CHAPTER 4 ACCOUNTS RECEIVABLE TECHNICAL KNOWLEDGE To know the classification and presentation of receivable To know the initial and subsequent measurement, accounts receivable. o identify the adjustments necessary in determining | net realizable value of accounts receivable, To understand the gross method and net method) recording credit sales, To know the accounting for doubtful accounts, worthle accounts written off and recoveries of accounts writt off. 108 Scanned with CamScannerDefinition Receivables are financial assets that represent a contractual Tight to receive cash or another financial asset from another entity. For retailers or manufacturers, receivables are classified into i ivables and : Trade and nontrade receivables Trade receivables refer to claims arising from sale of merchandise or services in the ordinary course of business. Trade receivables include accounts receivable and notes receivable. Accounts receivable are open accounts arising from the sale of goods and services in the ordinary course of business and (aobsupported by promissory notes. Other names of accounts receivable are customers’ accounts, trade debtors, and trade accounts receivable. Notes receivable are those Gupported by formal promises to pay in the form of Nontrade receivables represent claims arising from sources Giher thap the sale of merchandise or services in the ordinary course of business. Loans receivable For banks and other financial institutions, receivables result Primarily from loans to customers. The loans are made to heterogeneous customers and the repayment periods are frequently longer or over several yeara. 109 Scanned with CamScannerClassification ined i Trade receivables which are expected to be ren cath within the normal operating cycle or one Y°8K ig longer, are classified as current assets. Nontrade receivables which are expected to be oe att within one year, the length of the operating ove ding, are classified as current assets. If collectible beyond one year, nontrade receivables are classified as noncurrent assets. The classifications are in accordance with PAS 1, Presentation of Financial Statements, paragraph 66, which states: “An entity shall classify an asset as current when the entity expects to realize the asset 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." Presentation Trade receivables and nontrade receivables which are currently collectible shall be presented on the face of-the statement of financial position as one line item called trade and other receivables. However, the details of the total trade and other receivables shall be disclosed in the notes to financial statements. For example, the disclosure may appear as follows: Accounts receivable 5,000,000 Allowance for doubtful accounts ("200,000 Notes receivable 1,000,000 Accrued interest on note receivable 150,000 ‘Advances to officers and employees 15500 Dividends receivable 250,000 other r Total trade and eceivables “6,300,008 110 Scanned with CamScannerExamples of nontrade receivables a. Advances to or receivables from shareholders, directors, officera or employees. If collectible in one year, such advances or receivables should be classified as current assets, Otherwise, such advances or i i 0 an : receivables are classified as b. Advances to affiliates are usually treated as | ng-te: investments. ly treated as long-term c. Advances to supplier for the acquisition of merchandise are current assets. d. Subscriptions receivable are current assets if collectible within one year.(Otherwis subscriptions receivable should be shown preferably as a deduction from subscribed share capital. subscribed s] e. Creditors’ accounts may have debit balances as a result of overpayment or returns and allowances. These are classified as current assets. If the debit balances are(fiot)material, an offset may bé made against the creditors” accounts with credit balances and only the Gét)accounts payable may be presented. f. Special deposits on contract bids normally are classified as noncurrent assets because such deposits are likely to remain outstanding for a considerable long period of time. However, the deposits that are collectible currently should be classified as current assets. g. Accrued income such as dividend receivable, accrued rent receivable, accrued royalties receivable and accrued interest receivable on bond investment are usually classified as current assets. h. Claims receivable such as claims against comman carriers for losses or damages, claim for rebates and tax refunds, claim from insurance entity, are normally classified as current assets. 111 Scanned with CamScannerCustomers’ credit balances i 8 in accoun; Customers’ credit balances are credit balenée® ‘turne sna Teceivable resulting from overpay! mers. lowances, and advance payments liabilities These credit balances are classified a8 current ae customer are not offset against the debit balances ne in which oe accounts, except when the same is Gop mater ‘4 hich only the net accounts receivable may be Pt ivable controlling account ne rts a eae Sf'B500 000. E ‘Examination of the subsidiary rs reveals the following details in the customers’ accounts: Customer C 500,000 Collections 450,000 editbalance _ 50,000 Returns 100,000 280.000 550,000 ‘The accounts receivable should be Presented as current asset at P550,000 representing the accounts of A and B. ‘The credit balance in the account of C is classified as current Lability ond not offset against the debit balances in the accounts of No adjustment is necessary to formally recognize the istomers’ credit balances because ultimately these are canceled for sales and cash settlement, But an adjustment may be made only for worksheet urposes, meaning, not formally journalized and Posted to the Beager, as follows: Accounts receivable 50,000 Customers’ credit balances 60,000 112 Scanned with CamScannerInitial measurement of accounts receivable PFRS 9, vaerreh 5.1.1, provides that a financial asset shall be recognized initially at fair value (lu) transaction costs that are directly attributable to the acquisition. The fair value of a financial asset is usually the transaction price, meaning, the fai of the consideration given. For short-term receivables, the fair value is equal to the face amount or original invoice amount, Cash flows relating to si ti ivables are not 8 hort-term receivabl discounted because the effect of discounting is usually immaterial. Accordingly, accounts receivable shall be measured initially at face amount or original invoice amount. Subsequent measurement In accordance with PFRS 9, Paragraph 5.2.1, after initial recognition, accounts receivale shall be measured at amortized cost. The amortized cost is actually the net realizable value of accounts receivable. The term amortized cost has more relevance in long-term note receivable. the term net realizable value is preferably used in relation to accounts receivable. The net reali: of accounts receivable is the amount of cash expected to be collected or the estimated recoverable amount. \ 118 Scanned with CamScannerony “ Net realizable value . receivable sh; wakes zed for accounts receivable shal) Teraiveed Foaperiienineltn which in the ordinary, {purse of business will reduce the amount recovera mm the customer. is i tablished basic principle that assets mh is based on i abo their recoverable amount. i i imati izable value of trade rdingly, in estimating the net realizal een YO ole the following deductions are made: a. Allowance for freight charge ‘ b. Allowance for sales return c. Allowance for sales discount d. Allowance for doubtful acccounts Terms related to freight charge In order to give proper accounting recognition to freight charge in relation to accounts receivable, the following terms should be understood - FOB destination, FOB shipping point, freight collect and freight prepaid. The term POBdestination means that ownership of the goods purchased is vested in the buyer upon receipt thereof. Accordingly, the GelleD shall be responsible for the freight charge up to the point of destination. The term FOB. shipping point means that ownership of the goods purchased is vested in the buyer upon shipment thereof. Thus, it is incumbent upon the buyer to ay>for the transportation charge from the point of shipment to the point of destination The term /reight collect means that freight charge on the goods - shipped is Got yet paid. The common carrier shall collect the same from the buyer. Thus, under this, th actually paid by the buyer is, the Freight charge 1 The term freight prepaid means that freight ch: ne goods shipped isC@ireadp paid by the sell are? on 114 Scanned with CamScanneraccounting for freight charge gometimes, goods are sold FOB On the part of the seller, the frei, debitin: freight out and crediti charge- — ight charge is recorded by ng allowance for freight For example, an entity has q P00, . the end of accounting period, 1,000 account receivable at The terms are 2/10, n/30, FOB ai i i collect. The customer paid freight charge af P5000. — 1. To record the sale: Accounts receivable Freight out eon Sales . 100,000 Allowance for freight charge 5,000 2. To record the collection within the discount period: Cash 93,000 Sales discount 2,000 Allowance for freight charge 5,000 Accounts receivable 100,000 Allowance for sales returns The measurement of accounts receivable shall also recognize the probability that some customers will return goods that are unsatisfactory or will make other claims requiring ‘reduction in the amount due as in the case of shipment shortages and defects. For example, an amount of P50,000 of the total accounts receivable at year-end represents selling price of goods that will probably be returned. The journal entry to recognize the Probable return is: Sales return ~~ Allowance for sales return 50,000 115 Scanned with CamScannerSales discount discounts to credit custome, jes usually offer cash Freier aheidi ere, Bate ont ig a reduction from an invoice price by FeaLon of prompt payment. 4 nm as sales discount on the part of t] iT A cash discount may be expreséed as 5/10, 1/30. Thig means that the customer is entitled toa 5% discount it payment is made in 10 days from the invoice date. Ifthe customer fails to pay within the 10-day discount periog, the gross amount of the invoice price must be paid within 30 days from the invoice date. Methods of recording credit sales 1 Gross method - The accounts receivable and sales are recorded at gross amount of the invoice. This is the common and widely used method because it is simple to apply. Net method — The accounts receivable and sales are recorded at net amount of the invoice, meaning the invoice Price minus the cash discount. Illustration - Gross method 1 Sale of merchandise for P100,000, terms 5/ 10, n/30. Accounts receivable Sales 100,000 100,000 2 Assume collection is made within the discount period, Cash 95, Sales discount 4 Accounts receivable , 100,000 3. Assume collection is made beyond the discount period Cash Accounts receivable His-000 100,069 | ie | Scanned with CamScannerIllustration - Net method 1. Sale of merchandise for Pi00;000, terms 6/10, n/30, Accounts receivable Sal ‘95,000 95,000 2, Assume collection is made within the discount period. Cash Accounts receivable eon 95,000 3. Assume collection is made beyond the discount Period. Cosh 100,000 Accounts receivable i 95,000 Sales discount forfeited 5,000 The sales discount forfeited account is classified as other income. Allowance for sales discount If customers are granted cash discounts for prompt payment, then, conceptually estimates of cash discounts on open accounts at the end of the period based on past experience shall be made. . . For example, of the accounts receivable of P1,000,000 at the end of the period, it is reliably estimated that discounts to be taken will amount to P50,000. The adjustment to record the expected sales discount is: Sales discount 50,000 Allowance for sales discount 50,000 The adjustment may be reversed at the beginning of the next Period in order that discounts can then be charged normally to sales discount account. 117 Scanned with CamScannerAccounting for bad debts , n only for cash to . dit rather thar . ities sell on cret rt ase income. Business cntetes and thereby incre: entity that sells on credit assumes the risk that ‘0 i unts. = ‘customers will not pay their acco' collectible, the entity ha, rie ara pi one of doing business on credit. Two methods are followed in accounting for this bad debt loss, namely: 1. Allowance method 2 Direct writeoff method Allowance method The allowanee method Tequires recognition of a bad debt loss if the accourts are doubiful of collection. The journal entry to recognize the doubtful accounts is: Doubtful accounts XX Allowance for doubtful accounts. xx The “allowance for doubtful accounts” is deduction from accounts receivable. ‘ If the doubtful account: nts are Subsequently found to be fearthless or uncollectible, the accounts are written off as Allowance for doubtful accounts Accounte receivable xx xx Generally accepted accountin, i the allowance method because itenne ples Meee the use of principle. is ‘with the matching Moreover, accounts rece; ivabl at net realizable value. ® would be Properly measured lig Scanned with CamScannerRecoveries of accounts written off 1f a collection is made on account Previously written off as unoollectible, the customary procedure is trace recharge the customer's account with the amount collected and possibly with the entire amount previously charged off if it ia now expected that collection will be received in full, ‘The collection is then recorded noimally by debitin crediting accounts receivable. uv Sean saab. and ‘The recharging of the customer's account is usually followed because it is an'evidence of the attempt of the customer to reestablish his credit with the entity. What account should be credited when the customer's account is recharged? ‘The generally accepted approach is to simply reverse the original entry of writeoff regardless of whether the recovery is during the year of writeoff or subsequent thereto. Illustration - Allowance method 1, Accounts of P30,000 are considered doubtful of collection. Doubtful accounts 30,000 Allowance for doubtful accounts 30,000 2. The accounts are subsequently discovered to be worthless , or uncollectible. Allowance for doubtful accounts 30,000 Accounts receivable 30,000 8. The same accounts that are previously written off are unexpectedly recovered or collected. Accounts receivable 90,000 Allowance for doubtful accounts 30,000 Cash 30,000 Accounts receivable 90,000 119 Scanned with CamScannersews i" ition of a bad @ direct writeoff method requires recogni dehy Ire only when the accounts proved to be worthiles ‘uncollectible. iin inl tan forthless accounts are recorded by debi lebts ang edit ecounta receivable. If the accounts are only doubsfy)¢¢ collection, no adjustment is necessary. ; ‘This approach is often used by emall businesses because itis simple to apply. ‘As a matter of fact the Bureau of Internal Revenue recogni only this method for income tax purposes. However, the direct writeoff method violates the matching Principle because the bad debt loes is often recognized in later accounting period than the period in which the sales revenue ‘was recognized. The direct writeoff method is not permitted under IFRS, 8 op ?Dustration - Direct writeoff method 1, Accounts of P30,000 are considered doubtful of collection, No entry is necessary. 2. The accounts proved to be worthless, Bad debts 30,000 Accounta receivable ‘ 30,000 3. The same accounts that are i i oon ae that Previously written off a6 Accounts receivable Bad debts 30,000 30,000 Cash Accounts receivable 30,000 30,000 If the recovery is subsequent to the i ff method is uecl ‘Year of writeoff and the direct to other income. ‘he recovery may imply be credited Scanned with CamScanneryr poubtful accounts in the income statement 1. Distribution cost If the granting of credj i oe Goch tet it and collection of accounts are shall be considered ag distribution oy, Su hteUl accounts 2 Administrative expense If the granting of credit i under the charge of an ofa: he thon aol manage, doubtful accor i doubful unts shall be Considéred as administrative In the absence of any contr: ‘al accounts shall be classified as tdminineutne Pies 121 Scanned with CamScanner