MODULE 3

Lesson / Topic : ACCOUNTS RECEIVABLE

Learning Target(s) : Classify receivables as either current or noncurrent assets.
State the timing of recognition and measurement of trade
receivables.
Estimate the recoverable historical cost of trade receivables

Reference(s) : Millan, Z.V. 2020. Intermediate Accounting. Bandolin Enterprise

Introduction
In order to attract customers, companies allow credit sales or render service on
account. The accounting concern is on how to classify receivables in the financial statement
as well as how to recognize an measure receivables.

Name at least five receivables and classify each whether it is trade or non-trade
receivables and whether it is a current or non-current assets.
Receivables Trade or Non-trade Current or Non-Current
Assets

There are different types of receivables that a particular entity maintained in its
operation. Some are classified as trade receivables and non-trade receivables.
There are criteria also in classifying them into current and non-current assets

Receivables are assets that represent contractual rights to receive cash or other asset
from another entity.
Examples of receivables;
Accounts receivable
Notes receivable
Loans receivable
Advances
Accrued Income
Deposits
Claims receivable
Trade vs. Non-trade receivables

Trade receivables are receivables arising from the sale of goods or services in the
ordinary course of business. Receivables arising from other sources are non-trade
receivables.

Financial statement presentation

Trade receivables are classified as current assets when they are expected to be
realized in cash within the normal operating cycle or one year, whichever is longer.

Non-trade receivables are classified as current assets only when they are expected
to be realized in cash within one year.

Trade and non-trade receivables that are current assets are aggregated and
presented in the statement of financial position as “Trade and other receivables.”

Initial Measurement

Trade receivables that do not have a significant financing component are measured
at the transaction price in accordance with PFRS 15 Revenue from Contracts with
Customers.

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)

As a practical expedient under PFRS 15, an entity may not discount a trade
receivable if it is due within 1 year.

Recognition

Trade receivable is recognized when the entity has right to consideration that is
unconditional. This is normally the case when the control over the promised
goods or services is transferred to the customer.

FOB Shipping point vs. FOB Destination

Under FOB shipping point, ownership is transferred to the buyer upon shipment.
Therefore, sales and accounts receivable are recognized on shipment date.

Under FOB destination, ownership is transferred only upon receipt of the goods by
the buyer. Therefore, sales and accounts receivable are recognized only when the
buyer receives delivery of the goods.

Accounting for sales discounts

Trade discount vs. Cash discount

Trade discounts are given to encourage orders in large quantities or to avoid
frequent changes in catalogs, to alter prices for different quantities purchased, or to
hide true invoice price from competitors. Trade discounts are deducted from the list
price when determining the invoice price. Trade discounts are not recorded (i.e.,
not accounted for separately) by either the buyer or the seller.

Cash discounts are given to encourage prompt payment. Cash discounts are
deducted from the invoice price when determining the net amount collectible within
the discount period. Cash discounts are accounted for separately.
Accounting for Cash discounts
There are two accounting treatments for cash discounts - one is in accordance with
PFRS 15 Revenue from Contracts with Customers and the other one is in
accordance with traditional GAAP.

PFRS 15
When the consideration includes a variable amount (for example, the customer
is given a discount), the entity is required to estimate the amount to which it
expects to be entitled in exchange for transferring the promised good or service.
The entity then assesses whether there is a high probability that the estimated
amount will not significantly change once the uncertainty is resolved. (This is
referred to in PFRS 15 as constraining estimates of variable consideration.)
The entity recognizes revenue and receivable) equal to the estimated amount
when it satisfies its performance obligation in the contract.

Traditional GAAP
Under traditional GAAP, cash discounts are accounted for using either the (a) gross
method or (b) net method.
Gross Method - Under this method, accounts receivable and sales are initially
recorded at amounts gross of cash discounts. Cash discounts are recorded only
when they are taken by the buyer.
Cash discounts taken by the buyer are debited to the "Sales discounts" account
and deducted from Sales when computing for net sales.
Net Method - Under this method, accounts receivable and sales initially recorded at
amounts net of cash discounts. Cash discounts not taken by the buyer are credited
to the "Sales discounts forfeited" account and included as part of "other
income" or "finance income." Cash discounts taken by the buyer are not accounted
for.
Accounts receivable recorded at net amount are adjusted for sales discounts that
have expired. However, sales are not adjusted for discounts not taken.
The penalty for not availing discount represented by the "sales discounts forfeited"
should not be treated as part of sales revenue but rather as "other income." Some
contend that sales discount forfeited represents income arising from the provision
of financing and therefore should be presented as "finance income" or "interest
income."
(For Illustration, see page 162-166 of the textbook).

Subsequent measurement of accounts receivable

Accounts receivable are subsequently measured at recoverable historical cost (or

net realizable value). Recoverable historical cost (net realizable value) represents
the amount of cash expected to be recovered from the contractual cash flows of the
receivable. Net realizable value is normally computed as the transaction price minus
subsequent repayments of principal and minus any reduction (directly or through
the use of an allowance account) for uncollectability or impairment.

Estimating the recoverable historical cost of accounts receivable

In estimating the recoverable historical cost (net realizable value) of trade accounts
receivable, an entity considers the following:
a. Sales discounts
b. Doubtful accounts

Sales discount
When discounts are made available to customers, the amount of consideration
may not be wholly recoverable when it is probable that customers will avail of the
cash discounts in the future.
As stated in PFRS 15, the entity considers any discounts that are expected to be
taken by customers when recognizing accounts receivable. At the reporting
date, the entity updates the measurement of the accounts the accounts receivable.
Any adjustment is accounted for prospectively as an
adjustment to revenue.

Allowance for doubtful accounts

Credit is often granted to customers to encourage sales. However, the reward of
increased sales entails the assumption of risk of loss when customers fail to pay
their dues. 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. A basic accounting concept is
that assets should not be recognized at more than their recoverable amount. The
resulting allowance, commonly termed as "allowance for doubtful accounts," is
treated as a contra-asset (deduction) to accounts receivables when determining net
realizable value. Other similar terms include "allowance for bad debts," "allowance
for uncollectible accounts," "allowance for probable losses on receivables"
and "loss allowance."

Accounting for bad debts

There are two methods of accounting for bad debts, namely,
(a)Allowance method and
(b) Direct write-off method.

Allowance method
As the name implies, an allowance is recognized for bad debts expense when the
collectability of accounts becomes doubtful or questionable. This method conforms
to the concepts of accrual basis of accounting, matching, and conservatism in that,
bad debts expenses are recognized when they become probable so as not to
overstate receivables. When it becomes certain that accounts are uncollectible or
worthless (as opposed to being merely 'doubtful' of collection), the accounts are
written off.

Write off-"An entity shall directly reduce the gross carrying amount of a financial
asset(e.g., a receivable) when the entity has no reasonable expectations of
recovering a financial asset in its entirety or a portion thereof. A write-off
constitutes a derecognition event." (PFRS 9).

Direct write-off method

In this method, bad debts expense is directly written-off from the balance of
accounts receivable only when the accounts are deemed worthless. No entry
is made for accounts that are merely doubtful of collection. This method does not
conform to the concepts of accrual basis of accounting, matching, and conservatism
because bad debts expenses are recognized only when uncollectability becomes
certain and not when loss becomes probable. Consequently, receivables may be
overstated prior to the write-off.
The direct method is usually not acceptable for financial reporting purposes,
except for micro-entities (entities with total assets or total liabilities of below
P3,000,000). However, the direct write-off method is favored for taxation purposes
because bad debt expenses are tax deductible only when accounts receivable
are deemed worthless.
When accounts previously written-off are subsequently recovered, the collection
is simply recognized as gain.

Illustration 1: Allowance method vs. Direct method

• Collectability become doubtful

1. Accounts receivable of P10,000 is found to be doubtful of collection.
Allowance method Direct method
Bad debt expense 10,000 No entry
Allowance for bad debts 10,000
To record bad debt expense.
• When it become worthless( to be written -off)
Allowance method Direct method
Allowance for bad debts 10,000 Bad debt expense 10,000
Accounts Receivable 10,000 Accounts Receivable 10,000
To record write-off. To record bad debts expense.

• Recovery
Accounts Receivable 10,000 No entry.
Allowance for bad debts 10,000
To reverse the previous write-off.

Cash 10,000 Cash 10,000

Accounts Receivable 10,000 Gain on recovery 10,000
To record the collection of accounts receivable.

Estimating doubtful accounts

Percentage of net credit sales

Percentage of receivables; and
Aging of receivables

Percentage of Net Credit Sales

This method is computed by applying a percentage on the net credit sales during
the period. It does not consider the beginning balance of allowance for doubtful
accounts, write-offs and recoveries during the year. This method favors the income
statement in that strict adherence to the matching principle is attained. ( Refer to
page 172-174 of the textbook for the example).

Bad Debts expense= % x Net Credit Sales

Percentage of Receivable (Single loss-rate approach)

Under this method, required balance of allowance for doubtful accounts is
computed by applying a percentage on the ending balance or receivables. Bad
debts is computed as the difference between the required balance and unadjusted
carrying amount of the allowance of doubtful accounts. This method favors the
statement of financial position because it provides a reasonable estimate of the
receivables’ net realizable value.( Refer to page 174-177 of the textbook for the
example).
Required Allowance for Doubtful Accounts = % x Accounts Receivable
Bad Debts Expense Expense= Required balance of Allowance for Doubtful
Accounts - Unadjusted Carrying amount of Allowance of Doubtful Accounts

Aging of Receivable
The required balance of allowance for doubtful accounts is computed by
applying various estimated percentages to the breakdown of the ending receivable
according to ages. Bad debt expense is computed similar to the percentage of
receivables.

The age of receivables is determined based either on the number of days the
receivables are outstanding or on the number of days the receivables are past due.
Entities do not usually prepare an aging schedule solely to determine bad debt
expense. Rather, the aging schedule is prepared as a control device to determine
the composition of receivables and to identify delinquent accounts.

Moreover, PFRS 7 Financial Instruments requires disclosures of past due and

not past due receivables. This means that even if entities use either the percentage
of credit sales or percentage of receivables, they still need to prepare schedules of
aging of receivables. The percentages applied to each of the age brackets of
receivables are determined based on the entity's past experience, careful analysis
of the historical relationship between credit sales and bad debts with the advice of
credit department personnel, and other available statistics. Normally, larger
percentages are applied to older accounts.
For regulated entities (e.g., banks), the percentages applied are based on
regulations issued by the related regulatory bodies (e.g., Bangko Sentral ng
Pilipinas).

Illustration 1: Aging based on days outstanding

ABC has the following information:
During the year also, ABC wrote off P 7,000 receivables and recovered P 4,000 that
had been written-off inprior years. The allowance for doubtful accounts has a
beginning balance of P2,000.
Compute for (a) doubtful expense for the year and (b)net realizable value

Days Outstanding Receivable % Required allowance

balances uncollectible (c) = (a) x (b)
(a) (b)
0-60 120,000 1% 1,200
61-120 90,000 2% 1,800
Over 120 100,000 6% 6,000
Total Accounts receivables 310,000 9,000

Requirement A: Doubtful Accounts Expense:

Allowance for Doubtful Accounts

Debit Credit
2000 Beg. balance
Write-offs 7,000 4,000 Recoveries
10,000 Doubtful accounts
expense(squeeze)
Ending balance 9,000

Net realizable value/Carrying amount

Accounts Receivable 310,000
Less: Allowance for Doubtful Expense (9,000)
Net Realizable Value 301,000

Illustration 2: Aging based on days past due

ABC Co. Sells to wholesalers on term s 2/15, n/30. In addition, the company uses
the aging of receivables method. The estimated percentages or collectability are as
follows:

Overdue for less than 31 days 97%

Overdue for 31-60 days 90%
Overdue for 61-90 days 85%
Overdue for 91-120 days 65%
Overdue for over 120 days 40%

Allowance for doubtful accounts has a balance of P8,000 as of January 1, 20x1. No

write-offs or recoveries were made during the year. Compute for the (a) balalnce of
allowance for doubtful accounts on December 31, 20x1 and (b) the doubtful
accounts expense for the year.
Requirement (a)Allowance of doubtful accounts
Age in days Receivable % Uncollectible Required allowance
balances(a) (b) x (b)
0-15 100,000 None
16-30 60,000 None
31-60 50,000 3% 1,500
61-90 40,000 10% 4,000
91-120 30,000 15% 4,500
121-150 20,000 35% 7,000
Totals 300,000 17,000

Since the credit term is 2/15, n30, receivables aging 0-15 and 16-30 days are not
yet considered as past due, therefore no allowance is required.

Requirement (b)Doubtful accounts expense

Allowance for Doubtful Accounts

Debit Credit
8,000 Beg. balance
Write-offs 0 0 Recoveries
9,000 Doubtful accounts
expense(squeeze)
Ending balance 17,000

Combination of Methods

Entities may estimate bad debts using more than one method. For example, an
entity uses the percentage of credit sales in monthly reports for convenience and
the aging method in the annual report. Furthermore, the entity identifies specific
accounts and individually assesses them for collectability(percentage of receivable).
(For illustrations, refer on page 182-186 of your textbook.

Part !. Theory.
Answer Chapter 4 Problems 1 and Problems 2 of the textbook.

Part II. Problem Solving

Shine Company provided the following information during the first year of
operations:
Total merchandise purchases for the year 14,000,000
Cash collections from customers 8,000,000
Merchandise inventory on December 31 2,800,000
Shine sell all merchandise at a mark-up of 40% above cost. All sales are on a credit
basis and all receivables are collectible.d What amount should be reported as
accounts receivable on December 31?
On March 31,2020, Gen Company had an unadjusted credit balance of P10,000 in
its allowance for uncollectible accounts. An analysis of Gen's trade accounts
receivable at that date revealed the following:
Age Amount Estimated Uncollectible
0 - 30 days P600,000 5%
31-60 days 40,000 10%
Over 60 days 20,000 14,000
P14,000 14

What amount should Gen report as allowance for uncollectible accounts in

its March 31,2020 statement of financial position?

During 2020, the JRD Company wrote off uncollectible accounts of P 7,500 and
recovered accounts of P 3,700 that had been written off in 2015. In addition, the
following information is available.
Accounts Receivable Amortized Cost
December 31, 2019 375,000 P 362,500
December 31, 2020 500,000 480,000

The uncollectible accounts expense for the year 2020 is?