Accounts Receivable, Loans Receivable, and Notes Receivable Q&A PDF

Preview

Summary

FINANCIAL ACCOUNTINGTHEORY & PRACTICERECEIVABLES(Accounts Receivable, Notes Receivable, Loans Receivable and Receivable Financing) QUIZZERFINANCIAL ACCOUNTINGEssay Questions – Accounts Receivable Page 2Trade receivables and nontrade receivables which are currently collectible shall be presented ...

Description

FINANCIAL ACCOUNTING THEORY & PRACTICE RECEIVABLES (Accounts Receivable, Notes Receivable, Loans Receivable and Receivable Financing) QUIZZER

Accounts Receivable ACCOUNTS RECEIVABLE 1. Define receivables and enumerate the classes of receivables. Receivables are financial assets because they represent a contractual right to receive cash or another financial asset from another entity. For retailers or manufacturers, receivables are classified into trade receivables and nontrade receivables. Trade receivables refer to claims arising from sale of merchandise or services in the ordinary course of business operations. The usual types are accounts receivable and notes receivable. Accounts receivable are open accounts or those not supported by promissory notes. Other names of accounts receivable are customers' accounts, trade debtors, and trade accounts receivable. Notes receivable are those supported by formal promises to pay in the form of notes. Nontrade receivables represent claims arising from sources other than the sale of merchandise or services in the ordinary course of business. For banks and other financial institutions, receivables result primarily from loans to customers. The loans are made to heterogeneous customers and the repayment periods are frequently longer or over several years. 2.

Explain the classification of receivables in the statement of financial position. 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. Nontrade 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, nontrade receivables are classified as noncurrent assets.

Essay Questions – Accounts Receivable

Page 1

FINANCIAL ACCOUNTING Trade receivables and nontrade receivables which are currently collectible shall be presented as one line item called "trade and other receivables". 3.

Explain the "initial measurement" of receivables. PFRS 9, paragraph 5.1.1, provides that when a financial asset is recognized initially, an entity shall measure it at fair value plus transaction costs that are directly attributable to the acquisition. The fair value of a financial asset is usually the transaction price, meaning, the fair value of the consideration given. For short-term receivables, the fair value is equal to the face value or original invoice amount. Cash flows relating to short-term receivables are not discounted because the effect of discounting is usually immaterial. Thus, accounts receivable shall be measured initially at face value. For long-term receivables that are interest-bearing, the fair value is equal to the face value. However, for long-term receivables that are noninterest-bearing, the fair value is equal to the present value of all future cash flows discounted using the prevailing market rate of interest for similar receivables. Thus, initially, long-term interest-bearing notes receivable shall be measured at face value and long-term noninterest-bearing notes receivable shall be measured at present value.

4.

Explain the measurement of accounts receivable. Accounts receivable shall be measured initially at face value or original invoice amount. However, subsequently the accounts receivable shall be measured at net realizable value, meaning the amount of cash expected to be collected or the estimated recoverable amount. The initial amount recognized for accounts receivable shall be reduced by adjustments which in the ordinary course of business will reduce the amount receivable from the customer. This is based on the established principle that assets shall not be carried at an amount above their recoverable amount.

Essay Questions – Accounts Receivable

Page 2

Accounts Receivable Accordingly, in estimating the net realizable value of trade accounts receivable, the following deductions are made: a. b. c. d. 5.

Allowance for freight charge Allowance for sales return Allowance for sales discount Allowance for doubtful accounts

What are customers' credit balances? Customers' credit balances are credit balances in accounts receivable resulting from overpayments, returns and allowances, and advance payments from customers. Customers' credit balances are classified as current liabilities and shall not be offset against the debit balances in other customers' accounts. However, when the amount is not material, only the net accounts receivable may be presented in the statement of financial position.

6.

Explain the two methods of accounting for bad debts. The two methods of accounting for bad debts are the allowance method and direct writeoff method. The allowance method requires recognition of bad debt loss if the accounts are doubtful of collection. The doubtful accounts are recorded by debiting doubtful accounts and crediting allowance for doubtful accounts. Generally accepted accounting principles require the use of the allowance method because it conforms with the matching principle. Moreover, accounts receivable will be properly measured at net realizable value. The direct writeoff method requires recognition of a bad debt loss only when the accounts are worthless or uncollectible. Worthless accounts are recorded by debiting bad debts and crediting accounts receivable.

Essay Questions – Accounts Receivable

Page 3

FINANCIAL ACCOUNTING This approach is often used by small businesses because it is simple to apply. As a matter of fact, the Bureau of Internal Revenue recognizes only this method for income tax purposes. 7.

What is the treatment of "recoveries of accounts previously written off? If a collection is made on account previously written off, the customary procedure is 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 received in full. In other words, the recovery is recorded by reversing the entry of writeoff by debiting accounts receivable and crediting allowance for doubtful accounts. The collection is then normally recorded by debiting cash and crediting accounts receivable.

8.

What are the three methods of estimating doubtful accounts? Doubtful accounts are recognized when the loss is probable and the amount can be estimated reliably. The three methods of estimating doubtful accounts are aging, percentage of accounts receivable and percentage of sales. Aging method The aging method involves an analysis of the accounts whether not due or past due. Past due accounts are further classified in terms of the length of the period past due. The required allowance for doubtful accounts is then determined by multiplying the total of each classification by the rate of loss experienced by the entity for each category. The major argument for this method is the more accurate and scientific computation of allowance for doubtful accounts. Consequently, the accounts receivable would be fairly presented at net realizable value. Thus, this method is a statement of financial position approach.

Essay Questions – Accounts Receivable

Page 4

Accounts Receivable Percent of accounts receivable method A certain rate is multiplied by the ending accounts receivable balance in order to get the required allowance balance. The rate used is usually determined from past experience of the entity. This procedure has also the advantage of presenting the accounts receivable at estimated net realizable value. This method is also a statement of financial position approach because it favors the statement of financial position. Percent of sales method The amount of sales for the year is multiplied by a certain rate to get the doubtful accounts expense. The rate may be applied on credit sales or total sales. When this method is used, proper matching is achieved because doubtful accounts are directly related to sales from which they arise, and are reported in the same year of sale. Thus, this method is an income statement approach because it favors the income statement. 9.

How would you classify doubtful accounts in the income statement? 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. 2. Administrative expense - If the granting of credit and collection of accounts are under the charge of an officer other than 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.

10. Explain impairment of accounts receivable. Many entities record allowance for doubtful accounts using aging, percentage of accounts receivable and percentage of sales. The approach is relatively direct and uncomplicated. Actually, accounts receivable considered uncollectible are deemed to be "impaired". Essay Questions – Accounts Receivable

Page 5

FINANCIAL ACCOUNTING PFRS 9, paragraph 5.2.2, provides that an entity shall apply the impairment requirements in paragraphs 58 to 65 of PAS 39 for financial asset measured at amortized cost. PAS 39, paragraph 58, provides that an entity shall assess at every year-end whether there is an objective evidence that a financial asset or group of financial assets is impaired. Paragraph 59 provides that a financial asset or group of financial assets is impaired if there is objective evidence of impairment as a result of one or more "loss events" having an impact on the estimated cash flows of the financial asset that can be measured reliably. In other words, an account receivable is considered impaired if a loss event indicates a "negative effect" on the estimated cash flows to be received from the customer. 11. What are the "loss events" that would indicate impairment of accounts receivable? Paragraph 59 provides that the following loss events may indicate evidence of impairment of accounts receivable: a. Significant financial difficulty of the customer. b. Breach of contract, such as default in payment of principal and interest. c. Restructuring or renegotiation of the terms of the accounts receivable due to the financial distress of the customer. d. Measurable decrease in the estimated cash flows from a group of accounts receivable, although the decrease cannot yet be identified with individual accounts receivable. 12. Explain the assessment whether accounts receivable should be considered impaired. PAS 39, paragraph 64, provides the following detailed guideline in assessing whether accounts receivable should be considered impaired: a. Individually significant accounts receivable should be considered for impairment separately and if impaired, the impairment loss is recognized. b. Accounts receivable not individually significant should be collectively assessed for impairment. c. Accounts receivable not considered impaired should be included with other accounts receivable with similar credit-risk characteristics and collectively assessed for impairment.

Essay Questions – Accounts Receivable

Page 6

Notes Receivable NOTES RECEIVABLE 1. Define notes receivable. Notes receivable are claims supported by formal promises to pay usually in the form of notes. A negotiable promissory note is an unconditional promise in writing made by one person to another, signed by the maker, engaging to pay on demand or at a fixed determinable future time a sum certain in money to order or to bearer. Simply stated, a promissory note is a written contract in which one person, known as the maker, promises to pay another person, known as the payee, a definite sum of money. The note may be payable on demand or at a definite future date. Standing alone, the term "notes receivable" represents only claims arising from sale of merchandise or service in the ordinary course of business. Thus, notes received from officers, employees, shareholders and affiliates shall be designated separately. 2.

Explain the treatment of "dishonored notes". When a promissory note matures and is not paid, it is said to be dishonored. Theoretically, dishonored notes shall be removed from the notes receivable account and transferred to accounts receivable at an amount to include, if any, interest and other charges. The journal entry to record dishonored notes is: Accounts receivable Notes receivable Interest income

xx xx xx

Such approach is defended on the ground that the overdue note has lost part of its status as a negotiable instrument and really represents only an ordinary claim against the maker. 3.

Explain the initial measurement of notes receivable. Conceptually, notes receivable shall be measured initially at present value.

Essay Questions – Notes Receivable

Page 7

FINANCIAL ACCOUNTING The present value is the sum of all future cash flows discounted using the prevailing market rate of interest for similar notes. The prevailing market rate of interest is actually the effective interest rate. However, short-term notes receivable are measured at face value. Cash flows relating to short-term notes receivable are not discounted because the effect of discounting is usually not material. The initial measurement of long-term notes depends on whether the notes are interestbearing or noninterest-bearing Interest bearing long-term notes are measured at face value which is actually the present value upon issuance. Noninterest-bearing long-term notes are measured at present value which is the discounted value of the future cash flows using the effective interest rate. Actually, the term "noninterest-bearing" is a misnomer because all notes implicitly contain interest. It is simply a case of the "interest being included in the face amount" rather than being stated as a separate rate. 4.

Explain the subsequent measurement of notes receivable. Subsequent to initial recognition, long-term notes receivable shall be measured at amortized cost using the effective interest method. The "amortized cost" is the amount at which the note receivable is measured initially minus principal repayment, plus or minus the cumulative amortization of any difference between the initial carrying amount and the principal maturity amount minus reduction for impairment or uncollectibility. For long-term noninterest-bearing notes receivable, the amortized cost is the present value plus amortization of the discount, or the face value minus the unamortized unearned interest income.

Essay Questions – Notes Receivable

Page 8

Loans Receivable LOAN RECEIVABLE Essay Questions 1. Define loan receivable. A loan receivable is a financial asset arising from a loan granted by a bank or other financial institution to a borrower or client. The term of the loan may be short-term but in most cases, the repayment periods cover several years. 2.

Explain the initial- measurement of loan receivable. At initial recognition, an entity shall measure a loan receivable at fair value plus transaction costs that are directly attributable to the acquisition of the financial asset. The fair value of the loan receivable at initial recognition is normally the transaction price, meaning, the amount of the loan granted. Transaction costs that are directly attributable to the loan receivable include origination fees. Direct origination costs should be included in the initial measurement of the loan receivable.

3.

Explain the subsequent measurement of loan receivable. PFRS 9, paragraph 4.1.2, provides that if the business model in managing financial asset is to collect contractual cash flows on specified dates and the contractual cash flows are solely payments of principal and interest, the financial asset shall be measured at amortized cost. Accordingly, a loan receivable is subsequently measured at amortized cost using the effective interest method. The "amortized cost" is the amount at which the receivable is measured initially minus principal repayment, plus or minus the cumulative amortization of any difference between the initial amount recognized and the principal maturity amount, minus reduction for impairment or uncollectibility.

4.

Explain "origination fees" in relation to a loan receivable. Lending activities usually precede the actual disbursement of funds and generally include efforts to identify and attract potential borrowers and to originate a loan.

Essay Questions – Loans Receivable

Page 9

FINANCIAL ACCOUNTING The fees charged by the bank against the borrower for the creation of the loan are known as "origination fees". Origination fees include compensation for activities such as 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. 5.

What is the treatment of origination fees? The origination fees received from borrower are recognized as unearned interest income and amortized over the term of the loan. If the origination fees are not chargeable against the borrower, the fees are known as "direct origination costs". The direct origination costs are deferred and also amortized over the term of the loan. Preferably, the direct origination costs are offset directly against any origination fees received. If the origination fees received exceed the direct origination costs, the difference is unearned interest income and the amortization will increase interest income. If the direct origination costs exceed the origination fees received, the difference is charged to "direct origination costs" and the amortization will decrease interest income. Accordingly, the origination fees received and the direct origination Costs are included in the measurement of the loan receivable.

6.

Explain impairment of loan receivable. PFRS 9, paragraph 5.2.2, in conjunction with PAS 39, paragraph 58, provides that an entity shall assess at every end of reporting period whether there is objective evidence that a financial asset or group of financial assets is impaired. If such evidence exists, the entity shall determine and recognize the amount of any impairment loss. Objective evidence of impairment may result from the following "loss events" occurring after the initial recognition of the financial asset:

Essay Questions – Loans Receivable

Page 10

Receivable Financing 1. Significant financial difficulty of the issuer or obligor. 2. Breach of contract, such as default or delinquency in interest or principal payment. 3. Debt restructuring The lender, for economic or legal reason relating to the borrower's financial difficulty, grants to the borrower a concession that the lender would not otherwise consider. 4. Probability that the borrower will enter bankruptcy or other financial reorganization. 5. The disappearance of an active market for the financial asset because of financial difficulty. 6. Measurable decrease in the estimated future cash flows from a group of financial assets since the initial recognition, although the decrease cannot yet be identified with the individual financial assets in the group. 7.

Explain the measurement of impairment loss on loan receivable. PFRS 9, paragraph 5.2.2, provides that if there is evidence that an impairment loss on loan receivable carried at amortized cost has been incurred, the amount of the loss is measured as the "difference between the carrying amount of the loan receivable and the present value of estimated future cash flows discounted at the original effective rate of the loan." The carrying amount of the loan receivable shall be reduced either directly or through the use of an allowance account. The amount of the impairment loss sha...