CHAPTER 6

ACCOUNTS RECEIVABLE

Ninia C. Pauig-Lumauan, MBA, CPA

2nd Semester SY 2020-2021
Lyceum of Aparri

Intermediate Accounting Part 1

 DEFINITION
• Receivables are financial assets that
represent a contractual right to receive
cash or another financial asset from
another entity.
• Related Standards: PFRS 9 – Financial
Instruments and PFRS 15 – Revenue from
Contracts with Customers.
• For retailers or manufacturers, receivables
are classified into trade receivables and
non-trade receivables.
Intermediate Accounting Part 1
 EXAMPLES OF RECEIVABLES
a. Accounts receivable – receivables
supported by oral or informal promises
to pay. These are not supported by
formal promissory notes.
b. Notes receivable – receivables supported
by written or formal promises to pay in
the form of promissory notes. Some
notes receivable are supported by post
dated checks.
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 EXAMPLES OF RECEIVABLES
c. Loans receivable – receivables arising from
loans extended by financial institutions,
such as banks, financing companies and
lending institutions. Loans receivable are
also supported by promissory notes and
are generally backed by collateral
securities or post dated checks.
d. Advances – receivables arising from
advance to officers and employees,
advances to suppliers, and advances to
affiliates. Intermediate Accounting Part 1
 EXAMPLES OF RECEIVABLES

e. Accrued income – receivables arising from

income earned but not yet collected, such
as interest income, dividend income, and
the like.
f. Deposits – receivables from reimbursable
deposits paid to cover potential damages
or losses, deposits for guarantee of
performance or payment, and deposits for
returnable items (e.g. Crates, containers,
etc.)
Intermediate Accounting Part 1
 EXAMPLES OF RECEIVABLES
g. Claims receivable – receivables from
insurance companies for casualties
sustained, defendants under suit,
government agencies for refundable
taxes and other remittances, common
carriers for damaged or lost goods, and
suppliers for returned or damaged
goods.

Intermediate Accounting Part 1

 TRADE AND NON TRADE RECEIVABLES
• Trade receivables refer to claims arising
from sale of merchandise or services in the
ordinary course of business. Trade
receivables include accounts receivable
and notes receivable.
• Accounts receivable are open accounts
arising from the sale of goods and services
in the ordinary course of business and not
supported by promissory notes.

Intermediate Accounting Part 1

 TRADE AND NON TRADE RECEIVABLES
• Other names of accounts receivable are
customer’s accounts, trade debtors, and
trade accounts receivable.
• Notes receivable are those supported by
formal promises to pay in the form of notes.
• Non trade receivables represent claims
arising from sources other than the sale of
merchandise or services in the ordinary
course of business.

Intermediate Accounting Part 1

 LOANS RECEIVABLE
• For banks and other financial
institutions, receivables result primarily
from loans to customers.
• The loans are made to heterogenous
customers and the repayment periods are
frequently longer or over several years.

Intermediate Accounting Part 1

 CLASSIFICATION
• Trade receivables which are expected to be
realized in cash within the normal operating
cycle or one year, whichever is longer, are
classified as current assets.
• Non trade receivables which are expected to
be realized in cash within one year, the length
of the operating cycle notwithstanding, are
classified as current assets.
• If collectible beyond one year, non trade
receivables are classified as noncurrent
assets. Intermediate Accounting Part 1
 CLASSIFICATION
• The classification are in accordance with
PAS 1, Presentation of Financial
Statements, paragraph 66, which states:
“ An entity shall classify an assets as
current when the entity expects to realize
the asset or intends to sell or consume it in
the entity’s normal operating cycle, or
when the entity expects to realize the asset
within twelve months after the reporting
period.”
Intermediate Accounting Part 1
 NORMAL OPERATING CYCLE
• The normal operating cycle of an entity
is the time between the acquisition of
assets for processing and their realization
in cash or cash equivalents.
• When the entity’s normal operating
cycle is not clearly identifiable, it is
assumed to be 12 months.

Intermediate Accounting Part 1

 NORMAL OPERATING CYCLE
• Financial institutions need not classify
their receivables as trade or non trade
because their statement of financial
position is presented based on liquidity,
i.e. no current and non current
distinction. However, receivables
expected to be realized within one year
and beyond one year are disclosed in the
notes.
Intermediate Accounting Part 1
 PRESENTATION
• Trade receivables and non trade
receivables which are currently
collectible shall be presented on the face
of the statement of financial position as
one line item called trade and other
receivables.
• However, the details of the total trade
and other receivables shall be disclosed
in the notes to financial statements.
Intermediate Accounting Part 1
 ILLUSTRATIVE EXAMPLE
• For example, the disclosure may appear
as follows:
Accounts Receivable 5,000,000
Allowance for Doubtful Accounts (200,000)
Notes Receivable 1,000,000
Accrued Interest on Notes Receivable 150,000
Advances to Officers and Employees 100,000
Dividends Receivable 250,000
Total Trade and Non Trade Receivables 6,300,000

Intermediate Accounting Part 1

EXAMPLES OF NON TRADE RECEIVABLES
1. Advances to or receivables from
shareholders, directors, officers or
employees. If collectible in one year, such
advances or receivables should be classified
as current assets. Otherwise, such advances
or receivables are classified as noncurrent
assets.
2. Advances to affiliates are usually treated as
long term investments.
3. Advances to supplier for the acquisition of
merchandise are current assets.
Intermediate Accounting Part 1
EXAMPLES OF NON TRADE RECEIVABLES
4. Subscription receivable are current assets if
collectible within one year. Otherwise,
subscriptions receivable should be shown
preferably as a deduction from subscribed capital
share.
5. Creditors’ accounts may have debit balances as a
result of overpayment or returns and allowances.
These are classified as current assets. If the debit
balances are not material, an offset may be made
against the creditor’s accounts with credit
balances and only the net accounts payable may
be presented.
Intermediate Accounting Part 1
 EXAMPLES OF NON TRADE RECEIVABLES
6. Special deposits on contract bids
normally are classified as noncurrent
assets because such deposits are likely
to remain outstanding for a
considerable long period of time.
However, the deposits that are
collectible currently should be
classified as current assets.

Intermediate Accounting Part 1

EXAMPLES OF NON TRADE RECEIVABLES
6. Accrued income such as dividends
receivable, accrued rent income, accrued
royalties income and accrued interest on
bond investment are usually classified as
current assets.
7. Claims receivable such as claims against
common carriers for losses or damages,
claim for rebates and tax refunds, claims
from insurance entities, are normally
classified as current assets.
Intermediate Accounting Part 1
 ABNORMAL BALANCES IN ACCOUNTS
• A basic accounting concept is that an asset
should never have a credit balance and a
liability should never have a debit balance.
When such instance occurs, adjustment is
needed to eliminate the abnormal balance
prior to the preparation of financial
statements.
• Customers’ credit balances are credit
balances in accounts receivable resulting
from overpayments, returns and allowances,
and advance payments from customers.
Intermediate Accounting Part 1
 CUSTOMERS’ CREDIT BALANCES

• Credit balances in customers’ accounts

are presented as current liabilities and
not offset against receivables.
• Suppliers’ accounts (accounts payable)
may at times have debit balances
resulting from overpayments, advance
payments or errors. Debit balance in
accounts payable are presented as part of
current assets and not off set against
payables.
Intermediate Accounting Part 1
 ILLUSTRATIVE EXAMPLE
• The accounts receivable controlling account
report a balance of P 500,00. Examination of
the subsidiary ledgers reveals the following
details in the customers’ accounts:
CUSTOMER A
Sales 800,000 Collections 400,000
vvvvvvv Debit Balance 400,00
800,000
vvvvvvv
CUSTOMER B
Sales 600,000 Collections 450,000
vvvvvvv Debit Balance 150,000
600,000
vvvvvvv

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 ILLUSTRATIVE EXAMPLE
CUSTOMER C
Sales 500,000 Collections 450,000
Credit Balance 50,000 Returns 100,000
550,000 Debit Balance 550,000
vvvvvvv vvvvvv

• The accounts receivable should be presented

as current asset at P 550,000 representing the
accounts of A and B. The credit balance in the
account of C is classified as current liability
and not offset against the debit balances in
the accounts of A & B. The adjusting entry is:
Accounts Receivable 50,000
Advances from Customer C 50,000
Intermediate Accounting Part 1
 ABNORMAL BALANCES IN ACCOUNTS

• The identification of abnormal balances in

accounts is normally included as part of audit
procedures because of the basic accounting
concept that accounts should not have
abnormal balances. In a typical audit
engagement, the auditor performs an analytical
procedure called “scanning” whereby accounts
are scanned for abnormal balances. In an audit
utilizing computer assisted techniques (CAATs),
data from the client’s data base is uploaded to
the auditor’s computer and the CAATs app
identifies abnormal balances. These are
adjusted before further audit procedures are
performed. Intermediate Accounting Part 1
 INITIAL MEASUREMENT OF ACCOUNTS
RECEIVABLE
• PFRS 9, paragraph 5.1.1. provides that a financial
asset shall be recognized initially at fair value
plus transaction costs that are directly attributable
to the acquisition.
• However, trade receivables that do not have a
significant financing component are measured at
their transaction price in accordance with PFRS 15
Revenue from Contracts with Customers.
• The fair value of a financial asset is usually the
transaction price, meaning, the fair value of the
consideration given.
Intermediate Accounting Part 1
 INITIAL MEASUREMENT OF ACCOUNTS
RECEIVABLE
• 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
(e.g. some sales taxes).” PFRS 15
• Moreover, as a practical expedient, PFRS 15
allows the non-discounting of the amount of
consideration if it is due within 1 year from the
date of the transfer of goods.
Intermediate Accounting Part 1
 INITIAL MEASUREMENT OF ACCOUNTS
RECEIVABLE
• Example:
An entity sells goods at a 12 month installment
price of P 12,000. The regular price for outright
payment in cash is P 10,000.
Under the practical expedient allowed under
PFRS 15, the entry may recognize the accounts
receivable at the transaction price of P 12,000.
• For short term receivables, the fair value is equal
to the face amount or original invoice amount.

Intermediate Accounting Part 1

 SUBSEQUENT MEASUREMENT
• In accordance with PFRS 9, paragraphs 5.2.1.,
after initial recognition, accounts receivable
shall be measured at amortized cost.
• The amortized cost is usually the net realizable
value of accounts receivable. The term
“amortized cost” has more relevance in long-
term note receivable. Thus, the term “net
realizable value” is preferably used in relation
to accounts receivable. The net realizable
value is the amount of cash expected to be
collected or the estimated recoverable value.
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 NET REALIZABLE VALUE
• The initial amount recognized for
accounts receivable shall be reduced by
adjustments which in the ordinary course
of business will reduce the amount
recoverable from the customer.
• This is based on the established basic
principle that “assets shall not be carried
at above their recoverable amount.”

Intermediate Accounting Part 1

 NET REALIZABLE VALUE
• Accordingly, in estimating the net
realizable value of trade accounts
receivable, the following deductions are
made:
a. Allowance for freight charge
b. Allowance for sales return
c. Allowance for sales discount
d. Allowance for doubtful accounts
Intermediate Accounting Part 1
 TERMS RELATED TO FREIGHT CHARGE

• In order to give proper accounting recognition

to freight charge in relation to accounts
receivable, the following terms should be
understood – FOB Destination, FOB Shipping
Point, Freight Collect and Freight Prepaid.
• The term FOB Destination means that
ownership of the goods purchased is vested in
the buyer upon receipt thereof. Accordingly,
the seller shall be responsible for the freight
charge up to the point of destination.
Intermediate Accounting Part 1
TERMS RELATED TO FREIGHT CHARGE
• The term FOB Shipping Point means that
ownership of the goods purchased is
vested in the buyer upon shipment
thereof.
• Thus, it is incumbent upon the buyer to
pay for the transportation charge from
the point of shipment to the point of
destination.

Intermediate Accounting Part 1

TERMS RELATED TO FREIGHT CHARGE
• The term “freight collect” means that
freight charge on the goods shipped is
not yet paid. The common carrier shall
collect the same from the buyer. Thus,
under this, the freight charge is actually
paid by the buyer.
• The term “freight prepaid” means that
freight charge on the goods shipped is
already paid by the seller.
Intermediate Accounting Part 1
 ACCOUNTING FOR FREIGHT CHARGE
• Sometimes, goods are sold “FOB
destination” but shipped “freight
collect” with the understanding that the
buyer will pay for the freight charge and
deduct the same when remittance is
made by him. On the part of the seller,
the freight charge is recorded by debiting
freight out and crediting allowance for
freight charge.

Intermediate Accounting Part 1

 ACCOUNTING FOR FREIGHT CHARGE
• For example, an entity has a P 100,000 account
receivable at the end of accounting period.
The terms are 2/10, n/30, FOB Destination and
freight collect. The customer paid freight
charge of P 5,000.
1. Accounts Receivable 100,000
Freight Out 5,000
Sales 100,000
Allowance for Freight Charge 5,000
To record the sale.
2. Cash 93,000
Sales Discount 2,000
Allowance for Freight Charge 5,000
Accounts Receivable 100,000
To record the collection within the discount period.
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 ALLOWANCE FOR SALES RETURNS
• The measurement of accounts receivable
shall also recognize the probability that
some customers will return goods that
are unsatisfactory or will make other
claims requiring reduction in the amount
due as in the case of shipment shortages
and defects. The journal entry for
probable sales returns is as follows:

Sales Return 50,000

Allowance for Sales Return 50,000

Intermediate Accounting Part 1

 SALES DISCOUNT
• Entities usually offer cash discounts to
credit customers. A cash discount is a
reduction from an invoice price by reason
of prompt payment.
• A cash discount is known as sales discount
on the part of the seller and a purchase
discount on the part of the buyer.
• A cash discount may be expressed as 5/10,
n/30. This means that the customer is
entitled to a 5% discount if payment is
made in 10 days from the invoice date.

Intermediate Accounting Part 1

 SALES DISCOUNT
• If the customer fails to pay within the 10-
day discount period, the gross amount of
the invoice price must be paid within 30
days from the invoice date.
METHODS OF RECORDING CREDIT SALES
1. Gross Method – The accounts receivable
and sales are recorded at gross amount of
the invoice. This is the common and widely
used method because it is simple to apply.
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 METHODS OF RECORDING CREDIT SALES

2. Net Method – The accounts receivable and sales

are recorded at net amount of the invoice,
meaning the invoice price minus the cash
discount.
ILLUSTRATION – GROSS METHOD
1. Accounts Receivable 100,000
Sales 100,000
To record sale of merchandise , terms 5/10, n/30
2. Cash 95,000
Sales Discount 5,000
Accounts Receivable 100,000
To record payment within the discount period.
3. Cash 100,000
Accounts Receivable 100,000
To record payment beyond the discount period
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 METHODS OF RECORDING CREDIT SALES
ILLUSTRATION – NET METHOD
1. Accounts Receivable 95,000
Sales 95,000
To record sale of merchandise of P 100,000 , terms 5/10, n/30
2. Cash 95,000
Accounts Receivable 95,000
To record payment within the discount period.
3. Cash 100,000
Accounts Receivable 95,000
Sales Discount Forfeited 5,000
To record payment beyond the discount period.

• The sales discount forfeited is classified

as other income.
Intermediate Accounting Part 1
 ALLOWANCE FOR SALES DISCOUNT
• If customers are granted cash discounts for
prompt payment, then, conceptually
estimates of cash discounts on open accounts
at the end of the period based on past
experiences shall be made.
• For example, of the accounts receivable of P
1,000,000 at the end of the period, it is
reliably estimated that discounts to be taken
will amount to P 50,000.
Sales Discount 50,000
Allowance for Sales Discount 50,000

Intermediate Accounting Part 1

 ACCOUNTING FOR BAD DEBTS
• Business entities sell on credit rather
than only for cash to increase total sales
and thereby increase income. However,
an entity that sells on credit assumes the
risk that some customers will not pay
their accounts.
• When an account becomes uncollectible,
the entity has sustained a bad debt loss.
This loss is simply one the costs of doing
business on credit.

Intermediate Accounting Part 1

ALLOWANCE FOR DOUBTFULT ACCOUNTS
• The recoverable historical cost of receivables
is assessed at each reporting date. When
collectability becomes doubtful, an
allowance is recognized to adjust the
receivables to their recoverable amount.
• Other similar terms include allowance for
bad debts, allowance for uncollectible
accounts, allowance for probable losses on
receivables and loss allowance.

Intermediate Accounting Part 1

 ACCOUNTING FOR BAD DEBTS
• Two methods are followed for this bad
debt loss, namely:
1. Allowance Method
2. Direct Write Off Method
Allowance Method
• The allowance method requires recognition of a
bad debt loss if the accounts are doubtful of
collection. The “allowance for doubtful accounts”
is a contra asset (deduction) from accounts
receivable when determining net realizable value.
Intermediate Accounting Part 1
 ACCOUNTING FOR BAD DEBTS
• If the doubtful accounts are subsequently
found up to be worthless or uncollectible,
the accounts are written off.
• Generally accepted accounting principles
require the use of the allowance method
because it conforms with the matching
principle.
• Moreover, accounts receivable would be
properly measured at net realizable value.

Intermediate Accounting Part 1

 ACCOUNTING FOR BAD DEBTS
ALLOWANCE METHOD
1. Doubtful Accounts xxx
Allowance for Doubtful Accounts xxx
To record doubtful accounts.
2. Allowance for Doubtful Accounts xxx
Accounts Receivable xxx
To record accounts receivable discovered to be worthless & uncollectible and are
written off
RECOVERIES OF ACCOUNTS WRITTEN OFF
3. Accounts Receivable xxx
Allowance for Doubtful Accounts xxx
To record reversing entry for accounts receivable written off
4. Cash xxx
Accounts Receivable xxx
To record unexpected collection of accounts receivable previously written off.

Intermediate Accounting Part 1

RECOVERIES OF ACCOUNTS WRITTEN OFF
• If a collection is made on account previously
written off as uncollectible, the customary
procedure is first to recharge the customer’s
account with the amount collected and
possibly with the entire amount previously
charged off if it is now expected that
collection will be in full.
• The collection is then recorded normally by
debiting cash and crediting accounts
receivable.
Intermediate Accounting Part 1
RECOVERIES OF ACCOUNTS WRITTEN OFF
• The recharging of the customer’s accounts is
usually followed because it is an evidence of
the attempt of the customer to re-establish
his credit with the entity.
• What account should be credited when the
customer’s account if recharged?
• The accepted procedure is to simply reverse
the original entry of write off regardless of
whether the recovery is during the year of
write off or subsequent thereto.
Intermediate Accounting Part 1
 DIRECT WRITE OFF METHOD

• The direct write off method requires

recognition of a bad debt loss only when the
accounts proved to be worthless or
uncollectible.
• Worthless accounts are recorded by debiting
bad debts and crediting accounts receivable.
If the accounts are only doubtful of
collection, no adjustment is necessary.
• This approach is often used by small
businesses because it is simple to apply.
Intermediate Accounting Part 1
 DIRECT WRITE OFF METHOD
• As a matter of fact, the Bureau of Internal
Revenue recognizes only this method for income
tax purposes.
• However, the direct write off method violates
the matching principle because the bad debt
loss is often recognized in later accounting
period that the period in which the sales
revenue was recognized.
• If the recovery is subsequent to the year of
write off and the direct write off method is
used, the recovery may simply be credited to
other income. Intermediate Accounting Part 1
 DIRECT WRITE OFF METHOD
1. Accounts of P 30,000 are considered doubtful of collection.
No entry is necessary
2. Bad Debts xxx
Accounts Receivable xxx
To record accounts receivable proved to be worthless.
3. Accounts Receivable 30,000
Bad Debts 30,000
To record accounts receivable that are previously written off
but are recovered or collected.
4. Cash 30,000
Accounts Receivable 30,000
To record the collection.

Intermediate Accounting Part 1

 DOUBTFUL ACCOUNTS IN THE INCOME
STATEMENT
• Write offs and recoveries under the allowance
method do not affect profit because no expense
account is involved in recording them. Under the
direct write off method, both write off and
recoveries affect profit, working capital and
current ratio.
1. Distribution Cost
If the granting of credit and collection of
accounts are under the charge of the sales
manager, doubtful accounts shall be considered
as distribution cost .
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 DOUBTFUL ACCOUNTS IN THE INCOME
STATEMENT
2. Administrative Expense
If the granting of credit and collection of
accounts are under the charge of an officer
other than the sales manager, doubtful
accounts shall be considered as
administrative expense.
In the absence of any contrary statement,
doubtful accounts shall be classified as
administrative expense.
Intermediate Accounting Part 1
 ACCOUNTING FOR BAD DEBTS
ALLOWANCE METHOD DIRECT WRITE OFF METHOD
 Collectability become doubtful  Collectability become doubtful
Bad Debts Expense xxx No entry
Allowance for Bad Debts xxx
To record bad debts expense
 Write Off  Write Off
Allowance for Bad Debts xxx Bad Debts Expense xxx
Accounts Receivable xxx Accounts Receivable xxx
To record write off of accounts receivable. To record bad debts expense
Recovery Recovery
Accounts Receivable xxx No entry
Allowance for Bad Debts xxx
Cash xxx Cash xxx
Accounts Receivable xxx Gain on Recovery xxx
To record the collection. To record the collection.

Intermediate Accounting Part 1