Impairment of Receivables

Measurement subsequent to Initial Recognition

Notes and accounts receivable meet the requirements in IFRS 9 Financial Instruments for the financial
assets to be classified as subsequently measured at amortized cost. The two conditions are:

a. The financial asset is held within the enterprise’s business model whose objective is to hold assets
in order to collect contractual cash flows; and
b. The contractual terms of the financial asset give rise on specified dates to cash flows that are solely
payments of principal and interest (SPPI).

The amortized cost of receivables is its principal amount plus accrued interest and any unamortized
premium and minus the unamortized discount using the effective interest method, and minus any
reduction (directly or through the use of the allowance account) for impairment of uncollectibility. In
case some portion of the receivable is assessed to be impaired, the amount believed to be uncollectible
shall be deducted.
Accounts receivable that are granted within the entity’s usual credit terms are not generally discounted
to their present value, because any amount of the discount or interest is usually immaterial.
 Impairment of Receivables

Receivable that had been proved uncollectible is recognized as expense in profit or loss. This is called
impairment loss, or more popularly called uncollectible accounts expense or bad debts expense.

There are two methods of accounting for uncollectible accounts:

• Direct write-off method – When a specific account is ascertained or proven to be uncollectible (which
may not occur in the period of sale). The direct write-off recognizes impairment loss or bad debts
expense by crediting directly the receivables account. It is the only method allowed for income tax
purposes.

• Allowance method – It requires the use of valuation account for the receivables. This method
recognizes the impairment of receivables by charge to Bad Debt Expense or Impairment Loss and a
credit to the allowance account. The resulting balance of allowance for bad debts is deducted from
accounts or notes receivable to arrive at its amortized cost
Under the allowance method, the write-off of an uncollectible account does not change the net amount
of accounts receivable nor does it affect profit or loss.

In some cases, the allowance for bad debts may result in a debit balance before year-end adjustment.
This may indicate that there have been excessive write-offs during the period and the previous
estimate of the company may not be adequate. In such a case, the company has to review the basis
of estimating its uncollectible accounts and should bring its uncollectible accounts to the appropriate
balance at year-end based on the most reasonable estimate.
Under the allowance method, the write-off of an uncollectible account does not change the net amount
of accounts receivable nor does it affect profit or loss.

In some cases, the allowance for bad debts may result in a debit balance before year-end adjustment.
This may indicate that there have been excessive write-offs during the period and the previous
estimate of the company may not be adequate. In such a case, the company has to review the basis
of estimating its uncollectible accounts and should bring its uncollectible accounts to the appropriate
balance at year-end based on the most reasonable estimate.
 Illustrative Problem: Direct write-off

Assume that Company A uses direct-write off method to record uncollectible accounts. On March 1, 2021,
Company A wrote-off P30,000 of its accounts receivable for the uncollectible accounts from customer XYZ.
Subsequently, on June 30, 2021, Company recovered and collected the account previously wrote-off from
customer XYZ. Record the foregoing transactions.

Mar. 1, 2021 Bad Debts Expense (or Uncollectible Accounts

Expense or Impairment loss) 30,000
Accounts Receivable (or Notes Receivable) 30,000

Jun. 30, 2021 Accounts Receivable (or Notes Receivable) 30,000

Bad Debts Recovery (or Recovery of Previous
Impairment of Receivable) 30,000
Jun. 30, 2021 Cash 30,000
Accounts Receivable (or Notes Receivable) 30,000
 Illustrative Problem: Allowance Method

Assume that Company A uses Allowance method to record uncollectible accounts. On March 1, 2021,
Company A wrote-off P30,000 of its accounts receivable for the uncollectible accounts from customer
XYZ. Subsequently, on June 30, 2021, Company recovered and collected the account previously wrote-
off from customer XYZ. The company uses fiscal calendar for the year-ended June 30, 2021 and it was
estimated that P50,000 of accounts receivable is deemed to be uncollectible. Record the foregoing
transactions.

Mar. 1, 2021 Allowance for Bad debts 30,000

Accounts Receivable 30,000

Jun. 30, 2021 Accounts Receivable 30,000

Allowance for Bad Debts 30,000
Jun. 30, 2021 Cash 30,000
Accounts Receivable 30,000

Bad Debts Expense 50,000

Allowance of Bad Debts 50,000

At year-end, the amount of accounts receivable that may prove to be uncollectible must be estimated.
 Measuring of Impairment Loss

IFRS 9 requires an entity to measure its expected credit losses not necessarily based on a loss event but
based on reasonable and supportable information available without undue cost and effort and which
includes past experiences, present condition and future expectations.

Stage 1: Recognize in profit or loss, through an allowance account, an impairment loss based on 12-
month expected credit losses

Stage 2: Recognize in profit or loss lifetime expected credit losses, if credit risk increases significantly.
Effective interest is calculated based on the gross carrying amount of the receivables

Stage 3: Assess individually the receivables when the receivables are considered credit impaired. In this
stage, the effective interest rate is calculated based on the receivable balance, net of any related
allowance.
 Illustrative Problem: Impairment loss

On December 31, 2019, the ABC Finance Company had a P5,000,000 note receivable from XYZ
Company. The note bears 10% interest. The books reported accrued interest of P500,000 on this date.
Because of financial distress being suffered by XYZ Company, ABC Finance agreed to the restructuring
and modification of the terms of its loan to XYZ as follows:
- Annual payment of P1,100,000 with first payment due on December 31, 2020.
- No further interest will be collected during the extended 5-year term; and
Based on the ledger balance of the company for allowance for uncollectible notes and accounts,
P150,000 relates to this note.

Principal and accrued interest P5,500,000

Allowance for doubtful accounts (150,000)
Present value of future cash flows
(1,100,000 x 3.7908) (4,169,880)
Impairment loss 1,180,120
Dec. 31, 2019 Impairment loss 1,180,120
Allowance for uncollectible accounts 150,000
Restructured Notes Receivable 5,500,000
Discount on Restructured Notes Receivable 1,330,120
Notes Receivable 5,000,000
Interest Receivable 500,000
To recognize the impairment loss on December 31, 2019

Dec. 31, 2020 Cash 1,100,000

Discount on Restructured Notes Receivable 416,988
Restructured Notes Receivable 1,100,000
Interest Revenue 416,988
 Illustrative Problem: Impairment loss

On December 31, 2019, the ABC Finance Company had a P5,000,000 note receivable from XYZ
Company. The note bears 12% interest. The books reported accrued interest of P600,000 on this date.
Because of financial distress being suffered by XYZ Company, ABC Finance agreed to the restructuring
and modification of the terms of its loan to XYZ as follows:
- Reduction of principal to P4,000,000
- Reduction of interest to 10% payable annually beginning December 31, 2020.
- Accrued interest on December 31, 2019 is condoned; and
- Principal payment was reset to December 31, 2021.
The prevailing market rate of interest for similar obligations on the date of restructuring decreased to
9%. Use present value factors rounded four decimal places.
Carrying value of the note 5,600,000
Present value of future cash flows
(4,000,000 x .7972) 3,188,800
(4,000,000 x .08 x 1.6901) 676,040 (3,864,840)
Impairment loss 1,735,160
Dec. 31, 2019 Impairment loss 1,735,160
Restructured Notes Receivable 4,000,000
Notes Receivable 5,000,000
Discount on Notes Receivable 135,160
Interest Receivable 600,000

Dec. 31, 2020 Cash 400,000

Discount on Restructured Notes Receivable 63,781
Interest Revenue 463,781

Dec. 31, 2021 Cash 4,400,000

Discount on Restructured Notes Receivable 71,379
Interest Revenue 71,379
Restructured Notes Receivable 4,000,000