2.3.1.

1 Accounting for Accounts Receivable

Accounting for Accounts Receivable

Receivables are debts owed to customers and other parties for goods,
services, or money. Receivables are classified as a contractual right to
receive cash or another financial asset from another firm and are considered
to be financial assets under IAS 32. Trade and non-trade receivables are the
two categories under which receivables fall.
 
Major Types of Receivables

1. The right to receive money from consumers in the future in exchange

for goods sold or services rendered is represented by accounts
receivable, also known as trade receivables. As it is often short term,
current assets are provided.
2. Promissory notes, also known as notes receivable, are written
promises to pay a predetermined sum for the principle and interest at
a later time (maturity date). includes unpaid loans as well.
3. Any other sort of receivable with a future cash payment entitlement is
represented by the term "Other Receivables."

Examples of Non-trade Receivables:

1. advancements for officers and staff.

2. money given to subsidiaries.
3. Deposits to cover any losses or damages
4. deposits used as a sort of performance or payment
guarantee.
5. Receivable dividends and interest.
6. Arguments against:
7. insurance providers for incurred losses.
8. Plaintiffs' defendants.
9. government agencies that handle tax refunds.
10. Common carriers for missing or damaged goods
11. creditors for lost, stolen, or returned items.
12. Clients who purchase returnable goods (crates,
containers, etc.).).

 
Recognition of Accounts Receivable
 
Initially
Under PFRS 9, par 5.1.1, financial assets shall be recognized initially at fair
value plus transaction cost that are directly attributable to the acquisition.
Fair value of the financial asset is usually the transaction price or the fair
value of the consideration given. For short-term receivables, the fair value is
the face amount or original invoice price.
 
Summary:

 Initially at FV plus transaction costs that are directly attributable to

the acquisition
 Transaction price – FV of the consideration given
 Face value – for short-term receivables
 Face value – long-term interest bearing receivables
 Present value – for long-term non-interest bearing receivables

 
Subsequent Measurement
According to PFRS 9, paragraph 5.2.1, accounts receivable must be valued at
amortized cost after initial recognition. The net realizable value of accounts
receivable is equal to the amortized cost. The amount of money anticipated to
be received or the predicted amount of recoverable value is known as net
realizable value.
 
Factors Affecting Net Realizable Value

 Allowance for freight charges

 Allowance for sales return
 Allowance for sales discount
 Allowance for doubtful accounts

 
Freight Charges and Terminologies

1. Ownership of the acquired items is given to the customer upon receipt

under the terms of FOB Destination. The cost of freight up to the
destination point is the seller's responsibility.
 2. Ownership of the purchased items is given to the buyer upon
shipment FOB Shipping Point. The cost of transportation from the
point of shipping to the destination is covered by the buyer.
3. Freight Collect means that the freight for the shipped items has not
yet been paid. The courier gets the buyer's package.
4. Pre-Paid Freight - The vendor covers the cost of freight.

 
Allowance for Freight Charges
Example:  An entity sold on account goods with terms of 2/10, n/30, FOB
destination and freight collect.   The customer paid freight charge of P5,000.

1. To record the sale:

 
Accounts receivable                                    100,000
Freight-out                                                        5,000
              Sales                                                                             100,000
              Allowance for freight charges                                     5,000
 

2. To record the collection within the discount period:

 
Cash                                                               93,000
Sales discount                                                2,000
Allowance for freight charges                     5,000
              Accounts receivable                                    100,000
 
 
Allowance for Sales Return
Recognize the probability purchased goods will be returned by the customer. 
For example with it is estimated that about P20,000 of the total accounts
receivable at year-end will represent the selling price of goods that will probably
be returned by the customer.  The entry is:
 
Sales Return                                                 20,000
              Allowance for sales return                        20,000
 
 
Discounts to Customers
Trade discounts or quantity discounts are used to avoid often updating
catalogs, adjust pricing for various quantities bought, or keep the actual
invoice price a secret from rival businesses. The business simply deducts
the trade discount from the list price before issuing a net invoice to the
client. As a result, the consumer records the transaction at a reduced
price without accounting for the trade discount.
On the other hand, credit sales are given a cash discount (sometimes known as
a sales discount) to encourage quick payment. The most common formats are
2/10, n/30 (2 percent if paid within 10 days, gross amount due in 30 days)
and 2/10, E.O.M., net 30, E.O.M. (2 percent if paid any time by the tenth day
of the following month, with full payment due by the thirtieth of the following
month).
 
Methods of Recording Credit Sales

1. Gross method – the accounts receivable and sales are recorded as

gross amount of the invoice.
2. Net method – the accounts receivable and sales are recorded at net
amount of the invoice (net of cash discounts).

Accounts receivable and related revenue should be recorded by businesses at

the amount of consideration anticipated to be received from a customer. Due to
the fact that the receivable is valued at its cash realizable value, this method is
known as the "net method." Sales on account using the sales discount option
in this instance are first recorded net of the discount. However, if the customer
did not pay during the discount time, a settlement credit for "Sales Discounted
Forfeited" will be recorded. This account is listed in the income statement's
Other Income and Expense column.
 
Illustration to differentiate entries between Gross Method and Net Method
of recording cash discounts.
Allowance for Sales Discount
At the end of the accounting period, organizations who choose to report credit
sales at gross amount should estimate the cash discount that will be taken.
Example: As of December 31 of the current year, the company has P1,000,000
in unpaid Accounts Receivable. According to reliable estimates, the consumer
will use P50,000 of the discounts the next year. To record the modification,
enter the following:
Sales Discount                                                                           50,000
   Allowance for Sales Discount                                                           
50,000
 
This adjusting entry may be reversed at the beginning of the next accounting
period.
 
Doubtful Accounts
Sales on account raise the possibility of accounts not being collected. Past
experience would determine the losses from uncollectibility of receivable
accounts that companies must be able to estimate the losses that they may
incur, and recognize this loss on the period where the related revenue (sales)
was recognized.
 
Methods in Accounting for Uncollectible Accounts

1. Direct write-off method

2. Allowance method

 
Direct Write-off Method for Uncollectible Accounts
When a company determines a specific accounts receivable to be uncollectible,
a loss is recognized.   Example if one of the account receivable in the amount of
P100,000  is considered uncollectible, the entry to made is:
 
Bad debt expense                                                      100,000
    Accounts Receivable                                                           100,000
 
The bad debt expense will only record actual losses from uncollectibles.
Therefore, the company reports accounts receivable at its gross amount and
not the cash realizable value.
If the account that was previously written off as uncollectible was recovered or
collected, the entry would be:
 
Accounts receivable                                                  100,000
    Bad debt expense                                                                100,000
 
Cash                                                                              100,000
    Accounts receivable                                                             100,000
 
If the recovery was in the next accounting period, a credit to other income may
be used instead of bad debt expense.
 
bad for Uncollectible Accounts
Estimating the amount of receivables that would be impossible to collect for
each period is necessary for the allowance approach. Therefore, using this
method would reflect accounts receivable at its cash realizable value in the
statement of financial condition. A loss is recorded in the income statement at
the same time as the projected amount of uncollectibility. The proportion of
uncollectibility will be determined by the company's prior performance or by
the performance of other businesses in the same sector.
IASB requires the allowance method for financial reporting purposes when bad
debts are material in amount.   The essential features of this method are:

1. Uncollectible accounts receivable are estimated by businesses, who

then contrast the updated estimate with the allowance account's
current balance.
2. Companies make an adjustment entry at the end of each period to
credit estimated increases in uncollectibles to Allowance for Doubtful
Accounts (a contra asset account) and debit estimated increases in
uncollectibles to Bad Debt Expense.
3. Companies subtract actual uncollectibles from Accounts Receivable
and credit Allowance for Doubtful Accounts when they write off a
specific account.
 
Illustration:  Brown Furniture in 2019, its first year of operations, has credit
sales of P1,800,000.  Of this amount, P150,000 remains uncollected at
December 31.  The credit manager estimates that P10,000 of these sales will be
uncollectible.  The adjusting entry to record the estimated uncollectibles
(assuming a zero balance in the allowance account) is:
 
Bad debt expenses                                                    10,000
  Allowance for doubtful accounts                                        10,000
 
In the statement of financial position at December 31, Brown Furniture will
report Accounts receivable as follows:
 
Accounts Receivable                                                 P 150,000
Less: Allowance for Doubtful Accounts                      10,000
Cash Realizable Value                                              P 140,000
 
The amount of customer claims that the business estimates it won't be able to
collect in the future is shown in the Allowance for Doubtful Accounts. Because
they cannot predict which customers would default on payments, businesses
employ a contra account rather than a direct credit to accounts receivable. The
precise write-offs will be absorbed as they happen by the credit balance in the
allowance account. The cash realizable value of the accounts receivable at the
statement date is represented by the sum of P140,000. At the end of the fiscal
year, businesses do not close their allowance for doubtful accounts (adopted
from Kieso).
 
Write-off of Uncollectible Account
When a receivable account proves to be uncollectible, the company writes-off
this account from the books.  For example, P5,000 of the accounts receivable
from J. Co is considered uncollectible, the company would pass the following
entry:
 
Allowance for Doubtful Accounts                          5,000
   Accounts Receivable (J. Co)                                                 5,000
 
Recovery of Uncollectible Account Written-off
When accounts receivable previously written-off was recovered, the company
makes two entries:

1. Reversal of the entry made in writing off the account, and reinstates
the customer’s account.
2. Journalizes the collection as usual.

Assuming that J.Co pays the company for the amount owed, P5,000.  The
entries would be:
Accounts receivable (J.Co)                                       5,000
   Allowance for Doubtful Accounts                                      5,000
 
Cash                                                                              5,000
   Accounts Receivable                                                             5,000
 
Estimating Doubtful Accounts
Expected uncollectible accounts receivables are based on information about
past events (loss experience), adjusted for current conditions and reasonable
forecast factors that would affect uncollectible accounts.  The goal is to develop
the best estimate of expected uncollectible accounts (adopted from Kieso).
 
Methods

1. Statement of financial position approach : Percentage of receivable

approach and aging of accounts receivable or “statement of financial
position approach.”
2. Income statement approach: Percentage of sales

 
Percentage of Receivables Approach
Without naming specific accounts, the corporation can estimate the proportion
of its outstanding receivables that will become uncollectible. The realizable
value of the receivables is estimated using this approach with a degree of
reasonable accuracy. The rate is based on historical performance, and when
multiplied by the entire amount of accounts receivable at the conclusion of the
accounting period, the required allowance balance is obtained.
Although this approach is straightforward, it goes against the idea of matching
bad debt expenditure to sales revenue.
 
Illustration (Valix):
The balance of accounts receivable is P2,000,000 and the credit balance in the
allowance for doubtful accounts is P10,000.  Doubtful accounts are estimated
at 3% of accounts receivable.   The required allowance for doubtful accounts
balance should be (3% x P2,000,000) P60,000.   Since the allowance for
doubtful accounts has a balance before adjustment of P10,000, therefore an
increase of P50,000 will be made by passing this entry:
 
Bad debt expense                                                      50,000
   Allowance for doubtful accounts                                       50,000
Assuming the same given as above, except that the allowance for doubtful
accounts has a balance before adjustment of P85,000,  a reduction of P25,000
has to be made to bring the balance to required amount of P60,000.  The
following entry will be made:
Allowance for doubtful accounts                           25,000
   Bad debt expense                                                                 25,000
 
Aging of Receivables
This method involves an analysis of the accounts classified into not due or past
due. Example would be classifying the accounts as follows:

1. Not due
2. 1-30 days past due
3. 31-60 days past due
4. 61-90 days past due
5. 91-120 days past due
6. 121-180 days past due
7. 181-365 days past due
8. More than 1 year past due

 
A corresponding percentage of loss will be applied to each category based on
past experience.
Example of aging is as follows:

  
The percentage of estimated accounts to be uncollectible increases as the
number of days past-due increases. In the example, the required balance of the
allowance for doubtful accounts will be P37,650. If the beginning balance of the
account is zero, the company will simple pass the following entry:
 
Bad debt expense                                                      37,650
   Allowance for doubtful accounts                                       37,650
 
 
Percentage of Sales Approach
In this method, the company determines the percentage of uncollectible
accounts based on past experience and expected credit policy.   The rate is
applied on total credit sales for the period to derive the bad debt expense.  This
method disregards the existing balance in the allowance for doubtful accounts.
This method achieves proper matching of cost against revenue since the bad
debt expense is directly related to sales and reported in the year of sale. This
method however may not be able to show the estimated cash realizable amount
of the receivables since the allowance may prove excessive or inadequate.   It is
advisable to age the receivables from time to time to ascertain probable loss.  A
revision on the rate used may be necessary.
 
Illustration (Valix)
The following accounts were gathered from the books of the company:
Accounts receivable                                                  1,000,000
Sales                                                                             5,050,000
Sales return                                                                       50,000
Allowance for doubtful accounts                                 20,000
 
If the doubtful accounts are estimated at 1% of net sales, the doubtful
accounts expense is P50,000 (1% x P5,000,000) and recorded as follows:
 
Bad debt expense                                                      50,000
    Allowance for doubtful accounts                                      50,000
 
The allowance for doubtful accounts after the above entry will be P70,000
(P20,000 + P50,000).
 
Adjustment to the Allowance for Doubtful Accounts
The percentage of sales method may result to the balance in the allowance for
doubtful accounts being excessive or inadequate. An aging of accounts may be
done to test the reasonableness of the allowance. The adjustment can result to
either an addition or subtraction from bad debt expense.  This will be treated
as change in estimate and treated currently and prospectively, if necessary.
Adjustments will be as follows:
 
Inadequate balance of the allowance:
 
Bad debt expense                                                      xxx
      Allowance for doubtful accounts                                    xxx
 
Excessive balance of the allowance:
 
Allowance for doubtful accounts                           xxx
      Bad debt expense                                                              xxx
 
Adjusted Resulting to Abnormal Balance in Bad Debt Expense
Example, if the amount of correction due to excessive allowance is P30,000 and
the bad debt expense for the period has a debit balance of P20,000, the above
entry would result to a bad debt expense with credit balance of P10,000.   This
negative balance of an expense account will be treated as miscellaneous
income, thus:
 
Allowance for doubtful expense                                           30,000
    Bad debt expense                                                                20,000
    Miscellaneous income                                                        10,000