entry
will follow for Allowance for Method but in the Direct Write-off instead of crediting
the Bad Debts Expense the account, the credit will now be to the Miscellaneous
Income account.
NOTES RECEIVABLES
A note receivable is a formal, written promise to receive a specific amount of cash from
another party on one or more future dates. A written promise from a client or customer to
pay a definite amount of money on a specific future date is called a note receivable. Such
notes can arise from a variety of circumstances, not the least of which is when credit is
extended to a new customer with no formal prior credit history.
The lender uses the note to make the loan more formal and enforceable. Such notes
typically bear interest charges. Overdue accounts receivable are sometimes converted into
notes receivable, thereby giving the creditor more time to pay, while also sometimes
including a personal guarantee by the owner of the creditor.
The maker of the note is the party promising to make payment, the payee is the party to
whom payment will be made, the principal is the stated amount of the note, and the
maturity date is the day the note will be due.
The term “Notes Receivable” in itself pertains only to claims arising from the sale of
merchandise or services in the ordinary course of business. So, Notes Receivables coming
from officers, employees, shareholders and affiliates shall be accounted for separately since
they do not arise from the ordinary course of business.
Types of Notes Receivables
Notes may be interest bearing or non-interest bearing and may require periodic payments
or a single payment upon the maturity date.
An interest-bearing note is issued at face value and requires the maker to pay the face value
of the note at maturity plus interest on specified interest dates.
A non-interest-bearing note is issued at a discount to its face value and requires the maker
to pay the face value of the note at maturity. No interest rate is stated on the note, because
the interest is already part of the face amount of the note.
Dishonored Notes
When the maker of a promissory note fails to pay, the note is said to be dishonored. The
dishonored note may be recorded in one of two ways, depending upon whether or not the
payee expects to collect the debt.
If payment is expected, the company transfers the principal and interest to accounts
receivable, removes the face value of the note from notes receivable, and recognizes the
interest revenue or removes accrued interest receivable if accrual for interest has been
made.
The entry to record the transfer of dishonored notes to accounts receivable is as follows:
Notes Receivable xx
Interest Income/ Accrued Interest income xx
Such entry is prepared due to the fact that the note has already lost its property of being a
negotiable instrument and becomes now an ordinary claim against the maker.
FINANCIAL STATEMENT PRESENTATION
A note receivable is classified in the balance sheet as a current asset if it is due within 12
months or as non-current (i.e., long-term) if it is due in more than 12 months.
If a note has a duration of longer than one year, and the maker does not pay interest on the
note during the first year, then it is customary to add the unpaid interest to the beginning
principal balance in the second year, and use that as the basis upon which to calculate
interest in the second year.
VALUATION OF NOTES RECEIVABLES
Notes Receivables shall be primarily measured at its present value. Present Value is the sum
of all future cash flows discounted using the prevailing interest rate, which is usually the
effective interest rate for similar notes.
In cases where the notes receivable is due on a short-term basis, less than 12 months, it shall
be measured at its face value. Short term notes receivables are no longer discounted, due
to that fact that the effect of the discounting is immaterial to the notes value.
ILLUSTRATION: Interest Bearing Note – Short term
On January 1, Aruba Bungee Cords (ABC) sold a number of bungee cords to Arizona
Highfliers for P 15,000. Arizona issued a note payable to ABC for P 15,000, at an interest rate
of 10%, and with payment of P 5,000 due at the end of the month for three months starting
January 31.
The entry to record the sale and receipt of note on January 1 is:
Sales 15,000
After the first month, the entry to record the receipt of the payments are as follows:
January 31 Cash 5,125
Interest Income (15,000x10%x1/12) 125
February 28 Cash 5,083

March 31
Cash 5,042
Observe that the since there are periodic payments of principal, interest is also declining
based on the unpaid balance.
For long term notes receivable, valuation will depend on whether the note is interest bearing
or non-interest bearing. Interest bearing notes receivables shall be measured at its face value
while, Non-interest-bearing notes receivables are measured at its present value.
After recording the notes receivable at its corresponding initial value, notes receivables
should be measured at its amortized cost using the effective interest method.
Amortized cost is the initial amount which a note receivable is measured minus any principal
payments, plus or minus any aggregate amortization of any difference between the initial
carrying amount and the maturity value minus allowances for impairment or uncollectibility.
To illustrate the concept of amortization, the following illustrations may be followed.
ILLUSTRATION: Interest Bearing Note – Long term
On January 1, 2020 Freewill Incorporated sold a machine costing P 400,000 to Grutee

Company for P 500,000. The company received a 3-year note bearing an interest of 10% per
annum payable on maturity date.
The following are the entries for the said transaction:
Jan 1, 2020 Notes Receivable 500,000

Machinery 400,000
Gain on Sale 100,000
Dec 31, 2020 Accrued Interest Receivable 50,000

Interest Income 50,000
(P 500,000 x 10%)

(P 500,000 x 10%)

(P 500,000 x 10%)
Jan 1, 2023 Cash 650,000

Accrued Interest Receivable 150,000
Face Value P 500,000

Accrued Interest
Year 1 P 50,000
Year 2 50,000
Year 3 50,000 150,000
Total Cash Received P 650,000
Assuming the same illustration, but interest becomes compounded annually. When interest
is compounded, this means that any accrued interest shall also earn interest in the next years.
The following are the entries for 2021 – 2023:

(P 550,000 x 10%)
(P 605,000 x 10%)
Jan 1, 2023 Cash 665,500


Accrued Interest
Year 1 (500,000 x 10%) P 50,000
Year 2 (550,000 x 10%) 55,000
Year 3 (605,000 x 10%) 60,500 165,500
Total Cash Received P 665,500
ILLUSTRATION: Non-Interest-Bearing Note – Long Term (Outstanding Method of Amortization)
ABC Co. sells equipment on installment basis. On January 1, 2020, the entity sold an
equipment costing P 500,000 for P800,000. The buyer issued a non-interest-bearing note for P
800,000 payable in four equal instalments every December 31. The equipment’s cash price
is P 600,000.

Present Value – Cash Sales Price 600,000
Unearned Interest Income P 200,000
Cash Sales Price P 600,000

Cost of Equipment 500,000
Gross Income P 100,000
The following are the entries for 2020:
To record the Sale on January 1, 2020:

Sales 600,000
Unearned Interest Income 200,000
To record collection of first installment payment on December 31, 2020:
Cash 200,000
To transfer unearned interest income to interest income over the term of the note on
December 31, 2020:

Year Notes Fraction Interest

Receivable Income
2020 800,000 8/20 80,000
2021 600,000 6/20 60,000
2022 400,000 4/20 40,000
2023 200,000 2/20 20,000
2,000,000 200,000
The first installment received on December 31, 2020 will decrease the value of the notes
outstanding, thus notes receivable decreases by P200,000 each year.
To be able to get the amount of interest income to be recognized each year, fractions are
developed from the notes receivable balance each year. The fractions developed will then
be multiplied by total unearned interest income to get the interest income for the year.
In the Statement of Financial Position on December 31, 2020 the Notes Receivable will then
be presented partly current and non-current, since payments are scheduled annually.
Current
Notes Receivable - Current P 200,000
Less: Amortization of Interest 60,000
Carrying Amount P 140,000
Non-Current
Notes Receivable – Non-Current P 400,000
Less: Unearned Interest Income 60,000
The Unearned Interest Income will now have a balance of:
Total unearned Interest Income P 200,000

Realized 2020 80,000
Total Unearned Interest Income P 120,000
ILLUSTRATION: Non-Interest-Bearing Note – Long Term (Effective Method of Amortization)
On January 1, 2020, ALPHA Corporation sold a machine costing P 400,000 for P 600,000. The
buyer paid a down of P 150,000 and issued a non-interest-bearing note for P 450,000 payable
for 3 years in equal annual instalments payable every December 31.
The prevailing interest rate for a note of this type is 10%. The present value factor for an
ordinary annuity of 1 for three periods at 10% is 2.4869.
To be able to arrive at the present value, the annual installment payments of P 150,000 will
then be multiplied to the present value factor of 2.4869 for a total present value of P 373,035.
The following are now the computations for the Unearned Interest Income and Gain on Sale:

Present Value of Notes Receivable 373,035
Down Payment P 150,000

Present Value of Note Receivable 373,035
Sales Price P 523,035
Cost of Machine 400,000
Gain on Sale of Machine P 123,035
To record the sale on January 1, 2020:
Cash 150,000
Machinery 400,000
Gain on Sale of Machine 123,035
To record collection of first installment payment on December 31, 2020:
Cash 150,000
To transfer unearned interest income to interest income over the term of the note on
December 31, 2020:

For this case, the computation of the interest income is now made through effective interest
method.
Date Annual Interest Principal Present

Collection Income Value
Jan. 1, 2020 373,035
Dec. 31, 2020 150,000 37,304 112,696 260,339
Dec. 31, 2021 150,000 26,034 123,966 136,373
Dec. 31, 2022 150,000 13,627 136,373 -
The interest income is computed by multiplying the present value by the interest rate of 10%.
Therefore, in 2020 multiplying P 373,035 X 10% for an interest income of P37,304.
To arrive at the principal payment, annual collection minus payment applicable to interest
income. Thus, in 2020 P 150,000 minus P 37,304 to arrive at P 112,696.
The present value balance will now then be decreased by the applicable principal
payment. So, in 2020 from the beginning balance of P 373,035 minus P 112, 696 (the principal
payment) equals P 260,339 the carrying amount of the note as of December 31, 2020.
ILLUSTRATION: Non- Interest-Bearing Note – Long Term (Lump Sum Payment)
On January 1, 2020, DEF Corporation sold an equipment costing P 800,000 with an

accumulated depreciation of P 400,000. The entity received cash amounting to P 200,000
and a P 300,000 non-interest-bearing note due January 1, 2023.
The prevailing rate of interest for a note of this type is 10% the present value of 1 at 10% for 3
years is 0.7513.
Consider that the note has no periodic payments thus becoming collectible on a lump sum
basis after 3 years.
The following are now the computations for the Unearned Interest Income and Gain on Sale:

Present Value (300,000 x 0.7513) 225,390
Down Payment P 200,000

Present Value of Note Receivable 225,390
Sales Price P 425,390
Carrying Amount of Equipment
(800,000-400,000) 400,000
Gain on Sale of Equipment P 25,390
To record the sale on January 1, 2020:
Cash 200,000
Accumulated Depreciation 400,000
Machinery 800,000
Gain on Sale of Machine 25,390
To transfer unearned interest income to interest income over the term of the note:
Dec 31, 2020 Unearned Interest Income 22,539



To record payment on January 1, 2023:
Cash 300,000
For this case, the computation of the interest income is still made through effective interest
method.
Date Interest Unearned Interest Present

Income Income Value
Jan. 1, 2020 74,610 225,390
Dec. 31, 2020 22,539 52,071 247,929
Dec. 31, 2021 24,793 27,278 272,722
Dec. 31, 2022 27,278 - 300,000
The interest income is computed by multiplying the present value by the interest rate of 10%.
Therefore, in 2020 multiplying P 225,390 X 10% for an interest income of P 22, 539.
To arrive at the unearned interest income simply deduct the interest income for the current
year to the balance of the unearned interest income. So, in 2020 P 74,610 minus P 22,539 to
arrive at P 52,071
The present value now will then be increased by the interest income for the current year.
Thus, P 225,390 plus P 22, 539 equals P 247,929.
The goal of this kind of amortization on a lump sum basis is to bring the present value of the
notes receivable at exactly the same as of its face amount.
LOANS RECEIVABLES
Loans Receivable is a financial asset similar to accounts receivable but is specific to loans
given to an individual or company. The lender could be a bank, financial institutions and
private investors to individuals.
The term of the loan may vary from being short term (less than 12 months) or more often than
that on a long-term basis which covers a period of more than one year.
VALUATION OF LOANS RECEIVABLES
Initially, an entity must measure a loan receivable at fair value plus any transaction costs that
are directly attributable to the issuance of the loan.
The fair value of the loan receivable at initial recognition is the transaction price or the
amount of loan that is actually granted. On the other hand, transaction costs are directly
attributable costs to the loan receivable which may include direct origination costs.
According to PFRS 9, if an entity manages its financial assets in a way to collect contractual
cash flows on specified dates and the contractual cash flows are solely payments of
principal and interest, such financial assets must be measured at amortized cost. Therefore,
loans receivables are measured at amortized cost using effective interest method.
Amortized cost is the initial amount which a note receivable is measured minus any principal
payments, plus or minus any aggregate amortization of any difference between the initial
carrying amount and the maturity value minus allowances for impairment or uncollectibility.
If initial amount recognized is lower than the principal amount, then the amortization of the
difference is added to the carrying amount and vice versa.
Origination Costs
Usually lending activities come first before the actual disbursement of funds and generally
include efforts to identify and attract potential borrowers and to originate a loan.
Fees charged by the bank/lender against the borrower for the creation of the loan are
known as origination fees. These origination fees include payment for activities such as
assessing of borrower’s financial condition, guarantees, collaterals and other security,
negotiation, preparation and processing of payments and closing of loan transactions.
On initial measurement of the loan receivable, direct origination costs should be included
as part of the value of the loan. However, indirect origination costs should be considered as
an outright expense.
If origination fees are received from the borrower, they are recognized as unearned interest
income and amortized over the term of the loan. However, if the origination fees are not
chargeable against the borrower, the fees are known as direct origination costs.
Direct origination costs are deferred and also amortized over the term of the note however,
if possible direct origination costs are offset directly against any unearned origination fees
received.
For that reason, the origination fees received and the direct origination costs are included
in the measurement of the loan receivable.
If the origination fee received is greater than the origination costs, the difference is unearned
interest income and the amortization will increase interest income. On the other hand, in the
origination costs is greater than the origination fees received, the difference is charged to
direct origination costs and amortization will decrease interest income.
ILLUSTRATION: Origination fees
Universal Bank granted a loan to a borrower on January 1, 2020, the interest on the loan is
12% payable annually starting December 31, 2020. The loan has a term of three years. The
loan has the following data:
Principal Amount P 3,000,000

Direct Origination Costs incurred 100,000
Origination fees received from the borrower 378,400
The initial carrying amount of the loan is computed as follows:
Principal Amount P 3,000,000

Origination fees received (239,080)
Direct Origination Costs Incurred 100,000
Initial Carrying amount of the Loan P 2,860,920
The following are the entries to record the loan on January 1, 2020:
To record the loan:
Loans Receivable 3,000,000

Cash 3,000,000
To record the receipt of origination fees received from the borrower:
Cash 239,080
Unearned Interest income 239,080
To record the direct origination costs incurred by the bank:

Cash 100,000
As a result of these entries, the unearned interest income has a credit balance of P 139,080
to be amortized using effective interest method over the term of the loan.
Due to the origination fees received and the direct origination costs, a new effective rate
must be computed through interpolation or “trial and error”. Since the initial carrying amount
of the loan receivable of P 2,860,920 is lower than the principal amount, it means that there
is a discount and therefore the effective rate must be higher than the nominal rate of 12%.
The effective rate is the rate where in the present value of the future cash inflows are equal
to the initial carrying amount of the loan receivable.
Using an effective rate of 13%, the present value of 1 for three periods is .693, and the present
value of an ordinary annuity of 1 for three periods is 2.361. Accordingly, the present value is
computed as follows:
Present Value of Principal (3,000,000 x 0.693) P 2,079,000

Present Value of Interest (360,000 x 2.361) 849,960
Total Present Value P 2,928,960
Based on the tabulated computation at a rate of 13%, the present value is at P 2,928,360
which is higher that the initial carrying amount of P 2,860,920. This means that the effective
interest rate must be higher than 13%.
Using now an effective rate of 14%, the present value for 1 for three periods is 0.675 and the
present value for an ordinary annuity of 1 for three periods is 2.322. The present Value is
computed as follows:
Present Value of Principal (3,000,000 x .675) P 2,025,000

Present Value of Interest (360,000 x 2.322) 835,920
Total Present Value P 2,860,920
Through various computations, the initial carrying amount now of P 2,860,920 is the same as
the present value, thus concluding now that the effective interest is 14%.
With the effective interest method, the amortization of unearned interest income is as follows:
Date Interest Interest Amortization Carrying

Received Income Amount
Jan. 1, 2020 2,860,920
Dec. 31, 2020 360,000 400,529 40,529 2,901,449
Dec. 31, 2021 360,000 406,203 46,203 2,947,652
Dec. 31, 2022 360,000 412,348 52,348 3,000,000
Interest received = Principal X Nominal Rate
Interest income = Carrying amount X Effective Rate
The entries on December 31, 2020 are as follows:

Cash 360,000

In the Statement of Financial Position as of December 31, 2020, the loans receivable will be
presented as follows:
Loan Receivable P 3,000,000

Less: Unearned Interest Income (139,080 – 40,529) 98,551
Carrying Amount, December 31, 200a P 2,901,449
This presentation is in accordance with the standard requiring loans receivables to be

measured at amortized cost which is now the loan’s carrying amount.
Cash 360,000

Cash 360,000

Cash 3,000,000
LOAN IMPAIRMENT
According to PAS 39, paragraph 58, an entity shall assess at every end of reporting period
whether there is objective evidence that a financial asset or group of financial assets is
impaired. If such evidence exists, then the entity shall determine and recognize the amount
of any impairment loss.
The evidence of impairment which may have resulted to the following loss events occurring
after initial recognition is as follows:
a. Significant financial difficulty of the issuer or obligor.

b. Any breach of contract which may be in the form of default or delinquency in the
interest or principal payments.
c. Debt Restructuring – The lender for economic or legal reasons relating to the
borrower’s financial difficulty, grants to the borrower a concession that the lender
would not otherwise consider.
d. A probability that the borrower will enter bankruptcy or other financial reorganization.
e. The disappearance of an active market for the financial asset due to financial
difficulty.
f. Observable data indicating that there is a measurable decrease in the estimated
future cash flows from a group of financial assets since the initial recognition of those
assets, although the decrease cannot yet be identified with the individual financial
assets in the group.
Measurement of Impairment
If there is an evidence that an impairment loss on loans receivable carried at amortized cost
has been incurred, the amount of loss is measured as the difference between the carrying
amount of the loan and the present value of estimated future cash flows discounted at the
original effective interest rate of the loan as per PAS 39, paragraph 63.
The impairment shall be recorded either by directly reducing the carrying amount of the
loan receivable or through the use of an allowance account. The amount of loss recognized
shall then be recognized in the profit or loss.
ILLUSTRATION: Impairment with accrued interest.
Asian International Bank loaned P 4,000,000 to Bank Arote Company on January 1, 2020. The
terms of the loan require an annual principal payment of P 1,000,000 each year for 4 years
plus interest at 10%. The first principal payment is due on December 31, 2020. The company
made the required payments for year 2020 and 2021.
In 2022, the company began experiencing financial difficulties and was unable to make the
required principal and interest payment on December 31, 2022. On December 31, 2022, the
Bank assessed the collectability of the loan and determined that the remaining principal will
be collected but the collection of interest is doubtful.
The loan receivable has a carrying amount of P 2,200,000 inclusive of accrued interest of P
200,000. The bank has the following projected cash flows from the loan on December 31,
2022 as follows:
Amount
Date of Cash Flow Projected
December 31, 2023 300,000
December 31, 2024 700,000
December 31, 2025 1,000,000
Total Cash Flows 2,000,000
The following are the corresponding present value of 1 using the original effective interest
rate of 10%:
One Period 0.9091
Two Periods 0.8262
Three Periods 0.7513
As a result, the present value of the cash flows is computed as follows:
December 31, 2023 ( 300,000 x 0.9091) 272,730

December 31, 2024 ( 700,000 x 0.8262) 578,340
December 31, 2025 (1,000,000 x 0.7513) 751,300
Total Present Value of Cash Flows 1,602,370
To compute for the impairment loss, get the difference of the carrying amount of the loans
receivable and the present value of cash flows:
Carrying Amount of the Loan P 2,200,000

Total Present Value of Cash Flows 1,602,370
Impairment Loss P 597,630
The entry to recognize the impairment loss on December 31, 2022is:
Loan Impairment Loss 597,630

Allowance for loan impairment 397,630
Any accrued interest must be credited directly since collection of the interest is already
doubtful. On December 31, 2022 the loan receivable is now shown as follows:

Allowance for Impairment (397,630)
Carrying Amount P 1,602,370
The following will now be the entries for the collection and recognition of interest income for
the next three years:
December 31, 2023

To record the cash collection:
Cash 300,000
Loans Receivable 300,000
To record the interest income using effective interest method:
Interest Income (1,602,370 x 10%) 160,237
The interest income is computed by multiplying the carrying amount of the loan by its rate
of 10%. Consider that the recognition of interest income is charged against the allowance
for impairment thus reducing its balance.
December 31, 2024

Cash 700,000
Loans Receivable 700,000

Interest Income(1,462,607 x 10%) 146,261

Allowance for Impairment (397,630-160,237) (237,393)
December 31, 2025

Cash 1,000,000


Interest Income (P 908,868 x 10%) P 90,887
Note: The difference of P245 between P90,887 and P91,132 is due to rounding of present
value factors.
ILLUSTRATION: Impairment without accrued interest.
On January 1, 2020 Legend Bank granted a loan to Furious Inc. in the amount of P 4,500,000.
The terms of the loan were payment in full on December 31, 2025 plus an annual interest of
10% payable every December 31. First interest payment was made on December 31, 2020.
However, on December 31, 2020, due to financial difficulties, Furious Inc. informed the bank
that it would possibly miss the interest payments for the next two years. After that the
borrower expects to resume annual interest payments but the principal is expected to be
settled on December 31, 2026 or one year late with interest paid for the additional year.
Accordingly, the payments are scheduled as follows:
December 31, 2021 No interest payment 0

December 31, 2022 No interest payment 0
December 31, 2023 Interest Payment (4,500,000 X 10%) 450,000
December 31, 2024 Interest Payment 450,000
Principal Payment 4,500,000
Using the original effective interest rate of 10%, the present value of 1 is as follows:
Three periods .7513

Four periods .6830
Five periods .6209
Six periods .5645
Present Value is computed as follows:
December 31, 2023 (450,000 x .7513) 338,085

December 31, 2024 (450,000 x .6830) 307,350
December 31, 2025 (450,000 x .6209) 279,405
December 31, 2026 (4,950,000 x .5645) 2,794,275
Total Present Value of Loan 3,719,115
Carrying amount of loan P 4,500,000

Present Value of Loan 3,719,115
Impairment Loss P 780,885
Unlike the first illustration, there is no accrued interest in this problem. The following are the
entries:
Jan 1, 2020 Loans Receivable 4,500,000

Cash 4,500,000
Dec 31, 2020 Cash 450,000

Loan Impairment Loss 780,885

Dec 31, 2021 Allowance for loan impairment 371,912
Interest Income (10% x 3,719,115) 371,912
Dec 31, 2022 Allowance for loan impairment 408,973


10% of P 4,091,027 equals P 409,103 or a difference of P 130 due to rounding off.
Observe that amortization is done only for the two-year period wherein the company cannot
pay the interest.
Dec 31, 2023 Cash 450,000

Dec 31, 2024 Cash 450,000

Dec 31, 2025 Cash 450,000

Dec 31, 2026 Cash 4,950,000

RECEIVABLE FINANCING
Accounts receivable financing can be a loan for the business with its account receivable as
collateral or a factoring in which the accounts receivable is sold outright to a commercial
finance company for cash. It is one way of expanding an entity’s capability to raise money
from its receivables.
Accounts receivable is sales revenue to be collected from customers and created when a
business sells goods or services on credit terms. Depending on how long before accounts
receivable can be converted to cash, a business may sometimes find itself short of working
capital for continued operations. Absent of funding from other sources, accounts receivable
financing provides a quick access to needed cash.
The common forms of receivable financing are as follows:
a. Pledge of Accounts Receivable

b. Assignment of Accounts Receivable
c. Factoring of Accounts Receivable
d. Discounting of Notes Receivable
PLEDGE OF ACCOUNTS RECEIVABLE
Businesses can use accounts receivable as collateral for short-term loans to fund on-going
operations. When an entity obtains a loan from a bank or any financial institution such
receivables may be used as a collateral security for the payment of the loan. In pledging of
accounts receivable, general accounts receivable may be used as collateral. Usually,
pledged accounts are greater than the amount of the loan.
The borrowing entity still makes the collections but is required to turn over the collections to
the bank as payment for the loan for pledged accounts. Accounting for pledged accounts
is simple. The loan is simply recorded by debiting cash and discount on note payable if with
discount and crediting Notes Payable and Premium on Notes payable if issued on a
premium. Payment of Notes Payable is recorded by debiting Notes Payable and Crediting
Cash.
With regard to pledged accounts, there is no entry necessary for such transaction, but
proper disclosure must be made in the notes to financial statements. Pledged accounts are
still part of the company’s receivables.
ILLUSTRATION
On September 1, 2020, an entity borrowed P 1,500,000 from Security Bank and issued a
promissory note for the same. The loan is for one year and is discounted at 10%. The entity
pledged accounts receivable of P 2,000,000 to secure the loan.
On September 1, 2020, the entry to record the loan is:
Cash 1,350,000
Discount on Note Payable 150,000
Note Payable - Bank 1,500,000
When a loan is discounted, it means that the interest is deducted in advance.
Face Value 1,500,000

Less: Interest deducted in advance (1,500,000 x 10%) 150,000
Net Proceeds 1,350,000
On December 31, 2020, using the straight-line method of amortization, the discount on notes
payable is amortized as interest expense for the 4-month period September 1 to December
31.
Interest Expense 50,000
Discount on Note Payable (150,000 x 4/12) 50,000
Upon preparation of the Statement of Financial Position on December 31, 2020, the note
payable – bank and the corresponding discount on notes payable are presented as follows:
Current Liabilities:
Notes Payable – bank P 1,500,000
Discount on Notes Payable 100,000
A note to financial statement may appear as follows:
The Note Payable to bank amounting to P1,500,000 with a term of one year, maturing
September 1, 2021 is secured by accounts receivable with face value of P 2,000,000.
On September 1, 2021, the following are the entries:
To record amortization of discount:

To record payment of loan:

Notes Payable - bank 1,500,000
Cash 1,500,000
ASSIGNMENT OF ACCOUNTS RECEIVABLE
From the term assign, assignment of accounts receivable is a process wherein the borrower
called the assignor transfers its rights in some of its accounts receivable to a lender called
the assignee in exchange for a loan.
Assignment of accounts receivable is a more formal type of pledging, wherein the financing
agreement is supported by a promissory note signed by the assignor.
Unlike pledging, assignment of accounts receivable is specific to an accounts receivable,

because a specific account of accounts receivable serves as a collateral for the loan.
Features of Assignment
1. There are two methods to which assignment may be done. When customers are not
informed about the assignment of their accounts, assignment is done on a
nonnotification basis. In this case the customers continue to make payments to the
€assignor, who in turn remits the collections to the assignee.
On the other hand, if the customers are informed of the assignment of their accounts, it
is assignment on a notification basis.
2. In assignment, the assignee, generally a bank or financial institution, assess the borrowers
accounts receivable. The assignee lends only a portion or a percentage of the face
value of the accounts assigned depending on the evaluation made. This is because of
certain instances or events that may affect the net realizable value of the accounts
receivable, such as sales returns and allowances, discounts and uncollectibility.
3. A service charge or finance charge or commission for assignment may be charged by

the assignee against the assignor.
ILLUSTRATION: Assignment on Nonnotification Basis
On January 1, 2020 a company assigned P 1,000,000 of accounts receivable to PBC Bank

under a nonnotification basis. The bank advanced 80% less a service charge of P 10,000. The
loan is evidenced by a promissory note that has an interest of 1% per month on the unpaid
balance of the loan.
The entry to transfer accounts receivable to assigned accounts is:
Accounts Receivable – Assigned 1,000,000

The entry to record the loan is:
Cash ( 800,000 – 10,000) 790,000

Service Charge 10,000
Notes Payable–bank(1,000,000x 80%) 800,000
On January 10, 2020 the company issued a credit memo for sales return from the accounts
assigned in the amount of P 25,000. The entry to record the transaction is:
Sales return 25,000
Accounts Receivable - Assigned 25,000
On January 15, 2020, the company collected P 450,000 of the assigned accounts less a 3%
discount. The entry to record the transaction is:
Cash 436,500
Sales Discount ( 3% x 450,000) 13,500
On January 30, 2020, the company remitted the collections to the bank including interest for
1 month. The entry to record the transaction is:
Notes Payable - bank 436,500

Interest Expense (800,000x1%) 8,000
Cash 444,500
On February 5, 2020, assigned accounts amounting to P 10,000 were proven to be worthless.

The entry to record the transaction is:
On February 15, 2020, P 400,000 of the accounts assigned was collected. The entry to record
the transaction is:
Cash 400,000
On February 27, 2020, the company remitted the total amount due to pay off the bank plus
interest for one month.
The entry to record payment of loan is:
Notes Payable–bank (800,000-436,500) 363,500

Interest Expense (363,500x 1%) 3,635
Cash 367,135
The entry to transfer the remaining balance of assigned accounts to accounts receivable is:

Accounts Receivable – Assigned 115,000
Total accounts receivable assigned 1,000,000

Less: Collections (436,500 + 400,000) 836,500
Sales Return 25,000
Worthless Accounts 10,000 885,000
Balance of Accounts Receivable assigned 115,000
ILLUSTRATION: Assignment on a Notification Basis
On January 1, 2020 a company assigned P 2,000,000 of accounts receivable to PBC Bank

under a notification basis. The bank advanced 70% less a service charge of 4% on the gross
amount assigned. The loan is evidenced by a promissory note that has an interest of 1% per
month on the unpaid balance of the loan.
The entry to transfer accounts receivable to assigned accounts is:

Accounts Receivable – Assigned 2,000,000
The entry to record the loan is:
Cash (1,400,000 – 80,000) 1,320,000

Service Charge (2,000,000 x 4%) 80,000
Notes Payable–bank (2,000,000x 70%) 1,400,000
On January 30, 2020, the company received notice from the bank that P 700,000 of the
assigned accounts were collected less 2% discount. A check was sent to the bank as
payment for interest due. The entry to record the collection and payment of interest are as
follows:

Sales Discount (700,000 x 2%) 14,000
Interest Expense (1,400,000 x 1%) 140,000

Cash 140,000
On February 27, 2020 the company received notice from the bank that P 800,000 of the
assigned accounts were collected. Final settlement was made by the bank for excess
collections and uncollected assigned accounts.
The entry to record settlement is:

Cash 78,860
Note Payable – bank 714,000
Accounts Receivable Assigned 800,000
Bank Loan 1,400,000

Less: 1st Collection by bank 686,000
Balance due to the bank 714,000
February collection by bank 800,000

Less: Loan Balance 714,000
Excess Collection 86,000
Less: Interest (714,000 x 1%) 7,140
Remittance from bank 78,860
The entry to transfer the remaining balance of assigned accounts to accounts receivable is:
Accounts Receivable – Assigned 500,000
Financial Statement Presentation
The following accounts were gathered from the ledger of ABC Company:
Accounts Receivable – unassigned 2,000,000

Accounts Receivable – assigned 1,000,000
Allowance for Doubtful accounts 150,000
Note Payable – bank (with assigned accounts) 700,000
Accounts Receivable – unassigned 2,000,000
Total Accounts Receivable 3,000,000
Allowance for Doubtful Accounts (150,000)
Net Realizable Value 2,850,000
The net realizable value of P 2,850,000 will be part of the entity’s trade and other receivables
and to be presented as part of the current assets.
Furthermore, the entity shall make a disclosure in its equity in the assigned accounts
determined as follows:

Less: Note Payable – bank 700,000
Equity in assigned accounts 300,000
The equity in assigned accounts is the excess of the receivables assigned over the liability
from the loan.
FACTORING OF ACCOUNTS RECEIVABLE
Depending on the collectability of its accounts receivable, a business may also consider
selling accounts receivable to a finance company for cash without having to make any loan
payments. Hard-to-collect accounts receivable makes a good candidate for such an
outright sale. On the flip side, a business may have to sell the accounts receivable at a
discount, potentially a deep one, to compensate the finance company for risking any
unsuccessful collections.
Factoring is a manner of financing wherein the entity sells its accounts receivable on a
without recourse, notification basis. The entity that buys the accounts receivable is called a
factor usually a bank or a financial institution. Since, factoring is considered a sale, a gain or
loss is recognized accordingly for the difference of the receivables carrying amount and the
net proceed received from the receivables factored.
Unlike assignment, factoring transfers ownership of accounts receivable, thus transferring the
responsibility of collection and risks of loss. Due to the nature of the transaction, the customers
whose account is sold are notified and are required to pay directly to the factor. The factor
then is now responsible for the accounting of said collections.
Factoring may be done in the following:

a. Casual Factoring
b. Factoring as a Continuing Agreement
Casual Factoring
Casual factoring is considered as a direct sale of receivables. It is treated same as an

ordinary sale of an asset.
ILLUSTRATION
GUMPY Co. factored P 150,000 of its accounts receivable with an allowance for doubtful
accounts of P 10,000 for P 120,000. The entry to record the sale is:
Cash 120,000
Loss on factoring 20,000
From the transaction a gain or loss on factoring is immediately recorded as the difference of
the net proceed and the net realizable value of the receivables.
Factoring as a Continuing Agreement
In some cases, factoring may include a continuing agreement just like warranty on a sale, in
this case the selling entity requests for a factor’s credit approval. Upon approval the factor
then assumes the credit function as well as the collection function.
As compensation the factor charges a commission or a factoring fee usually in a certain

percentage ranging from 5% to 20% for its services of credit approval, billing, collecting and
bearing the risks of uncollectibility.
Furthermore, the factor may withhold a predetermined amount as a buffer for returns and
allowances and other special considerations. Such amount is called as a factor’s
holdback.
A factor’s holdback is a receivable from the factor and considered as a current asset.
Upon final settlement of debt, the factor may return such holdback.
ILLUSTRATION
XYZ Company factored accounts receivable of P 300,000 with credit terms of 2/10, n/30
upon shipment of goods to the customer. The factor charged a 5% commission based on
the gross amount of the receivables factored.
Moreover, the factor withheld 10% of the amount of receivables factored as an allowance
for sales returns.
The entry to record the factoring of receivables is as follows:
Cash 249,000
Commission 15,000
Receivable from factor 30,000
Gross Amount 300,000

Less: Sales Discount (2% x 300,000) 6,000
Commission (5% x 300,000) 15,000
Factors Holdback (10% x 300,000) 30,000 51,000
Cash Proceeds from factoring 249,000
If the customer returned damaged merchandise amounting P20,000 the entry is:
Sales Return and Allowances 20,000

Sales Discount (20,000x2%) 400
When all factored accounts are finally settled and no other returns were made, the factor
may now settle the holdback.
Cash 10,400
DISCOUNTING OF NOTES RECEIVABLE
Discounting a negotiable note receivable is a financing method wherein the payee (the
one entitled to receive the payment on maturity date) may obtain cash before maturity
date by discounting.
To discount a note, the payee must endorse it; thus, the payee becomes the endorser and
the bank or financial institution an endorsee. Endorsement may be done in two methods
which are, with recourse and without recourse.
When endorsement is done with recourse the endorser shall be liable to the endorsee if the
issuer or maker of the note dishonors it. The endorser now has a contingent or secondary
liability to the endorsee. On the other hand, discounting without recourse means that the
endorser has no further liability to the endorsee even if the maker refuses to pay on maturity
date.
Without any evidence to the contrary, endorsement is done with recourse.
Definition of Terms
a. The discounted value of the note received by the endorser from the endorsee is the
Net Proceeds. It is computed by deducting the discount from the Maturity Value.
b. Maturity Value is the amount due on the note upon maturity or settlement date. It is
inclusive of principal and interest due on maturity date.
c. Maturity date is the date where the note becomes due.
d. Principal is also known as the face value of the note. It is the value appearing on the
face of the note.
e. Interest is the amount received at the end of the term of the note aside from the
principal. It is computed by multiplying the principal amount by the rate and the time
or term of the note.
f. Interest rate is the rate appearing on the face of the note.
g. Time is the period within which the interest shall accumulate. The period covers the
date of the note until maturity date. Time is also associated as the full term of the note.
h. The amount of interest deducted in advance by the bank is called the discount.
Discount is computed by multiplying the maturity value by the discount rate and the
discount period.
i. The rate used by the bank in computing the discount is called the discount rate. Note
that the discount rate is different from the interest rate. When no discount rate is given,
then it is safely assumed that the interest rate is the same as the discount rate.
j. Discount Period is a period covering from the date of discounting to the date of
maturity. To compute for the discount period, deduct the expired portion of the note
up to the date of discounting from the notes original term. Simply stated the discount
period is the unexpired portion of the notes term.
ILLUSTRATION: Discounting Without Recourse
On July 30, 2020 ABC Corporation discounted without recourse a note dated June 1, 2020
having a face amount of P 500,000, 12%, due after 180 days. The bank discounted it at a
15% discount rate.
To determine the maturity value, interest is computed for the notes full term or until maturity.
Principal 500,000
Interest (500,000 x 12% x 180/360) 30,000
Maturity Value 530,000
After determining the maturity value, compute for the discount. Note that in counting days
“exclude the first day but include the last day”.
Discount = Maturity Value times Discount Rate time Discount period

Discount = (530,000 x 15% x 120/360) 26,500
The discount period is computed as:

Term of Note 180 days
Days expired (June 1 – July 30) (60) days
Discount Period 120 days
Then, determine cash proceeds by deducting the discount from the maturity value.
Maturity Value 530,000

Less: Discount 26,500
Net Proceeds 503,500
To determine Carrying amount of Notes Receivable, include from the principal amount the
interest earned from June 1 to July 30 or 60 days.
Principal 500,000
Accrued Interest (500,000 x 12% x 60/360) 10,000
Carrying Amount of Note 510,000
Then, determine Gain or loss on discounting. The difference of the net proceeds and the
carrying amount of the note is called gain or loss or discounting.

Carrying amount of Note 510,000
Loss on Discounting (6,500)
Considering in the illustration that the discounting is done without recourse, therefore the sale
of the note receivable is absolute, and no contingent liability is expected.
The entry to record the discounting is as follows:
Cash 503,500
Loss on Note Receivable Discounting 6,500
Note Receivable 500,000
The notes receivable is credited directly because the sale is absolute or without recourse.
The interest income is credited for the actual interest earned on the date of discounting.
ILLUSTRATION: Discounting with Recourse
A P 3,000,000, 6-month, 10% note dated January 1, 2020 is received from a customer by
HUMPY Corporation. The entity discounted the note to May Bank on March 1 at a rate of
15%.
Principal 3,000,000
Interest (3,000,000 x 10% x 6/12) 150,000
Maturity Value 3,150,000
Less: Discount (3,150,000 x 15% x 4/12) 157,500
Net Proceeds 2,992,500
Term of Note 6 months

Less: Age of Note (Jan 1-Mar 1) 2 months
Discount Period 4 months
As the term of the note is expressed in months, the counting is also done by months regardless
of the number of days in a month.
Principal 3,000,000
Accrued Interest Receivable
(3,000,000 x 10% x 2/12) 50,000
Carrying Amount of the notes receivable 3,050,000
Less: Net Proceeds 2,992,500
Loss on Discounting 57,500
On discounting with recourse, transaction may be accounted in several ways which are:
a. Conditional Sale of the Notes receivable recognizing a contingent liability.
b. Secured borrowing.
Conditional Sale
If the transaction is considered as a conditional sale the entry to record the discounting is as
follows:
Cash 2,992,500
Loss on Notes Receivable Discounting 57,500
Notes Receivable – Discounted 3,000,000
The Note Receivable Discounted account is a contra account and will be deducted from
the total notes receivables upon preparation of the statement of financial position with
disclosure to contingent liability.
If on July 1, 2020, date of maturity, the note is paid by the maker to the bank, then the
contingent liability is then extinguished as follows:
Notes Receivable - Discounted 3,000,000

Notes Receivable 3,000,000
On the other hand if the note was dishonored by the maker on July 1, 2020, the entity pays
the maturity value of the note amounting to P 3,150,000 plus protest fees and other charges
of P 20,000, the total payment will then be charged to Accounts Receivables as follows:
To record payment to bank.

Cash 3,170,000
To cancel contingent liability.
Notes Receivable - Discounted 3,000,000

Secured Borrowing
If discounting is considered as a secured borrowing, the note receivable is not derecognized

but an accounting liability is recorded at an amount equal to the face amount of the note
receivable discounted. The entry to record the transaction would be:
Cash 2,992,500
Interest expense 57,500
Liability for note discounted 3,000,000
Note that in secured borrowing there is no gain or loss in discounting. The interest expense in
this case may be offset against the interest income because the discounting transaction is
a borrowing.
So, if on July 1, 2020, the maker paid the note to the bank the entry would be:

On the other hand if the note was dishonored by the maker on July 1, 2020, the entity pays
the maturity value of the note amounting to P 3,150,000 plus protest fees and other charges
of P 20,000, the total payment will then be charged to Accounts Receivables as follows:
To record payment to bank.

Cash 3,170,000
To cancel contingent liability.

DERECOGNITION
According to PAS 39, paragraph 17, an entity shall derecognize a financial asset when either
one of the criteria is met:
a. The contractual rights to the cash flows of the financial asset have expired.
Contractual cash flows may expire when the note is fully collected or settled.
b. The financial asset has been transferred and the transfer qualifies for derecognition
based on the extent of transfer of risks and rewards of ownership.
Assessment must be done on the transfer of risks and rewards in the second criteria. PAS 30,
paragraph 20, provides the following guidelines for derecognition based on transfer of risks
and rewards of ownership:
a. If the entity has transferred substantially all risks and rewards, the financial asset shall
be derecognized. Otherwise, if the entity has retained substantially all risks and
rewards, the financial asset shall not be derecognized.
b. If the entity has neither transferred nor retained substantially all risks and rewards,
derecognition depends on whether the entity has retained control of the asset.
i. If the entity has lost control, then the asset is derecognized entirely. Loss of control
is when the other party or transferee has the practical ability to sell the asset in its
entirety to a third party without attaching any restrictions to the transfer.
ii. If the entity has retained control, then the asset is not derecognized. The entity must
continue to recognize the financial asset to the extent of its continuing
involvement.
Undoubtedly, the first criteria of derecognition does not apply since the contractual rights to
cash flows of the note receivable discounted with recourse have not yet expired.
The discounting of note with recourse does not also fall in the second criteria of transfer of
risks and rewards of ownership.
Consequently, the discounting transaction is a combination of the following guidelines in the

second criteria:
The entity has substantially transferred all rewards of ownership; the entity has retained
substantially all risks of ownership and the entity has lost control of the note receivable.
Specifically, under the American Standard, the transferor is determined to have surrendered
control over the note receivable discounted and therefore, the discounting shall be
accounted for as a sale if all of the following conditions have been met:
a. The transferred note receivable has been isolated from the transferor, meaning outside
the reach of the transferor and its creditors, even in bankruptcy or other receivership.
b. The transferee has the right to pledge or sell the note receivable.
c. The transferee has the complete control over the note receivable.
Therefore, it has been considered that discounting of notes receivable with recourse is to be
accounted for as a conditional sale with recognition of a contingent liability.
It is because upon discounting or endorsement whether with or without recourse, the

transferor or endorser has lost control over the note receivable because the other party or
transferee has the capacity to sell the asset in its entirety to a third party without any
restrictions or attachments.
DISCOUNTING OF OWN NOTE
Unlike the previous discussions, when the note to be discounted is made by the party
discounting, a primary liability exists, not a contingent liability. As a result, the party
discounting is entering into a contract of loan with the endorsee.
ILLUSTRATION
Assume that ABC Corporation discounted at the bank its own note amounting to P 400,000
at 10% for one year on July1, 2020.
The entry to record the discounting would be:
Cash 360,000
Principal 400,000
Less: Discount (400,000 x 10%) 40,000
Using the straight-line method of amortization, on December 31 the discount is amortized

and interest expense for six months from July 1 to December 31 as follows:
Interest Expense (40,000 x 6/12) 20,000
Cash 20,000
In the Statement of Financial Position, the note payable minus the discount on the note
payable is presented as current liability as follows:
Note Payable - bank 400,000

Discount on Note Payable (20,000)
Carrying amount 380,000
CREDIT CARDS
Purchases of inventory and supplies will often be made on account. Likewise, sales to
customers may directly (by the vendor offering credit) or indirectly (through a bank or credit
card company) entail the extension of credit. While the availability of credit facilitates many
business transactions, it is also costly. Credit providers must conduct investigations of credit
worthiness and monitor collection activities.
In addition, the creditor must forego alternative uses of money while credit is extended.
Occasionally, a borrower may refuse or is unable to pay. Depending on the nature of the
credit relationship, some credit costs may be offset by interest charges. And, merchants
frequently note that the availability of credit entices customers to make a purchase decision.
Banks and financial services companies have developed credit cards that are widely
accepted by many merchants and eliminate the necessity of those merchants maintaining
separate credit departments.
Popular examples include MasterCard, Visa, and American Express. These credit card
companies earn money off of these cards by charging merchant fees (usually a formula-
based percentage of sales) and assess interest and other charges against the users.
Nevertheless, merchants tend to welcome their use because collection is virtually assured
and very timely (oftentimes same day funding of the transaction is made by the credit card
company). In addition, the added transaction cost is offset by a reduction in the internal
costs associated with maintaining a credit department.
The accounting for credit card sales depends on the nature of the card. Some bank card-
based transactions are essentially regarded as cash sales since funding is immediate.
Assume that on January 9 Rayyan Company sold merchandise to a customer for P10,000.
The customer paid with a bank card, and the bank charged a 2% fee. Rayyan Company
should record the following entry:
Cash 9,800
Service Charge 200
Sales 10,000
Other card sales may involve delayed collection and are initially recorded as credit sales:

Sales 10,000
When collection occurs on January 25, notice that the following entry includes a provision
for the service charge. The estimated service charge could (or perhaps should) have been
recorded at the time of the sale on January 9, but the exact amount might not have been
known. Rather than recording an estimate, and adjusting it later, this illustration is based on
the simpler approach of not recording the charge until collection occurs.
Cash 9,800
Service Charge 200

3-1 AE111 NOTES Unit-3

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Unit 3: Trade and Other Receivables

Examples of Nontrade Receivables are:

STATEMENT OF FINANCIAL POSITION CLASSIFICATION OR PRESENTATION:

CURRENT RECEIVABLES include the following:

➢ All trade receivables

Accounts Receivable 1,000,000

NONCURRENT RECEIVABLES include:

CREDIT BALANCE IN ACCOUNTS RECEIVABLE

*Credit balance of customer Nes is due from overpayment

Accounts Receivable 50,000

INITIAL MEASUREMENT OF RECEIVABLES

ILLUSTRATION: (Recording transaction under different freight terms)

Jan 1 Accounts Receivable 300,000

Jan 7 Cash 300,000

Jan 1 Accounts Receivable 300,000

Jan 7 Cash 280,000

Jan 1 Accounts Receivable 320,000

Jan 7 Cash 320,000

Jan 1 Accounts Receivable 300,000

Jan 7 Cash 300,000

ACCOUNTING FOR ALLOWANCE FOR SALES RETURN

➢ Excess quantity shipped

Sales Return 30,000

ACCOUNTING FOR SALES DISCOUNT

A trade discount is granted as incentive to purchase of merchandise in large volume,

Methods of recording credit sales

There are two methods of recording credit sales, mainly

Sale of Accounts Receivable 200,000

DISCOUNT ON PARTIAL COLLECTION

The entry to record the sale is as follow:

ACCOUNTING FOR ALLOWANCE FOR SALES DISCOUNT

Sales Discount 25,000

ACCOUNTING FOR BAD DEBT EXPENSE

In the absence of any contrary statement, doubtful accounts shall be classified as

TWO METHODS IN ACCOUNTING FOR BAD DEBTS:

Doubtful Account/ Bad debt expense xx

Below is the balance sheet presentation of the Allowance Account:

The entry to recognize the worthless or uncollectible account as loss:

Doubtful Account/ Bad debt expense xx

COMPUTATION OF BAD DEBTS/DOUBTFUL ACCOUNTS

1. Percent of accounts receivable or statement of financial position approach

PERCENT OF ACCOUNTS RECEIVABLE

The following unadjusted December 31 account balances are available: Accounts

The adjusting entry to record bad debt is as follows:

Doubtful Account/ Bad debt expense 9,400

The adjusting entry to record bad debt is as follows:

Doubtful Account/ Bad debt expense 19,400

Debit balance in allowance account

The entry to record the expense for the year is:

Doubtful Accounts Expense 45,000

AGING OF THE ACCOUNTS RECEIVABLE

Accounts receivable aging is a technique to estimate bad debts expense by classifying

The adjusting entry to record bad debt is as follows:

Doubtful Accounts Expense 11,324

The adjusting entry to record bad debt is as follow:

Doubtful Accounts Expense 9,147

Then, Allowance for Bad debts would have a balance of:

Allowance for Bad Debts, beg. P 1,418

WHEN IS AN ACCOUNT PAST DUE?

CORRECTION IN ALLOWANCE FOR DOUBTFUL ACCOUNTS

The correction is to be reported in the income statement either as an addition to or

Adjustment for INSUFFICIENT allowance

Doubtful Accounts Expense / Bad Debts Expense xx