Chapter 10 - Loans and Receivable CHAPTER 10 LOANS AND RECEIVABLE TOPIC OVERVIEW: This chapter discusses loans and receivables, its characteristics ang | and subsequent measurement of each type of classifications, init receivable and provision for bad debts. LEARNING OBJECTIVES: After studying this chapter, you should be able to: Define and identify the different classification of receivables. Explain the initial recognition, initial measurement, subsequers measurement, financial statement presentation and derecognition of receivables. Explain the accounting of discounts and freight and how will it affea receivables account. 4. Apply the different methods of accounting for bad debts. Explain and identify the different methods of receivable financing. 6._Calculate the correct balances of receivables and r d RECEIVABLES Receivable is a financial asset that represents a contractual right to receive cash or another financial asset from another entity. It represents the amount collectible from customers and others, most frequently arising from sale of merchandise, claims for money lent, or the performance of services. Under paragraph 108 of PFRS 15, a receivable is an entity's right to consideration that is unconditional. A right to consideration is unconditional if only the passage of time is required before payment of that consideration is due. Classification of receivables A. Astosource 1. Trade receivables - refer to claims arising from sale of merchandise or services in the ordinary course of the business operations. This includes: a. Accounts Receivable/Customer’s Accounts/Trade Debtors - these are open accounts not supported by promissory note. b. Notes Receivable - these are supported by a formal claim against another entity called promissory note, or a written order to pay at a later time called time draft. Negotiable promissory note is an unconditional written agreement to pay @ 244Chapter 10 - Loans and Receivable chapter 10 - Loans and Receivable certain sum of money on a specific or determinable date to order of the payee or to bearer. Note: Only negotiable promissory note is included as part of notes receivable. Dishonored nates receivable daes not qualify as note receivable in the statement of financial position as well as overdue notes. They are reclassified as accounts receivable together with the accrued interest. 2. Nontrade Receivables - these are receivables that arise from sources other than from sale of goods or services in the normal course of business. Examples of Nontrade Receivables Description Classification 1. | Loans to officers, shareholders, directors and employees Noncurrent if due beyond 12-months from the reporting date 2, | Advances to affiliates Long-term investment, unless collectible within one year 3. | Advances to supplier for acquisition of merchandise Current asset 4. | Accrued income receivable such as accrued dividends, rent, royalties and interest Current asset 5. | Deposits to guarantee performance or | Current asset payment to cover possible damages or losses 6. | Deposit with creditors, claims for losses | Current asset and damages 7. | Claims receivables from common | Current asset carriers for damaged or lost goods; claims against creditors for returned, damaged or lost goods 8._| Claims for tax refunds or rebates Current asset 9. | Special deposit on contract bids Normally classified as other 10. | Debit balance of creditors account that overpayments or may arise from returns and allowance noncurrent assets unless ‘ollectible within one year Current tif material, otherwise it may be netted against accounts payable with credit balance.Chapter 10 - Loans and Receivable Issue on Subscriptions Receivable Under the Securities and Exchange Commission of the United States of ‘America (USA) and Section 22.7.c of the PFRS for SME, subscriptions receivable must be netted against the Subscribed Share Capital However, under the old Statement of Financial Standards of the Philippines (SFAS), it is presented as current asset if collectible currently, otherwise it is deducted from subscribed share capital. The authors still believe the latter treatment under SFAS will be used until the Financial Reporting Standards Council addresses this matter. B. Asto Statement of Financial Position Classification 1. Current a. Trade receivables - generally classified as current because of the concept of normal operating cycle notwithstanding the period from the reporting date b. Nontrade receivables - classified as current only if they are reasonably expected to be realized in cash within 12 months after the reporting date Normal operating cycle is the period between the acquisition of materials entering into a process (or the purchase of goods for resale) and its realization in cash or an instrument that is readily convertible into cash. 2. Non-current - nontrade receivables that are not reasonably expected to be realized in cash within 12 months after the reporting date. INITIAL RECOGNITION Receivables is a financial asset and recognized simultaneously with the recognition of revenue. In recognizing the receivable and revenue, the following must be considered: ¥ Under paragraph 2 of PFRS 15, an entity shall recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. Y Under paragraph 3.1.1 of PFRS 9, an entity shall recognize a financial asset or a financial liability in its statement of financial position when, and only when, the entity becomes party to the contractual provisions of the instrument Interrelationship of Revenue, Receivable and Inventory Once an entity is permitted to recognize revenue under PFRS 15, the seller should recognize the corresponding debit as a receivable or contract asset 246Chapter 10 - Loans and Receivable and should derecognize the inventory, Conversely, the buyer should recognize the inventory and payable in its books. Other Revenue Recognition Issues Bill and hold sales A ‘bill-and-hold’ arrangement is a contract under which an entity bills a customer for a product but the entity retains physical possession of the product until it is transferred to the customer at a point in time in the future. For example, a customer may request an entity to enter into such a contract because of the customer's lack of available space for the product or because of delays in the customer's production schedules. Revenue is recognized when the customer to have obtained control of a product. A customer has obtained control when all of the following criteria are met: (a) the reason for the bill-and-hold arrangement must be substantive (for example, the customer has requested the arrangement); (b) the product must be identified separately as belonging to the customer; (c) the product currently must be ready for physical transfer to the customer; and (d) the entity cannot have the ability to use the product or to direct it to another customer. Revenue is not recognized when there is simply an intention to acquire or manufacture the goods in time for delivery. Layaway sales Layaway sales are sales where the goods are delivered only when the buyer has paid a final installment in a series of payments. Revenue from such sales is recognized when the goods are delivered, However, when experience indicates that most such sales are consummated, revenue may be recognized when a significant deposit is received provided the goods are on hand, identified and ready for delivery to the buyer. Sales to distributors or other intermediate parties Revenue from such sales is generally recognized when the control has been transferred. However, when the buyer is acting in substance as an agent, the sale is accounted as a consignment sale. Orders when payment (or partial payment) is received in advance Orders when payment (or partial payment) is received in advance of delivery for goods not presently held in inventory, for example, the goods are still to be manufactured or will be delivered directly to the customer from a third party. 247Chapter 10 - Loans and Receivable Revenue is recognized when the control of goods is transferred to the buyer, Normally, control is transferred when delivery takes place. Subscriptions to publications and similar items ‘When the items involved are of similar value in each time period, revenue is recognized on a straight-line basis over the period in which the items are dispatched. When the items vary in value from period to period, revenue is recognized on the basis of the sales value of the item dispatched in relation to the total estimated sales value of all items covered by the subscription, Installment sales Installment sales are sales under which the consideration is receivable in installments. Revenue attributable to the sales price, exclusive of interest, is recognized at the date of sale, The sale price is the present value of the consideration, determined by discounting the installments receivable at the imputed rate of interest. The interest element is recognized as revenue as it is earned using the effective interest method. Credit Card Sales Credit card is plastic card which enables the holder to obtain credit up toa predetermined limit from the issuer of the card for the purchase of goods and services. Service is usually charged ranging from 1% to 5%. ILLUSTRATION: Credit Card Sales On January 1, of the current year, Oxide sold merchandise to customers using BPI Master Card totaling 1,000,000. On January 6, BPI Master Card remitted in full the amount minus service charge of 5%. Required: Prepare all the necessary journal entries. SOLUTION: Jan.1 Accounts receivable -BPI Master Card 1,000,000 Sales Jan.6 Cash (95% x P1,000,000) 950,000 Service charge (5% x P1,000,000) 50,000 Accounts receivable - BPI Master Card 1,000,000 1,000,000 INITIAL MEASUREMENT Receivables are recognized simultaneously with the recognition of revenue under PFRS 15. Under PFRS 15 Revenue from Contract with Customers, revenue should be measured at the amount of the transaction price, while 248SE Chapter 10 - Loans and Receivable under PFRS 9 Financial Instruments, financial asset (eg., receivables) are initially measured at fair value plus transaction cost. The transaction price is the amount of consideration to which an entity expects to be entitled in exchange for transferring promised goods or { services to a customer, excluding amounts collected on behalf of third | parties (for example, some sales taxes). The consideration promised in a contract with a customer may include fixed amounts, variable amounts, or both. Upon initial recognition of a receivable from a contract with a customer, any difference between the measurement of the receivable in accordance with PFRS 9 and the corresponding amount of revenue recognized shall be presented as an expense (for example, as an impairment loss). SUBSEQUENT MEASUREMENT Receivables are subsequently measured at amortized cost using the effective interest rate method. Amortized cost is the amount at which the receivable is measured initially | minus principal repayments, plus or minus the cumulative amortization of | any difference between the initial amount recognized and the principal maturity minus reduction for impairment or uncollectibility. The amortized cost is also mentioned under PFRS 9 as the gross carrying amount of the asset less allowance for expected credit loss. For short-term receivable, the amortized cost is normally its net realizable value. SHORT-TERM RECEIVABLES INITIAL MEASUREMENT: SHORT-TERM RECEIVABLES Short term receivables with no stated interest rates can be measured initially at transaction price (eg, invoice price) when the effect of discounting is immaterial. Financing Element As provided under paragraph 60 of PFRS 15, an entity shall adjust the promised amount of consideration for the effects of the time value of money if the timing of payments agreed to by the parties to the contract (either explicitly or implicitly) provides the customer or the entity with a significant benefit of financing the transfer of goods or services to the customer. However under paragraph 63 of PFRS 15, asa practical expedient, an entity need not adjust the promised amount of consideration for the effects of a significant financing component if the entity expects, at contract inception, that the period between when the entity transfers a promised good or 249Chapter 10 - Loans and Receivable service to a customer and when the customer pays for that good or service will be one year or less. Trade Discount/ Volume Discount/ Quantity Discount Trade discounts are given to encourage prospective customers to buy the goods in large quantities. These discounts are deducted from the list price tp arrive at the invoice price and are never recognized in the accounting record since amount recorded is based on the sales invoice. Note: Sales (revenue) and related receivables are always recorded net of trade discounts, which is the same with the transaction price. Cash Discount / Settlement Discount Cash discounts are reductions from invoice price as an inducement for prompt payment of an account within the discount period (e.g. 2/10, n/30), This is also called sales discount from the point of view of the seller, while jt is termed as purchase discount from the point of view of the buyer. 1) Gross price method - sales and receivables are recorded at the gross amount. Sales discounts taken by customers are debited to the Sales Discounts account which is reported as a reduction of sales. This is considered to be more practical than the net method. Note: Discount is computed based on invoice price, not including the freight paid by the seller. 2) Net price method - sales and receivables are recorded at the net amount. Sales discounts not taken by customers are credited to the Sales Discounts Forfeited (discounts not taken) account, which is reported in the “other income” line item of the statement of comprehensive income. This method is considered to be theoretically correct since the receivable and sales are recorded using the cash price equivalent. Allowance method - account receivable and sales are recorded at gross amount and a corresponding allowance for sales discount is recorded, Journal Entries: Gross and Net Method Gross Method ___Net Method To record sales: Accounts receivable Accounts Sales (invoice price) | Sales (invoice price 3 To record sales return: Sales return (invoice Sales return (invoice price) _| price - sales discount) Accounts receivable | Acc¢Chapter 10 — Loans ang Receivaby To record collec 7 e [cash ‘Within the discount period: Sales discount — [ Cash Tex [| Accounts receivable |_| 0a |_Aced ceivable_|_ Po iscount period: Cash [ooo | | __ Sales discount forfeited 1K ‘Accounts receivable |_| xxx ILLUSTRATION: Gross vs Net Method Naragsak Company entered into the following during the year: Jan.02 Sold 10,000 units of merchandise to Rex Company at a selling price of F100 with terms of 2/10, 1/20, n/30. Jan.04 Sold 15,000 units of merchandise to Zeus Company at a selling price of P100 with terms of 2/10, 1/20, n/30. Jan.06 — Rex returned 2,000 units of goods to the company. Jan.10 Rex paid his account availing of the cash discount. Feb.02 Zeus Company paid his account. Required: Prepare all the necessary entries assuming the company used: 1. Gross Method 2, Net Method SOLUTION: Journal entries: Gross Method Date ‘Account title Debit | Credit ‘Accounts Receivable 7,000,000 po Sales 1,000,000 Tccounts Receivable 7,500,000 Jan. 04 Sales I Sales Return 200,000 Jan. 06 “Accounts Receivable 200,000 [——— 784,000, as 000 x 2%) 16,000 10 [Sales Diseount (P8004 |__16000| is “ ccounts Receivable 800,000 — 1,500,000 Cash ple aa Feb. 02 ‘Accounts Recelval 500,000, few 251Gredit Jan. 04 980,000 Jan. 06 1,470,000 196,000 Jan. 10 | 196,000 | 784,000 Feb. 02, Sales Discount Forfeited PL 1,500,000 ccounts Receivable 5M -P1.470,000) | 30,000 70,000 COMPARISON Li Gross Net Sales Method rere Less: discount *2-500,000 2,460,000 ales return, 000 Net sales —200,000_ 196,060. Add: Sales discount forfeited 2,284,000 2,254,000 Net effect on income at — 30,000 —2,284,000 Notes: _ ¥ Both method uses the thebottom line, sales return account and result into the same effect in v ee gross method uses the sales discount account when discount is v 7 only te net method uses the sales discount forfeited account when discount Freight Charge Terms related to freight charge 1) FOB- means either ‘Free on Board’ or ‘Freight on Board’ 2) FOB Destination - means ownership of the goods will be transferred to the buyer only upon the receipt of goods at the point of destination FOB Shipping Point - means ownership of the goods will be transferred upon shipment of the goods by the seller to the buyer Freight Collect - means that the freight charge on the goods shipped is not yet paid by the seller and the common carrier shall collect the same from the buyer 3 4 252\ a chapter 10 - Loans and Receivable 5) Freight Prepaid - means that the freight charge on the goods shipped was already paid by the seller Formula for the computation of net collection or payment: Invoice price of merchandise sold or purchased Less: Invoice price of merchandise returned Net invoice price Less: Sales or Purchase discount if collection or payment is within the discount period (% x Net invoice price above) Net collection or payment before freight Less: Freight under FOB Destination, freight collect ‘Add: Freight under FOB Shipping Point, freight prepaid Total Net Cash Collection or Payment ER XBR FREE Note: ¥ Ifthe terms are FOB Destination, freight prepaid and FOB shipping point, freight collect; the total net cash collection or payment is not affected by the freight because it was paid by the appropriate parties. Summary Journal Entries - Accounting For Freight SELLER FOB destination, Freight prepaid BUYER Freight out _ No journal entry Cash | 300 FOB destination, Freight collect Freightout [xx [ ‘Accounts payable [hoo iccounts receivable | tmx | Cash L point, Freight collect Notes: ¥ Ifthe term is FOB Destination, the seller will record freight-out. If the term is FOB Shipping Point, the buyer will record a freight-in. Freight-out is also called cartage-out, transportation-out and delivery expense. Freight-in is also called cartage-in and transportation-in. 253‘Chapter 10 - Loans and Receivable | ¥_ Summary table for freight: Freight Terms Buyer FOB Destination | Freight collect__| Reduction of A/P Freight prepaid No effect FOB Shipping | Freight collect No effect Point Freight prepaid __| Addition to A/P ILLUSTRATION: Freight Terms Assume the following data for Nafoolish Company: List price of the merchandise sold 200,000 Trade discount 10, 20 Sales discount 3/10, 2/15, nyay Invoice price of the merchandise returned on Jan. 8 P10,000 Date of sale January 5 Date collected January 20 Freight cost 2,000 Assume the following freight terms: Case No. 1: FOB destination point, freight prepaid Case No. 2: FOB destination, freight collect Case No. 3: FOB shipping point, freight collect Case No. 4: FOB shipping point, freight prepaid Required: Using the above independent cases: 1. Prepare the journal entries for the freight both on the part of the buyer and seller. 2. Compute for the net cash collection on January 20. SOLUTION: CASE NO. 1: FOB destination point, freight prepaid Requirement No. 1 SELLER. Requirement No. 2 Invoice price of merchandise sold (P.200,000 x 90% x 80%) put Less: Invoice price of merchandise returned — Net invoice price PI3te Less: Sales discount (2% x 134,000) be Total cash collection a 254re” Th chapter 10 - Loans and Receivable i CASE NO. 2: ion, freight collect [ BUYER ‘Accounts payable | P2,000 | Cash | 2,000 Requirement No. 2 invoice price of merchandise sold (P200,000 x 90% x 80%) 144,000 Less: Invoice price of merchandise returned 10,000 Net invoice price Pi34,000- Less: Sales discount (2% x P134,000) 2,680 Collection before freight 131320" Less: Freight under FOB Destination, freight collect 2,000 Total net cash collection 129,320 CASE NO. 3: FOB shipping point, freight collect Requirement No. 1 es | No journal Freight-in [2,000 | Cash t | P2,000 Requirement No. 2 Invoice price of merchandise sold 144,000 (P200,000 x 90% x 80%) Less: Invoice price of merchandise returned 10,000 Net invoice price P134,000 Less: Sales discount (2% x P134,000) Total cash collection CASE NO. 4: FOB shipping point, freight prepaid Requirement No.1 ~____SELLER___[ Buyer Accounts receivable _| 2,000 | | Freight-in [20007 r = EX ‘Accounts payable | [2,000 Requirement No. 2 Invoice price of merchandise sold (P200,000 x 90% x 80%) P144,000 Less: Invoice price of merchandise returned 10,000 Net invoice price 134,000 2,680 Less: Sales discount (2% x P134,000) Collection before freight 131,320 255Chapter 10 - Loans and Receivable y Add; Freight under FOB shipping point, freight prepaid 2,000 Total cash collection P133,320 2133.32" Synthetic FOB Destination Synthetic FOB Destination is a shipping term in which a consumer products entities may ship goods "FOB shipping point” but have arrangements with their customers under which the seller continues to bear risk of loss or damage (either explicitly or implicitly) that is not covered by the carrier while the product is in transit. Accounting Treatment This arrangement may give rise to two performance obligations: (1) sale of a product and (2) protection against the risk of loss during transit, Instead of deferring all revenue recognition, consumer products entities would need to allocate the transaction price to each identified performance obligation and assess the satisfaction of each performance obligation separately, In those cases, revenue recognition could be accelerated depending on the determination of when control related to the underlying performance obligations is transferred. Maritime shipping terms (Incoterms) 1) Free alongside (FAS): A trade term requiring the seller to deliver goods to a named port alongside a vessel designated by the buyer. The buyer has to bear all costs and risks of loss of or damage to the goods from that moment it has been placed alongside the vessel. Cost and freight (CFR): A trade term in which the seller must pay the costs and freight necessary to bring the goods to the named port of destination. The title and risk of loss of or damage to the goods shall pass to the buyer after the goods have been delivered on board the vessel. 3) Cost, insurance and freight (CIF): A trade term which is the same with CFR but in addition, the seller is required to procure marine insurance during carriage. ip: A trade term in which the seller bears all expenses and risk of loss until the goods are unloaded up to the port of destination at which time title and risk of loss shall pass to the buyer. 2) SUBSEQUENT MEASUREMENT: SHORT TERM RECEIVABLES Short-term receivables are subsequently measured at their net realizable value. The net realizable value may be determined as follows: Face Value XxX Less: Allowance for doubtful accounts (XX) Allowance for sales returns (XX) Net Realizable Value XX 256Yr Chapter 10 - Loans and Receivable Methods of Accounting for Bad Debts 1) Direct write-off (tax): When a specific account is ascertained or proven 2) to be uncollectible (which may not occur in the period of sale), Bad Debt Expense is debited and Accounts Receivable iscredi This method is theoretically undesirable because it: a) Makes no attempt to match revenues and expenses; b) Does not result in receivables being stated at net realizable value in the statement of financial position. Allowance method (GAAP): At the end of each accounting period, an estimate is made of expected losses from uncollectible accounts. This estimate is debited to Bad Debt Expense and credited to the Allowance for Doubtful Accounts. This method is justified because a company has incurred a loss the moment customers receive goods or services that they will never pay for. This is true even if the specific identity of such customers will not be known for some time. Comments: Matches cost against revenue and receivable would be properly measured at net realizable value. Methods of estimating bad debt expense under the allowance method 1) Percentage of Sales (Income Statement Approach): Bad debt 2 3 expense is estimated directly by multiplying a percentage to a sales account (e.g. credit salesftiet credit sal@net sales, gross sales). Advantage: Proper matching of cost against revenue is achieved. Argument: Accounts receivable may not be shown at estimated realizable value because the allowance for doubtful accounts may prove excessive or inadequate. Percentage of A/R (Balance Sheet Approach) a) First, the required ending balance in the Allowance for Doubtful Accounts is estimated by multiplying a percentage (a single composite rate) times the ending outstanding receivables. ‘Then, bad debt expense is equal to the difference between the required ending balance and the existing balance in the Allowance account. Advantage: It presents accounts receivable at estimated realizable value. Itis also simple to apply. Argument: It violates matching principle and loss experience rate may be difficult to obtain and may not be reliable. Db) Aging of A/R (Balance Sheet Approach): This is the same procedure in percentage of receivables; the only difference is the percentage use for each term in the aging schedule 257Chapter 10 - Loans and Receivable Advantage: It is more accurate and scientific computation of the allowance for doubtful accounts; thus, the accounts receivable is fairly presented in the statement of financial position at net realizable value. Argument: It violates matching principle and time consuming if large number of accounts are involved. Note: ¥ Change in estimating bad debts is a change in accounting estimate, which is accounted currently and prospectively. Doubtful Accounts or Bad Debts in the SCI Doubtful account, which is also known as bad debts, impairment loss or credit losses, are classified as administrative expense in the statement of comprehensive income (SCI) since under a good internal control, the granting of credit is performed by credit department and not on the sales department. Please refer to the T-accounts of accounts receivable and allowance for bad debts in Chapter 05 Cash to Accrual. ILLUSTRATION: Different Methods of Accounting for Bad Debts Roxas Company's unadjusted trial balance at December 31 included the following accounts: Debit Cres \ Accounts receivable 1,500,000 Allowance for doubtful accounts P 40,000 Sales 10,000,000 Sales returns and allowances 700,000 The following analysis pertains to the account receivable reported in the trial balance: Classification Balance of Percentage AJR collectible 0-1 month category P 500,000 98% 1-6 months category 800,000 95% Over 6 months 200,000 80% ~P1,500,000_ Required: 1. Roxas Company estimates its bad debt expense to be 2% of net sales. Determine its bad debt expense for the year. 2. Assuming the same method of estimating bad debts in number 1, compute for the allowance for doubtful account end of the year.rr chapter 10 ~ Loans and Receivable 3, Roxas Company estimates its bad debt expense to be 5% of accounts | receivable. Compute for the allowance for doubtful account end of the ear. } 4 anne the same method of estimating bad debts in number 3, i determine its bad debt expense for the year. 1 5, Assuming the same method of estimating bad debts in number 3, il compute for the net realizable value of the accounts receivable. | 6. Roxas Company estimates its bad debt expense based on aging. Compute for the allowance for bad debts at the end of the year. 7. Assuming the same method of estimating bad debts in number 6, compute for the net realizable value of the accounts receivable. SOLUTION: Requirement No. 1 Net Sales (P10,000,000 - P700,000) P 9,300,000 i Multiply by: Percentage of uncollectible ——__2% Bad debts expense P_186,000 | Requirement No, 2 | Allowance for bad debts, beg. P 40,000 Add: Bad debts expense (No. 1) 186,000 | Recoveries - | Less: Accounts written-off sh = | Allowance for bad debts, end P_226,000 Requirement No. 3 Accounts receivable, end P 1,500,000 it Multiply by: Percentage uncollectible 5% | Allowance for bad debts - end P__75,000 | Requirement No. 4 ! Allowance for bad debts, beg. P 40,000 \ Add: Bad debts expense (squeeze) 35,000 | Recoveries : Less: Accounts written-off = | Allowance for bad debts - end P__75,000 Requirement No, 5 Accounts receivable, end P 1,500,000 Less: Allowance for bad debts - end 75,000 it Net realizable value 21,425,000 al Requirement No. 6 Required | Classification Balance } 0-1 month category (P500,000 x.02) P 10,000 1-6 months category (P800,000 x.05) 40,000 259 —Chapter 10 - Loans and Receivable Over 6 months (P200,000 x.20) 40,000 Allowance for bad debts - end P__90,000 Requirement No. 7 Accounts receivable, end P 1,500,000 Less: Allowance for bad debts - end 90,000 Net realizable value P.1,410,000 Sales Discount (PFRS 15) Under PERS 15, revenue is measured at transaction price. Transaction price is the amount of consideration to which an entity expects to be entitled in exchange for transferring promised goods or services to a customer, excluding amounts collected on behalf of third parties. The company should therefore determine on initial recognition the variable consideration by considering the discount and recognize revenue net of expected discount Hence, allowance for sales discount under PFRS 15 may not be used. ILLUSTRATION: Sales Discount Judycel Company originated a receivable of P100,000 On December 25, 2021. It is accounting its sales under the gross method. The credit term is 2/10, n/30. The entity, however, estimates that only 50% cash discounts will be availed by the customer. 60% of the customer paid on January 4, 2022. The balance was collected on January 31, 2022. Required: Prepare the journal entry to record the sale, allowance for sales discount (if any) and cash discount availed by the customer under PFRS 15. SOLUTION: 1. The journal entry to record the sales at the transaction price on December 25, 2021 is as follows: Accounts receivable 99,000 Sales [P100,000 - (?100,000 x 2% x 50%)] 99,000 On December 31, 2021, the receivable is included in the statement of financial position as follows: Accounts receivable = Net realizable value © P__99,000 2. The journal entry to record the collection of the 60% on January 4, 2022 is as follows: Cash (P100,000 x 60% x 98%) 58,800 Sales 600 Accounts receivable (?99,000 x 60%) 59,400 3. The journal entry to record the collection of the 40% on January 31, 2022 is as follows: 260 iChapter 10 - Loans and Receivable Cash 39,600 Accounts receivable (P99,000 x 40%) 39,600 Sales Return Under PFRS 15, sale with a right of return is an arrangement in which an entity transfers control of a product to a customer and also grants the customer the right to return the product for various reasons (such as dissatisfaction with the product) and receive any combination of the following: a, afull or partial refund of any consideration paid; b. acredit that can be applied against amounts owed, or that will be owed, to the entity; and c. another product in exchange. To account for the transfer of products with a right of return (and for some services that are provided subject to a refund), an entity shall recognize all of the following: (a) revenue for the transferred products in the amount of consideration to which the entity expects to be entitled (therefore, revenue would not be recognized for the products expected to be returned); (b) arefund liability; and (c) an asset (and corresponding adjustment to cost of sales) for its right to recover products from customers on settling the refund liability. In other words, an entity would recognize revenue only to the extent that it is highly probable that a significant reversal in the amount of cumulative revenue recognized will not occur when the uncertainty associated with the right of return is subsequently resolved. Pertinent journal entry would be: Cash / Accounts receivable / Contract asset XX Asset for right to recover product tobe returned XX Sales XX Refund liability XxX Therefore, allowance for sales return may not be used applying PFRS 15. ILLUSTRATION 1: Sales Return On December 31, 2021, Jimar Co. sold goods costing P100,000 and with sales price of ?150,000 to Rex, Inc. on account. To induce sale, Jimar Co. provides its buyers the right to return goods within 30 days upon purchase if the buyers are not satisfied with the goods. The company uses perpetual inventory system in recording its inventories. Required: 261Chapter 10 - Loans and Receivable | Provide all the necessary entries under PFRS 15 assum 1. Jimar Co. eliably estimate that 30% of the googs returned within the agreed period of time. On January 5, 94/4 way the goods were actually returned and the balance of ; 022 40,8 collected. 2. Jimar Co. cannot reliably estimate future returns. On Feby "rece Rs u the customer did not return any of the goods. ary 1, 229 SOLUTION: : Requirement No. 1 2021: Dec.31 Accounts receivable 105,000 Sales [P150,000 x (100%-30%)] tos 0 Cost of sales (P100,000 x 70%) 70,000 00 Asset for right to recover product to 30,000 be returned Merchandise inventory 100,099 2022: Jan.5 Cash [P150,000 - (45% x P150,000)] 82,500 Sales returns [(45%-30%) x P150,000] 22,500 Accounts receivable 105099 Merchandise inventory 45,000 Cost of sales 15,009 Asset for right to recover product to 30,000 be returned - Requirement No. 2 2021: Dec.31 Asset for right to recover product to 100,000 be returned Merchandise inventory 100,000 2022: Feb. 1 Accounts receivable P 150,000 Sales P 150,000 Cost of sales 100,000 Asset for right to recover product to be returned 100,000 Notes: Y Notice that under PFRS 15, no allowance for sales return is maintained. An entity should estimate its variable consideration and will only recognize revenue only to the extent that it is highly probable that a significant reversal in the amount of cumulative revenue recognized will not occur 262Chapter 10 - Loans and Receivable when the uncertainty associ i i il ciated with the right of return is subsequently ¥_ Revenue is recognized sit it n , , Pon ce the time period for rejecting/accepting has ILLUSTRATION 2: Right of Return yY Ci i ee aes into 200 contracts with customers. Each contract ae eel me product for P15,000. Cash is received when control as ae ee business practice is to allow a Ly used product withi i refund. CLOY’s cost of each product is P6, 000. ee Lea contract allows a customer to return the products, the variable consideratio from the customer is variable. To estimate the aetieteeere a to which the entity will be entitled, the entity decides products will not b value method and the entity estimates that 194 jot be returned (ie, 3% is expected to be returned). CLOY Company determines that although the returns are outside the ‘mating returns for this Santee e, it has significant experience in esti within a ae: class. In addition, the uncertainty will be resolved Company conch time frame (ie. the 30-day return period) Thus cLoY eee ore that a signi uncertainty i amount of revenue recognized will not ty is resolved (i.e. over the return period). ring the pr be reso icant reversal in occur as the CLOY Company estimates that the costs of recovel oriucts will be id ata profit ee and expects that the returned products ca" PASH rane foregoing data, assume the following independent ces CASENO. 1: The estimated 3% returned the goods. CASE NO. a estimated 3% did not return any goods. CASE NO. 8: The return prio has lapse CASE NO. 4: The customer returned 5% of goods. : The customer returned only 1% of the Required: Based : on th i are the jo Je foregoing data, PrePar erpett accordance wi system. e with PFRS 15 assuming the company goods. ; yurnal entries in al inventory SOLUTION: The journal entri ntries to r Hows: C ecord the sale are as fo ‘ash 3,000,000 3,910,000 90,0 aes (200 x P15,000 x 97%) fund liability (200 x P15,000 x 3%) 263Chapter 10 - Loans and Recei Asset for right to recover product to be returned (200 x P6,000 x 3%) Cost of sales (200 x P6,000 x 97%) Merchandise inventory (200 x 6,000) CASE NO. 1 Merchandise inventory Asset for right to recover product to be returned Refund liability Cash CASE NO. 2 Cost of sales ‘Asset for right to recover product to be returned Refund liability Sales CASE NO. 3 Cost of sales Asset for right to recover product to be returned Refund liability (200 x P15,000 x 3%) Sales Note that if the return period has lapsed or none is recorded. CASE NO. 4 Merchandise inventory (200 x P6,000 x 5%) Asset for right to recover product to be returned Cost of sales (200 x P6,000 x 3%) Refund liability (200 x P15,000 x 3%) Sales return Cash (200 x P15,000 x 5%) CASE NO. 5 Merchandise inventory (200 x P6,000 x 1%) Cost of sales ‘Asset for right to recover product to be returned Refund liability (200 x P15,000 x 3%) Cash (200 x P15,000 x 1%) Sales 264 36,000 1,164,000 36,000 90,000 36,000 90,000 36,000 90,000 ae aes Of the cr ‘goods, the refund liability is transferred to revenue and con seormer Pet 60,000 90,000 60,000 12,000 24,000 90,000 1.200094 36,009 90,009 36,009 0,000 36,000 90,000 med the Tesponding cost of sales 36,000 24,000 150,000 36,000 30,000 60,000Chapter 10 ~ Loans and Receivable AUDIT OF A/R AND RELATED ACCOUNTS Guide questions in the audit of A/R and related accounts: Ifanswer Scenario 1: is: Then, “Was there a valid sale? Yes — Was the sale recorded? Yes —_Noadjusting entry Were the inventories excluded in the count? Yes _Noadjusting entry Ifanswer — Scenario 2: is:___Then, Was there a valid sale? Yes Accounts receivable x Was the sale recorded? No Sales x Were the inventories Cost of sales x excluded in the count? No Mdse. inventory x Ifanswer Scenario 3: is:___Then, Was there a valid sale? None Was the sale recorded? No Noadjusting entry Were the inventories excluded in the count? No___Noadjusting entry Ifanswer Scenario 4: is: ___ Then, Was there a valid sale? None Sales x Was the sale recorded? Yes Accounts receivable xx ‘Were the inventories Mdse. inventory x excluded in the count? Yes Cost of sales xx ILLUSTRATION You are engaged to perform an audit of the accounts of the Marianne Co. for the year ended December 31, 2021 and have observed the taking of the physical inventory of the company on December 30, 2021. Only merchandise shipped by the Marianne Co. to customer up to and including December 30, 2021 has been eliminated from inventory. The inventory as determined by physical inventory count has been recorded on the books by the company's controller. No perpetual inventory records are maintained and all sales are made on an FOB shipping point basis. You are to assume that all other data not presented herein are correct. 265Chapter 10 - Loans and Receivable The following lists of sales invoices are entered in the sales books for the months of December 2021 and January 2022, respectively. December 2021: Cost of Sales invoice SalesInvoice Merchandise Date Amount Date Sold Shipped A. P 30,000 December 20 P 20,000 December 31, 2021 B. 20,000 December 31 8,000 November 8, 2021 C 10,000 December 29 6,000 December 30, 2021 D. 40,000 December 31 24,000 January 4, 2022 E 100,000 December 30 56,000 December 29, 2021 (shipped to consignee) January 2022: BR P 60,000 December 20 P 40,000 December 30,2021 G. 40,000 January 5 23,000 January 3, 2022 H. 80,000 January 4 55,000 December 31, 2021 Required: Prepare the necessary adjusting entries on December 31, 2021 in connection with the foregoing data. SOLUTION: Use the following guide questions: 1. Was there a valid sale? 2. Was the sale recorded? 3, Were the inventories excluded in the count? (Y-Yes; N-No) AYYN Cost of Sales P 20,000 Merchandise inventory-end P 20,000 B.YYY —_ Noadjusting journal entry C.YYY — Noadjusting journal entry D.NYN Sales 40,000 Accounts receivable 40,000 E.NYY Sales 100,000 Accounts receivable 100,000 Merchandise inventory-end 56,000 Cost of Sales 56,000 F.YNY Accounts receivable 60,000 Sales 60,000 266YS Chapter 10 - Loans and Receivable G.NNN No adjusting journal entry H.YNN Accounts receivable 80,000 Sales 80,000 Cost of Sales 55,000 Merchandise inventory-end 55,000 LONG-TERM NOTES RECEIVABLE Tong-term notes receivable may be classified as interest bearing and non- interest bearing. Interest bearing note may be further classified into two, with realistic and unrealistic interest rates. INITIAL MEASUREMENT: LONG-TERM NOTES RECEIVABLE A. Interest Bearing Notes Receivable - With Realistic Interest Rate Interest bearing notes with realistic or reasonable interest rate is initially measured at its fair value, which is equal to its face value. Interest Bearing Notes Receivable - With Unrealistic Interest Rate Interest bearing notes with unrealistic rates are discounted using the imputed interest rate that approximates the market rate of interest for the same note. Unrealistic Interest Rates - interest bearing note with a nominal rate which is significantly different from prevailing interest rate for similar notes or when the notes face value is significantly different from market value of the consideration given up on exchange for the note. Note: Discount on note receivable is same as unearned finance charge or unearned interest income. The discount or premium is amortized over the term of the note using the effective rate method. Premium amortization is a reduction of interest income while discount amortization is an addition. i. One-time collection PV of Principal (PrincipalxPVO1) ¥X of the principal Add: PV of interest (Principal x nominal rate x PVOA) aa PV of Notes Receivable eS ii, Uniform collection 1st collection (Principal + interest) *_ of the principal at —PVO1 after one period] the end ofeach year Nth collection [(Principal + interest) x x PVO1 after nth period] a PV of Notes Receivable ~~ Legend: PV - Present value PVO1 - Present value of 1 PVOA ~ Present value of ordinary annuity 267chapter 10 - Loans and Receivable ( Non-Interest Bearing Notes Receivable/Zero-Interest Bearing Non-interest bearing note is discounted to arrive at the fair value OF the present value of future cash flows using the prevailing market rate g interest for the similar receivables. This is a classic example applicable of substance over form. In determining the fair value of non, interest bearing notes, the following rules should be applied jy determining the present value (PV): | 4, Periodic payment (with available cash price) PV = Cash price equivalent | 2, One-time collection of principal (no available cash price) PV = Face value x PV of 1 3. Annual uniform collection of principal at the end of year (no | available cash price) | PV = Periodic collection x PV of Ordinary Annuity 4, Annual uniform collection of principal at the start of year (no | available cash price) | PV = Periodic collection x PV of Annuity Due SUBSEQUENT MEASUREMENT: LONG-TERM NOTES RECEIVABLE | Long-term notes receivable is subsequently measured at amortized cost | using effective interest method. A. Interest Bearing Notes Receivable - With Realistic Interest Rate | Its amortized cost is equal to its face value. The nominal interest rate | and effective interest rate in this case is the same. (try computing the | present value using the nominal rate, you will be shookt that the present) value will equal to its face value @) B. Interest Bearing Notes Receivable - With Unrealistic Interest Rate Amortized cost using the imputed interest rate that approximates the market rate of interest for the same receivables. C. Non-Interest Bearing Notes Receivable/Zero-Interest Bearing Amortized cost using the imputed interest rate that approximates the market rate of interest for the same receivables. The amortized cost for interest bearing note can be computed as follows: Face amount XX ‘Add: Premium on notes receivable XK Less: Discount on notes receivable ox) Loss allowance (XX) Amortized cost, xx” Note: The interest rate used in computing the initial value of the receivable is the rate to be used in amortizing the receivable. 268Chapter 10 - Loans and Receivable ILLUSTRATION: Interest-Bearing Note With Realistic Interest Rate On January 1, 2021, Florendo Co, sold a machine with a cost of P500,000 and accumulated depreciation of P350,000 to Gregorio Co. In lieu of cash payment, Gregorio gave Florendo a 4-year, 100,000, 10% note. The note requires interest to be paid annually on December 31. The 10% interest rate is a realistic rate of interest for a note of this type. Required: Compute for the following as of December 31, 2021: a. Effective interest rate b. Gain or loss on sale of machinery c. Interest income d. Current portion of the Notes Receivable e. Noncurrent portion of the Notes Receivable 2. Prepare all the necessary entries in 2021. SOLUTION: Requirement No. 1a The effective interest rate and nominal rate of a note with a realistic interest rate and on the assumption that no transaction cost is incurred is the same. The present value of the note on January 1, 2021 using 10%, which is the nominal and effective rate, is as follows: Present value of principal (100,000 x 0.6830) P 68,301 Add: Present value of interest (P100,000 x 10%x3,1699( _31,699_ Present value of note receivable 100,000 If we compute the present value on December 31, 2021 using 10% @ n=3years, you will also come up with a present value equal to the face value. Give ita try! ©. Note that effective interest rate is also known as internal rate of return (IRR). Requirement No. 1b Net selling price = PV of principal and interest = face value P 100,000 Less: Carrying amount of machinery Cost 500,000 Less: Accumulated depreciation 350,000 150,000. Loss on sale 50,000. Requirement No. 1¢ Interest income (P100,000 x 10%) = P10,000 269Chapter 10 - Loans and Receivable Requirement No. 1d Zero, since no principal amount is collectible within one year from the reporting date. Requirement No. 1e The entire principal amount of notes receivable of P100,000 is to be presented as noncurrent asset since it is collectible beyond one year from the reporting date. Requirement No. 2 Journal entries for 2021 are as follows: Jan.1 Notes receivable P100,000 Accumulated depreciation 350,000 Loss on sale 50,000 Machinery Dec.31 Cash 10,000 Interest income P500,000 10,000 ILLUSTRATION: Interest-Bearing Note With Unrealistic Interest Rate, One-Time Collection of Principal On January 1, 2021, Gregorio Co. sold a machine with a cost of P500,000 and accumulated depreciation of P350,000 to Florendo Co. In lieu of cash payment, Florendo gave Gregorio a 4-year, P100,000, 10% note. The note requires interest to be paid annually on December 31. The prevailing rate of interest for a note of this type is 16%. Required: 1. Compute for the following as of December 31, 2021: a. Gain or loss on sale of machinery. b. Interest income c. Current portion of the Notes Receivable d. Noncurrent portion of the Notes Receivable 2. Prepare all the necessary entries in 2021. SOLUTION: Requirement No. 1a Net selling price: Present value of principal (P100,000 x .5523) P 55,230 Add; Present value of interest (P100,000 x 10% x 2.7982) ___ 27,982 Less: Carrying amount of machinery Cost P 500,000 Less: Accumulated depreciation 350,000 Loss on sale 270chapter 10 ~ Loans and Receivable Chapter 10 - Loans and Receivable amortization table: Interest —_ Interest Discount Present Date Collection Income _ Amortization value 01/01/2024 P 83,212 12/31/2021 P10,000 13,314 73,314 86,526 42/31/2022 10,000 13,844 3,844 90,370 12/31/2023 10,000 14,459 4,459 94,829 12/31/2024 __10,000 15,173 5171 100,000 Notes: ¥ Interest income = Beginning balance of present value x effective interest rate V Present value 2"! year = Present value end of 1* year minus premium, amortization plus discount amortization. ¥ Ifthe principal amount of the note is collectible within one year, the entire carrying amount will be presented as current assets; otherwise, it will be presented as noncurrent assets. Requirement No. 1b Interest income = P13,314 (see amortization table above) Requirement No. 1c Zero, since no principal amount is collectible within one year from the reporting date. Requirement No. 1d The entire amortized cost of P86,526 (see amortization table above) is to be presented as noncurrent asset since it is collectible beyond one year from the reporting date. Requirement No. 2 Journal entries for 2021 are as follows: Jan.1 Notes receivable 100,000 Accumulated depreciation 350,000 Loss on sale 66,788 Machinery 500,000 Unearned interest income (P100,000-P83,212) 16,788 Dec.31 Cash 10,000 Interest income 10,000 Unearned interest income 3,314 Interest income 3,314 271Chapter 10 - Loans and Receivable ILLUSTRATION: Interest-Bearing Note With Unrealistic Interest Rate, Interest is Payable Semi-Annually, One-Time Collection of Principal On January 1, 2021, Teofilo Co. sold a machine with a cost of P500,000 anda carrying value of P150,000 to Candido Co. In lieu of cash payment, Candido gave Teofilo a 4-year, 100,000, 10% note. The note requires interest to be paid semi-annually every June 30 and December 31. ‘The prevailing rate of interest for a note of this type is 16%. Required: 1. Compute for the following as of December 31, 2021: a. Gain or loss on sale of machinery. b. Interest income. c. Current portion of the Notes Receivable. d. Noncurrent portion of the Notes Receivable. 2. Prepare all the necessary entries in 2021. SOLUTION: Requirement No. 1a Net Selling Price: Present value of principal (P100,000x.5403) 54,030 Add: Present value of interest (P100,000 x 5% x 5.7466) 28,733 P 82,763 Less: Carrying amount of machinery 150,000 Loss on sale (67,237) Amortization table: Interest Interest Discount Present Date Collection _Income _ Amortization value - 01/01/2021 , even 5,000 6,621 1,621 84,384 12/31/2021 5,000 6,751 1,751 86,135 06/30/2022 5,000 6,891 1,891 88,026 12/31/2022 5,000 7,042 2,042 90,068 06/30/2023 5,000 7,205 2,205 92,273 12/31/2023 5,000 7,382 2,382 94,655 06/30/2024 5,000 7572 2,572 97,227 12/31/2024 __5,000 1778 2,773 100,000 Note: Y Since the interest of the note is payable semi-annually, the present value factor to be used in computing for the total present value is 8% for 8 semi- annual periods (4 years x 2), both for the principal and interest. Requirement No. 1b Interest income (P6,621 + P6,751) = P13,372 (see amortization table above) 272__ Chapter 10 - Loans and Receivable Requirement No. 1c Zero, since no principal amount is collectible within one year from the reporting date. Requirement No. 1d The entire amortized cost of 86,135 (see amortization table above) is presented as part of noncurrent asset since it is collectible beyond one year from the reporting date. As an alternative, the non-current portion can also be determined using the following: Principal collectible beyond one year 100,000 Less: Unearned interest income (17,237 - P3,372) 13,865 Carrying amount of notes receivable P_86,135 Requirement No. 2 Journal entries for 2021 are as follows: Jan.1 Notes receivable ? 100,000 Accumulated depreciation 350,000 Loss on sale 67,237 Machinery P 500,000 Unearned interest income (P100,000 - P82,763) 17,237 June 30 Cash 5,000 Interest income 5,000 To record interest collection Dec.31 Cash 5,000 Interest income 5,000 To record interest collection Unearned interest income (P1,621 + 1,751) 3,372 Interest income 3,372 To record amortization of discount ILLUSTRATION: Interest-bearing Note With Unrealistic Interest Rate, Uniform Collection of Principal On January 1, 2021, Candido Co. sold a machine with a cost of PS00,000 and carrying value of P150,000 to Teofilo Co. In lieu of cash payment, Teofilo Gave Candido a 4-year, P100,000, 10% note. The note requires interest to be paid annually on December 31. The prevailing rate of interest for a note of this type is 16% and the principal amount of the note is to be paid in four equal annual installments of P25,000 every December 31. Required: 273Chapter 10 ~ Loans and Receivable + Compute for the following as of December 31, 2021: a. Gain or loss on sale of machinery. b. Interest income ¢. Current portion of the Notes Receivable d. Noncurrent portion of the Notes Receivable 2. Prepare all the necessary entries in 2021. SOLUTION: Requirement No. 1a Net selling price = Present value of N/R P 88733 Less: Carrying amount of machinery 150,000 Loss on sale P6126, Present value of notes receivable: Interest. Total Present Principal collection collection PVof1 Value Date ) @) C=A+B D E=Cxp 12/31/2021 P25,000 P10,000 P35,000 0.8621 30,172 12/31/2022 25,000 7,500 32,500 0.7432 24,153 12/31/2023 25,000 5,000 30,000 0.6407 19,220 12/31/2024 25,000 2,500 27,500 0.5523 15,188 Total present value of notes receivable P88,733 Amortization Table Interest Interest Amorti- Principal Present Date Collection Income zation Collection value 01/01/2021 P88,733 12/31/2021 10,000 14,197 4,197 25,000 67,930 12/31/2022 7,500 10,869 3,369 25,000 46,299 12/31/2023 5,000 7,408 2,408 25,000 23,707 12/31/2024 2,500 3,793 1,293 25,000 7 Requirement No. 1b Interest income = P14,197 (see amortization table above) Requirement No. 1c Principal collectible within one year P 25,000 Less: Discount amortization 3,369 Current portion of notes receivable P_21,631 Requirement No. 1d Principal collectible beyond one year (P25,000x2) P 50,000 Less: Discount amortization (P2,408 + 1,293) 3,701 Non-current portion of notes receivable P_ 46,299 274chapter 10 - Loans and Receivable Requirement No, 2 Journal entries for 2021 are as follows: Jan. 1 Notes receivable : P 100,000 ccumt ‘iatic 7 i mulated depreciation 350,000 Machinery ouee7 Pp: Unearned interest income (P100,000 - P88,733) sae Dec.31 Cash Notes receivable =m Interest income ieee Unearned interest income 4,197 : Interest income " 4,197 ILLUSTRATION: Noninterest-bearing Note, One-ti i Praia ty 2, One-time Collection of On January 1, 2021, Rosenio Co, sold a machine to Rose Co. In lieu of cash payment, Rose gave Rosenio a 5-year, P500,000 note. The machinery has a cost of P500,000 and accumulated depreciation as of January 1, 2 P150,000. mh eek ot The note is a non-interest bearing note and the prevailing rate of interest for anote of this type is 10%. Required: 1. Compute for the following as of December 31, 2021: a. Gain or loss on sale of machinery. b. Interest income c. Current portion of the Notes Receivable d. Noncurrent portion of the Notes Receivable 2. Prepare all the necessary entries in 2021. SOLUTION: Requirement No. 1a ; esent value of principal Net Selling price = Pr (P500,000x6209) 310,450 x ount of mach jinery i cae amou! te Less: Accumulated depreciation —150,000___350,000_ Loss on sale P39,550) jon Table Amortizatioe Tal interest income Frezentvalue ate P310,450 01/01/2021 275Chapter 10 ~ Loans and Receivable 12/31/2021 P31,045 12/31/2022 34,150 12/31/2023 37,565 4139 12/31/2024 41,321 45, 45 12/31/2025 45,453 500,004 Requirement No. 1b Interest income = P31,045 (see amortization table above) Requirement No. 1c Zero, the entire note receivable is collectible beyond one year, Requirement No. 1d The entire P341,495 (see amortization table above) is presented ag noncurrent asset since it is collectible beyond one year from the a date. Requirement No. 2 Journal entries for 2021 are as follows: Jan.1 Notes receivable 500,000 Accumulated depreciation 150,000 | Loss on sale 39,550 | Machinery P500,009 | Unearned interest income (P500,000 - 310,450) 189.555 Dec.31 Unearned interest income 31,045, | Interest income 31,045 | ILLUSTRATION: Noninterest-bearing Note, Uniform Collection | Principal On January 1, 2021, Ronaldo Co. sold a machine with a cost of 500,000 ani carrying value of P350,000 to Ron Co. In lieu of cash payment, Ron gue | Ronaldo a 3-year, P600,000 note. The note is a non-interest bearing note and the prevailing rate of interest fr a note of this type is 14% and the principal amount of the note is to be pail in three equal annual installments of P200,000 every December 31. Required: 1. Compute for the following as of December 31, 2021: a. Gain or loss on sale of machinery. b. Interest income. c. Current portion of the Notes Receivable. d. Noncurrent portion of the Notes Receivable. 2. Prepare all the necessary entries in 2021. SOLUTION: 276__ a | Chapter 10 - Loans and Receivable i Chapter 10 — Loans Tee Requirement No. 1a Net selling price (P200,000 x 2.3216) 464,320 Less: Carrying amount of machinery 350,000 Gain on sale P114,320 Amortization Table Annual Interest Present Date Collection __Income _ Amortization _value 01/01/2021 464,320 12/31/2021 200,000 —P65,005 134,995 329,325 12/31/2022 200,000 46,105 153,895 175,430 12/31/2023 200,000 24,570 175,430 : | Notes: ¥ Annual collection = periodic payment Interest income = Beginning balance of present value x effective interest rate = (P464,320 x 14%) SHORTCUT FORMULA: ¥ Present value of the next period end may be computed as follows: [Present value beginning x (1+effective interest rate)] - total annual collection of interest and principal - accrued interest ¥ Example: Using the previous amortization table, the present value of the note for years 2021 to 2023 is computed as follows: 1) PVend of 12/31/2021 = [(P464,320 x 1.14) - P200,000] = 329,325 2) PV end of 12/31/2022 = [(P329,325 x 1.14) - P200,000] = P175,430 3)_PV end of 12/31/2023 = [(P175,430 x 1.14) - P200,000) = 0 Requirement No. 1b | Interest income = P65,005 (see amortization table above) \ Requirement No. 1¢ H Principal collection next year TS Less: Amortization of discount / UII ise Current portion of notes receivable ee Requirement No. 14 Principal collectible beyond one year P aes Less: Amortization of discount / UII aan Non-current of notes receivable ee Requirement No, 2 Journal entries for 2021 are as follows: Jan. Notes receivable 600,000 Accumulated depreciation 150,000 Gain on sale 114,320 277—= | Chapter 10 ~ Loans and Receivable Machinery 500,000 Unearned interest income (P600,000 - 464,320) 135,680 Dec.31 Cash 200,000 Notes receivable 200,000 Unearned interest income 65,005 Interest income 65,005, ILLUSTRATION: Noninterest Bearing Note Periodic Payment and With Available Cash Price On January 1, 2021, Jasmin Co. sold a machine to Tabs Co. In lieu of cash payment, Tabs gave Jasmin a 3-year, P300,000 note. The machinery has a cost of P500,000 and accumulated depreciation as of January 1, 2021 of 200,000. The machinery has a cash price of P288,000. The note is a non-interest bearing and payable in three equal annual installments of P100,000 every December 31 beginning December 31, 2021. Required: 1. Compute for the following as of December 31, 2021: a. Gain or loss on sale of machinery. b. Interest income. c. Current portion of the Notes Receivable. d. Noncurrent portion of the Notes Receivable. | 2. Prepare all the necessary entries in 2021. SOLUTION: Requirement No. 1a Net Selling price = Cash price 288,000 Less: Carrying amount of machinery Cost 500,000 Less: Accumulated depreciation ___ 200,000 __300,000_ Loss on sale Using trial and error, the effective interest rate of the transaction is 2%, (Please refer to subsequent discussion in this chapter regarding interpolation). Amortization Table Annual Interest Date Collection __ Income _ Amortization 01/01/2021 288,000 12/31/2021 P100,000 P 5,760 p 94240 193,760 12/31/2022 100,000 3,875 96,125 97,635 12/31/2023 100,000 1,953 98,047 278Ye Chapter 10 - Loans and Receivable ‘sue to rounding-off. Requirement No. 1b Interest income = 25,760 (see amortization table above) Requirement No. 1c Principal collectible in 2022 100,000 Less: Amortization of discount / UII Current portion of notes receivable Requirement No. 1d Principal collectible in 2023 P 100,000 Less: Amortization of discount / UII 1,953 Noncutrent portion of notes receivable P 98,047 Observe the amount highlighted in the table. The carrying value of the note on December 31, 2021 is broken down as follows: Current portion of Notes receivable P 96,125 Non-current portion of Notes receivable 98,047 Carrying value - 12/31/2021 P193,760 Requirement No. 2 Journal entries for 2021 are as follows: Jan.1 Notes receivable 300,000 Accumulated depreciation 200,000 Loss on sale 12,000 Machinery 500,000 Unearned interest income (P300,000 - 288,000) 12,000 Dec.31 Cash 100,000 Notes receivable 100,000 To record collection of 100,000 notes receivable Unearned interest income 6,000 Interest income 6,000 To record amortization of interest Computation of periodic collection Traditionally, the principal of the loan is paid uniformly while the interest is based on the beginning outstanding loan. Hence, the principal is fixed and the interest is variable. However, nowadays, the total repayment of the loan is normally uniform and it includes payment of both the principal and the interest. In this case, repayment applicable to the principal and interest varies. 279Chapter 10 ~ Loans and Receivable Some problems will require computation of the uniform annual collection for the notes receivable when such notes are compounded. The formula for the annual collection is: Present value of the notes Annualcollection = : | PV of ordinary annuity or annuity due_| In actual practice, the more common frequency of payment is monthly. To compute for monthly collection, simply change the present value factor in months. ILLUSTRATION: Computation of Annual Payment or Collection On january 1, 2021, Jayzel Company sold an inventory to Joyce Company for 2,000,000. Anote was received in exchange for the product which provides that four equal annual installments will be made every December 31, Starting December 31, 2021. The effective rate of the notes receivable which is compounded annually is 10%. Required: Compute for the: 4. Annual collection. 2. Interest income in 2021. Case No. 1: Based on the given data. Case No. 2: Assume instead that the first payment is made on January 1, 2021. SOLUTION: CASE NO. 1 Requirement No. 1 Present value of the notes for 4 periods ‘Annual collection © = +——pyofordinary ann Annual collection = P2,000,000/3.1699 = 2630,935 Requirement No. 2 Interest income (10% x P2,000,000) = 200,000 CASE NO. 2 Requirement No. 1 : . Present value of the notes Annual collection = PV of annuity due for 4 periods ‘Annual collection = ?2,000,000/3.4869 = B573,575 Requirement No. 2 Interest income [10% x (P2,000,000 - 573,575)] = P142,642 280 -—- Chapter 10 - Loans and Receivable LOAN RECEIVABLE For banks and other financial institutions, loans receivable arises from loans to heterogeneous customers. INITIAL MEASUREMENT - LOAN RECEIVABLE Loans receivable should be initially measured at fair value plus transaction cost. In other words, the following items should be considered in the initial measurement of loans receivable which is directly related in granting a loan toa customer or borrower: 1) Origination fees include compensation for the loan origination activities. Origination fees charged to the borrower is recorded as credit to unearned interest income. 2) Direct origination cost refers to transaction cost incurred in evaluating the borrower's financial condition, evaluating guarantees, | collateral and other security, negotiating the terms of the loan, preparing and processing documents and closing the loan transaction. The process is also known as credit investigation. 3) Indirect origination cost is cost incurred that is not directly related to the loan origination, therefore, it shall be accounted as an expense. The journal entries to record the loan is as follows: 1. To record the loan Loan receivable xX Cash XX 2. To record the receipt of origination fees Cash XX Unearned interest income XX 3. To record the payment of direct origination costs Unearned interest income x Cash xX 4, To record collection of loan receivable Cash XX Loan receivable XX 5. To record amortization of unearned interest income Unearned interest income XX Interest income XX Based on the journal entries above, the initial carrying amount of the loan receivable may be computed as follows: Principal Amount XX Less: Origination fee received ox) Add: Direct origination cost XXL Initial carrying amount XC 281Chapter 10 - Loans and Receivable SUBSEQUENT MEASUREMENT: LOAN RECEIVABLE Loans receivable is subsequently measured at amortized cost using effective interest method. Since loans receivable frequently involves transaction cost, a new effective rate should be computed through interpolation. When computing the effective interest rate, always remember the rule on present value: The higher the rate, the lower the present value and vice versa, the lower] the rate, the higher the present value. 4 ILLUSTRATION: Computation of Effective Interest Rate through Interpolation On January 1, 2021, Loner granted a 4-year loan to a borrower in the amount of P5,000,000. The company incurs P200,000 of direct loan origination cost and receives nonrefundable origination fee amounting to 500,000. The stated interest is 10% payable annually every December 31. Required: 1. Compute for the following: a. Effective interest rate. .. Interest income on December 31, 2021. Carrying amount of the Loans Receivable, December 31, 2021. . Current portion of the Loans Receivable, December 31, 2021. Noncurrent portion of the Loans receivable, December 31, 2021. 'repare all the necessary entries in 2021. weeange 2 SOLUTION: Requirement No. 1a - Steps: 1. Compute for the initial present value of the loan receivable. Principal 5,000,000 Add: Direct origination cost incurred 200,000 Less: Origination fees received 500,000 Initial present value of loan receivable 4,700,000 2. Get the present value using a lower rate (in this example 11%, the present value is P4,844,700.) Note: There is a discount if effective rate is greater than nominal rate. Present value of principal (P5,000,000 x .6587) 3,293,500 Add: Present value of interest (P5M x 10% x 3.1024) __1,551,200 Total present value P4,844,700 3. Compute the present value using a higher rate (in this example, the present value using 12% is P4,696,150). 282QP chapter 10 - Loans and Receivable ! crater eee i The present value of lower rate must be higher than the net proceeds while the present value of the higher rate must be lower than the net proceeds. Present value of principal (P5,000,000 x.6355) 3,177,500 Add: PV of interest (PSM x 10% x 3.0373) 1,518,650 Total present value 4,696,150 4, Use the following formula in computing the effective interest rate. Rate Present value Gap in peso Gap in % 11% P 4,844,700 P 144,700 2 4,700,000 1% } P 3,850 12% P.4,696,150 Total gap difference P1468 550 Computation using the lower rate asa starting point: os (PV of LR - PV of X) = Lowerrate+[(HR-LR) * “pyofta-pvorHR | P144,700 X = 11%+ [(12%-11%) * “pragsso” X = 11.97% Computation using the higher rate as a starting point: a. (PV of X- PV of HR) = Higher rate-[(HR-LR) * “py ofLR-PVorHR” | a _P3,850_ = 12%-[(12%-11%) * “pragsso X = 11.97% Legend: LR - Lower rate HR - Higher rate PV Present value Amortization Table using 11.97% Interest —_ Interest Discount Present Date Collection _ Income Amortization value 01/01/2021 4,700,000 12/31/2021 500,000 562,590 62,590 4,762,590 12/31/2022 500,000 570,082 70,082 4,832,672 12/31/2023 500,000 578,471 78,471 4,911,143 || 12/31/2024 500,000 __587,864 88,857 5,000,000 283| ff i, | Chapter 10 - Loans and Receivable Requirement No. 1b Interest income = P562,960 (see amortization table above) Requirement No. 1c Principal amount collectible beyond one year 5,000,000 Less: Unearned interest income 237,410 Carrying amount of notes receivable P4,762,590 e890 Requirement No. 1d Zero, the entire note receivable is collectible beyond one year. Requirement No. 1e The entire P4,762,590 (see amortization table above) is to be included ag noncurrent asset since itis collectible beyond one year from the reporting date. Requirement No. 2 Journal entries for 2021 are as follows: Jan.1 Loans receivable 5,000,000 eal 5,000,000 Unearned interest income 200,000 Cash To record the direct origination cost incurred Jan. 1 Cash 500,000 Unearned interest income 500,000 To record the origination fees received 200,000 Dec.31 Cash 500,000 Interest income 500,000 Unearned interest income 62,590 Interest income 62,590 LOANS AND RECEIVABLE IMPAIRMENT At each reporting date, an entity shall recognize a loss allowance for expected credit losses on a lease receivable, a contract asset or a loan commitment and a financial guarantee contract as follows: 1. Lifetime expected credit loss - if the credit risk on that financial instrument has increased significantly since initial recognition 2. 12-month expected credit loss - if the credit risk on that financial instrument has not increased significantly since initial recognition Impairment gain or loss In accordance with paragraph 5.5.8 of PFRS 9, an entity shall recognize in profit or loss, as an impairment gain or loss, the amount of expected credit 284Chapter 10 - Loans and Receivable losses (or reversal) that is required to adjust the loss allowance at the reporting date. The following should be observed: [ Description PERS 9. 4._| Impairment loss P&L 2,_| Impairment gain P&L, no limit © 13, | Discount rate Original effective rate or credit-adjusted | effective interest rate for purchased or originated credit-impaired financial assets ‘Note: Impairment loss of financial assets under PFRS 9 is discussed in more detail in Chapter 16 of this book Impairment of Receivable Carrying amount of the receivable Less: Present value of expected future cash flows discounted Impairment loss or credit loss using the original effective rate zl Fy Carrying amount of loan receivable: 1. For receivable (e.g. loan) originally issued without premium or discount, its effective rate is equal to the nominal rate. Principal XK Add: Accrued interest (if recorded by the company) xX Carrying amount of loan receivable xX For receivable (e.g. loan) originally issued with premium or discount: Carrying amount of loan receivable = Present value at the date of impairment plus any unpaid accrued interest recorded by the company. Present value of expected future cash flows: Date Cashflow Presentvalue ‘Total end of (CF)___Factor (PVF) __(CFx PVF) Year 1 XK XX xX Year 2 XK XK xX Yearn XX XK XK Total present value of future cash flows XK The date is from the date of impairment until date of receipt of cash. Journal entries are as follows: 1. Date of impairment Impairment or credit loss Accrued interest receivable (if any) Loss allowance gos 285Chapter 10 - Loans and Receivable 2. Amortization of loan impairment Loss allowance XX Interest income XX Notes: ¥ Allowance for loan impairment may also be used instead of loss allowance, ¥ The original effective rate is the same with the nominal rate of an interest. bearing note with reasonable interest rate and no transaction cost. ¥ Prevailing interest is ignored. ILLUSTRATION: Impairment Loss On January 1, 2020, Kinakaya Pa Company granted a five year loan toa borrower amounting to P5,000,000. The loan bears interest of 10% and is collectible every December 31. On December 31, 2021, Kinakaya Pa considers the loan impaired and that only 4,000,000 principal amount will be collected. No cash was received in 2021. The prevailing rate of interest for a loan of this type is 12%. Assuming the following independent cases: Case No. 1: Kinakaya Pa Company accrued the interest on December 31, 2021 and the entire P4,000,000 will be collected on the maturity date. Case No. 2: Kinakaya Pa Company did not accrue the interest on December 31, 2021 and the entire #4,000,000 will be collected on the maturity date. Case No. 3: Kinakaya Pa Company did not accrue the interest on December 31, 2021 and the P4,000,000 will be collectible as follows: Date Amount December 31, 2022 1,500,000 December 31, 2023 2,500,000 Case No. 4: Kinakaya Pa Company did not accrue the interest on December 31, 2021 and the P4,000,000 will be collectible as follows: Date Amount January 1, 2022 1,000,000 December 31, 2022 2,000,000 December 31, 2023 1,000,000 Required: 1. Compute for the following: a, Loan impairment loss in 2021. b. Interest income in 2022. c. Carrying amount of the loan, December 31, 2022. 2. Prepare the necessary entries from the date of impairment to 2022. 286chapter 10 - Loans and Receivable SOLUTION: CASE No, Requirement No. 1a 1 Carrying amount of receivable: Principal ‘Add: Accrued interest 5,000,000 (P5,000,000 x 10% x 12/12) Less: Present value of expected cash flows —222000_ 5,500,009 (P4,000,000 x.7513) Impairment loss - 2021 3,005,200 2¢ Amortization Table 2494800 Date Interest Income 12/31/2021 : 12/31/2022 300,520 35.20 12/31/2023 330,272 3508.20 12/31/2024 363,708 $ea6202 Requirement No. 1b Interest Income = 300.520 (see amortization table above) Requirement No. 1¢ Carrying amount = 23,305,720 (see amortization table above) Presentation in the Statement of Financial Position Loan Receivable Less : Allowance for loan impairment (1,994,800 - 300,520) eo Carrying amount of Loan receivable 793.305.7020" 5, Requirement No. 2 Journal entries: 12/31/21 Impairment loss 2,494,800 Accrued interest receivable 500,000 Allowance for loan impairment 1,994,800 12/31/22 Allowance for loan impairment 300,520 Interest income 300,520 CASE NO. 2 Requirement No. 1a Carrying amount of receivable = Principal 5,000,000 Less: PV of expected cash flows (P4,000,000 x .7513) _3,005,200_ Impairment loss - 2021 287Chapter 1 Loans and Receivable ny i bl Amortization Table interest Income Present value ate 3,005,200 oa Oa 300,520 3,305,720 es 330,572 3,636,292 12/31/2024 363,708 4,000,000 : Ab ae gs0n.s2p (see amortization table above) i . 1c Requirement NO 395,720 (see amortization table above) Carrying amount = Presentation in the Stateme Loan Receivable the Notes to F/S nt of Financial Position P3,305,720 ceivable P5,000,000 Loan receivable an impairment (1,994,800-300520) __1,694,280_ Disclosure in Less: Allowance Carrying amount of Requirement No. 2 Journal entries 12/31/21 Impairment loss ‘Allowance for Joan impairment P3,305,721 f loan receivable P1,994,800 P 1,994,800 12/31/22 Allowance for loan impairment 300,520 Interest income 300,520 CASE NO. 3 Requirement No. 1a Carrying amount of receivable = Principal Less: Present value of expected cash flows* Impairment loss - 2021 P5,000,000 _3.429,650_ P1,570,350 *Present value of expected cash flows: Date Cashflow Present value Total end of cl Factor (PVF) (CE x PVF. 12/31/2022 P1,500,000 0.9091 P1,363,650 12/31/2023 2,500,000 0.8264 2.066.000 Total present value of future cash flows P3,429,650 288Chapter 10 - Loans and Receivable Amortization Table Annual —_Interest Present Date Collection _Income _ Amortization value 12/31/2021 3,429,650 12/31/2022 1,500,000 342,965 1,157,035 2,272,615 12/31/2023 2,500,000. 227,262 2,272,615 z Requirement No. 1b Interest Income = P342,965 (see amortization table above) Requirement No. 1c Carrying amount = 22,272,615 (see amortization table above) Presentation in the Statement of Financial Position Loan Receivable ~ 12/31/2022 Disclosure in the Notes to F/S Loan Receivable (P5,000,0000 - P1,500,000) Less: Allowance for loan impairment (1,570,350 -342,965) Carrying amount - 12/31/2022 Requirement No. 2 Journal entries 12/31/21 Impairment loss Allowance for loan impairment 12/31/22 Allowance for loan impairment Interest income Cash Loan receivable CASE NO. 4 Requirement No. 1a Carrying amount of receivable = Principal Less: Present value of expected cash flows* Impairment loss - 2021 *Present value of expected cash flows: Date Cashflow Present value end of (CF Factor (PV! 01/01/2022 1,000,000 1.0000 12/31/2022 2,000,000 0.9091 12/31/2023 1,000,000 0.8264 Total present value of future cash flows 289 2,272,615 3,500,000 1,570,350 P. 342,965, 1,500,000 5,000,000 3,644,600 400 Fri3s5 400, Total cE xPVI 1,000,000 1,818,200 400 3,644,600 1,227,385 -p2,272.615_ “pres 1,570,350 342,965 1,500,000Chapter 10 - Loans and Receivable Amortization Table Annual Interest Present Date Collection _Income __ Amortization value 12/31/2021 3,644,609 01/01/2022 1,000,000 - 1,000,000 2,644,600 12/31/2022 2,000,000 264,460 1,735,540 909,060 12/31/2023 1,000,000 909,060 Requirement No. 1b Interest Income = P264,460 (see amortization table above) Requirement No. 1¢ Carrying amount = P909,060 (see amortization table above) Presentation in the SFP Loan receivable (P5,000,0000 - P1,000,000 - P2,000,000) _ ? 909,060 90,906 Disclosure in the Notes to F/S Loan receivable (P5,000,0000 - P1,000,000-P2,000,000) 2,000,000 Less: Allowance for loan impairment (1,355,400 - 264,460) __1,090,940 Carrying amount - 12/13/2022 P_909,060 Requirement No. 2 Journal entries: 12/31/21 Impairment loss 1,355,400 Allowance for loan impairment P1,355,400 01/01/22 Cash 1,000,000 Loan receivable 1,000,000 12/31/23 Allowance for loan impairment 264,460 Interest income 264,460 Cash 2,000,000 Loan receivable 2,000,000 ILLUSTRATION: Reversal of Impairment Loss On January 1, 2020, Kinakaya Pa Company granted a five year loan to a borrower amounting to P5,000,000. The loan bears interest of 10% and to be collectible every December 31. On December 31, 2021, Kinakaya Pa considers the loan impaired and that only P4,000,000 principal amount will be collected. No cash flows received in 2021 and the company did not accrue the interest because of the impairment. The prevailing rate of interest for a loan of this type is 12%. 290chapter 10 - Loans and Receivable Chapter 10 - Loans and Receivable 0 On December 31, 2022, the financial condition of the borrower has improved and that it can pay its entire unpaid obligation, including principal and interest at maturity. Required: 4. Compute for the gain on reversal of impairment loss in 2022. 2. Prepare all the necessary entries in 2021 and 2022 under. SOLUTION: Recall that the loan impairment is computed as follows: Carrying amount of receivable = Principal 5,000,000 Less: Present value of expected cash flows (P4,000,000 x.7513) 3,005,200 Impairment loss - 2021 1,994,800 Amortization Table Date Interest Income Present value 12/31/2021 3,005,200 12/31/2022 300,520 3,305,720 12/31/2022 330,572 3,636,292 12/31/2023 363,708 4,000,000 Requirement No. 1 Present value of future cash flows using original effective rate: Principal 5,000,000 Add: Unpaid interest (PSM x 10% x4 years) 2,000,000 Total cash flow 7,000,000 Multiply by: PV of 1 for 2 periods 0.8264 Present value of future cash inflows 5,784,800 Less: Actual amortized cost/present value 3,305,720 Gain on impairment recovery 2,479,080 Requirement No. 2 Journal entries for 2021 and 2022 are: 12/31/21 Impairment loss P1,994,800 Allowance for loan impairment 1,994,800 12/31/22 Allowance for loan impairment 300,520 Interest income 300,520 Allowance for loan impairment 2,479,080 Gain on impairment recovery 2,479,080 Statement of Financial Position, 12/31/2022 Loan receivable (P3,305,720 + P2,479,080) 5,784,800 291— Chapter 10 - Loans and Receivable RECEIVABLE FINANCING Sufficient cash is an essential part of running the operations of a business, However, there are some occasions in which an entity may have insufficient funds to use for its operations. An entity may generate cash from various source of financing. One form of raising fund is through receivable financing which is the capability or financial flexibility of the company to generate cash out ofits receivables. ‘The most common forms of receivable financing are as follows: 1, Pledging of receivable 2. Assignment of receivable 3, Factoring of receivable 4, Discounting of receivable PLEDGING / HYPOTHECATING Pledging or hypothecating of receivables refers to borrowing of money from the bank or any financial institution in which receivables in general are used as collateral or security for a loan. Since receivables in general are used as collateral, pledging is sometimes called general assignment. ILLUSTRATION: Pledging of Accounts Receivable On October 1 of the current year, Blackberry Company borrowed 1,000,000 for one year from Samsung Bank with a stated interest rate of 12%. As a security for the loan, Blackberry Company hypothecated its accounts receivable amounting to P1,500,000. Samsung Bank deducted the one year interest in advance. Required: Prepare the entries in relation to the assignment of the accounts receivable, assuming amortization of interest deducted in advance is to be made equally for the entire loan term. SOLUTION: Journal entries are: Oct.1 Cash (P1,000,000 -P120,000) 880,000 Discount on notes payable (P1,000,000 x 12% x 12/12) 120,000 Notes payable-bank 1,000,000 Dec.31 Interest expense (P120,000/12 x 3) 30,000 Discount on notes payable 30,000 SFP Presentation SFP - Current Liability p 910,000 292Chapter 10 - Loans and Receivable Notes to F/S Note payable P 1,000,000 Less: Discount on note payable (P120,000 - P30,000) —— 90,000 Carrying value 2.910.000 Statement of Comprehensive Income Interest expense P 30,000 ASSIGNMENT Assignment is a more formal borrowing arrangement in which the specific receivables are identified and used as security. The assignor or borrower transfers its rights in some of its accounts receivable to a lender or assignee in consideration for a loan. The following are some of the characteristics of an assignment: a) The loan is at a specified percentage of the face value of the collateral and interest and service fees are charged to the assignor (borrower). b) The debtors are occasionally notified to make payments to the assignee (lender) but most assignments are non-notification basis. c) Assigned accounts are segregated from other accounts. The notes payable should be deducted from the balance of A/R assigned to determine the equity in assigned accounts receivable. Assignment may either be: 1, Non-notification basis - buyer is not informed of the assignment arrangement and will continue to remit its payment to the seller (assignor). 2. Notification basis - buyer is informed of the assignment arrangement and will remit payment directly to the assignee (e.g. bank). : non-notification vs notification Non-notification Notification To sepa ssigned accounts: Accounts receivable | | x0 Cash ieee | Service charge _ Service charge [ox | tes payabl Notes payable-bank | | xxx Issued credit m: ‘Sales return _ X [Sales return Teo | ext ned assigned 293A/R-assigned To record remittance: N/P- bank Interest expense Cash Torecord write-off of accounts assigned: Allowance for bad debt_| x0 ‘Allowance for bad del A/R- assigned A/R-assigned Accounts receivable A/R= assigned [ox J A/R- assigned ‘The amount to be transferred to unassigned accounts may be computed as follows: ‘Total accounts receivable - assigned Xxx Less: Collections XX Sales discount XX Sales return XX Worthless accounts XX__ (Xx) Balance XX ‘Asyou may have observed from the foregoing journal entries, the difference between notification and non-notification is on the recording of remittance to the bank. Non-notification calls for the buyer to pay directly to the seller and the seller will remit the total payment (i.e. principal and interest) to the bank, while notification basis calls for the buyer to remit directly to the bank and the seller will pay an additional amount to cover the interest. ILLUSTRATION: Assignment - Non-notification Basis On November 1, of the current year, Nokia Company assigned customers’ accounts in the amount of P1,000,000 to Brayden Company as a security for a loan in the amount of P750,000 and a stated interest rate of 10%. Brayden Company charges 5% in relation to the amount borrowed. Nokia Company will continue to collect the accounts from customers and will remit payment to Brayden Company. On December 30, of the current year, cash collections on the assigned accounts amounted to #450000. 294r Chapter 10 - Loans and Receivable Chante on December 31, Nokia Company remitted in full the amount collected plus interest due on the outstanding balance of the loan. Required: 4. Compute for the cash received from assignment. 2. Prepare the journal entries in relation to the assignment of the account's receivables. 3. Compute for the amount of equity over the assigned accounts to be disclosed on December 31. SOLUTION: Requirement No. 1 Notes payable 750,000 Less: Service charges (5% x P750,000) 37,500 Cash received _?712,500_ Requirement No. 2 Nov.1 Accounts receivable-assigned 1,000,000 Accounts receivable 1,000,000 To separate the accounts Cash (P750,000 - P37,500) 712,500 Service charge (5% x P750,000) 37,500 Notes payable-bank 750,000 Dec.30 Cash 450,000 Accounts receivable-assigned 450,000 Dec.31 Notes payable-bank 450,000 Interest expense (10% x P750,000 x 2/12) 12,500 Cash 462,500 Requirement No. 3 Accounts receivable-assigned (P1,000,000 - P450,000) 550,000 Less: Notes payable (P750,000 - P450,000) 300,000 Equity in assigned accounts to be disclosed in the notes 250,000 ILLUSTRATION: Assignment - Notification Basis Canon Company finances some of its current operations by assigning accounts receivable on a notification basis to Josiah Finance. On July 1 of the current year, it assigned, under guarantee, specific accounts amounting to 2,000,000. Josiah Finance shall advance to Canon Company 80% of the accounts assigned, less a finance charge of 1% of the total accounts assigned. 295Chapter 10 - Loans and Receivable On August 1, Canon Company received a statement that Josiah had collected 1,100,000 of these accounts and had made an additional charge of 1% of the total outstanding payable as of July 31. This charge is to be deducted a the time of the first remittance due to Canon Company from the Josiah Finance. On September 1, Canon Company received a second statement from Josiah Finance, together with a check for the amount due. The statement indicated that the Josiah had collected an additional of 600,000 and had made a further charge of 1% of the balance outstanding as of August 31. Required: 1. Compute for the cash received from assignment. 2. Prepare the entries in relation to the assignment of the accounls receivable. SOLUTION: Requirement No. 1 0 Notes payable (P2,000,000 x 80%) atte Less: Finance charges (1% x P2,000,000) 560,000 Cash received a Requirement No. 2 Jul? Accounts receivable - assigned 2,000,000 2,000,000 Accounts receivable ‘ To separate the accounts Cash 1,580,000 Service charge 20,000 690,000 Notes payable-bank : Aug.1 Notes payable-bank (P1.1M 16,000) 1,084,000 16,000 4,100.00 Service charge (1% x P1,600,000) Accounts receivable-assigned Sep.1 Notes payable - bank (PL6M - @ P1,084,000) ST Service charge (1% x P516,000 Sy Cash ee y 78,840 690,00 Accounts receivable-assigned Accounts receivable (P2M - P1.1M - rable (i 300,000 300.0 600,000) Accounts receivable-assigned 296 alChapter 10 - Loans and Receivable FACTORING Factoring involves the sale of receivables to a finance company, which is called the factor. The factor or buyer assumes the risk of collectivity and generally handles the billing and collection function. Factoring may either be: A. Factoring without guarantee (or without recourse) - this is a sale of receivables wherein there is transfer of title and transfer of risks and rewards. As in any sale of assets, the seller debits Cash for the proceeds and credits Accounts Receivable for the face value of the receivables. ‘The seller recognizes the difference, decreased by any provision for probable adjustments (discounts, returns, allowances, etc.), as a Loss on Sale of Receivables. The seller also uses a “Receivable from Factor” (factor’s holdback) account to account for portion retained for a purchase price to cover probable sales return, discount and allowance. B, Factoring with guarantee (or with recourse) - there are two types: 1, Allrisks and rewards of are retained by the entity-such as when the entity guarantees to compensate the transferee for credit losses that are likely to occur. In accordance with PFRS 9 paragraph 3.2.15, “the entity shall continue to recognize the transferred asset in its entirety and shall recognize a financial liability for the consideration received. In subsequent periods, the entity shall | recognize any income on the transferred asset and any expense } incurred on the financial liability.” As a result, the transfer is considered borrowing - sometimes referred to as a failed sale. The seller continues to recognize the receivable on its books, and the transaction is treated is treated as a borrowing. ) 2. Neither all the risks and rewards are transferred nor retained by the entity and the entity retains control of the transferred asset- such as when only a partial or limited amount is transferred to the transferee for credit losses that likely to occur. In accordance with PERS 9 paragraph 3.2.16, “the entity continues to recognize the transferred asset to the extent of its continuing involvement. The extent of the entity's continuing involvement in the transferred asset is the extent to which it is exposed to changes in the value of the transferred asset.” The transferred asset and the associated liability will be measured as follows: a. Transferred asset- at the lower of: (i)_ the carrying amount of the asset and (i) the maximum amount of consideration received in the transfer that the entity could be required to repay (‘the guarantee amount’). b. Associated liability 297