Chapter 4 - Accounts Receivable PDF

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Definition of Receivables Receivable are financial assets that represent a contractual right to receive cash or another financial asset from another entity. Common examples of receivables: A. Accounts receivable -Accounts receivable are open accounts or those not supported by promissory note. B.

Notes receivable – receivables supported by written or formal promises to pay in the form of promissory notes.

C. Loans receivable - receivables arising from loans extended by financial institutions, such as banks, financing companies, and lending institutions. D. Advances - receivables arising from advances to officers and employees, advances to suppliers, and advances to affiliates. E. Accrued income - receivables arising from income earned but not yet collected, such as dividend income, interest income, and the like. F. Deposits - receivables from reimbursable deposits cover potential damages or losses, deposits for guara performance of payment, and deposits for returnable (eg, crates, containers, etc.) G. Claims receivable - receivables from insurance companies casualties sustained, defendants under suit, govern agencies for refundable taxes and other remittances, co carriers for damaged or lost goods, and suppliers for reti or damaged goods.

Classification Of Receivables ●

Trade receivables which are expected to be realized in cash within the normal operating cycle, 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. The classification are in accordance with PAS 1, Presentation of financial Statements, paragraphs 66, which states: “An entity shall classify an asset 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.”

Presentation Of Receivables Trade receivables and nontrade 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 financial statements. For example, the disclosure may appear as follow: Accounts receivable

5,000,000

Allowance for doubtful accounts

( 200,000)

Notes receivable

1,000,000

Accrued interest on note receivable

150,000

Advances to officers and employees

100,000

Dividends receivable

250,000

Total trade and other receivables

6,300,000

Example of non trade receivable 1. Advances to or receivables from shareholders, drectors, 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 as long-term investments. 3. Advances to suppliers for the acquisition of merchandise are current assets. 4. Subscriptions receivable

are current assets if collectible within one year. Otherwise,

subscriptions receivable should be shown preferably as a deduction from subscribed share capital. 5. Creditor’s accounts may have debit balances as a result of overpayment or returns and allowances. These are classified as current assets. 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. 7. Accrued income such as dividends receivable, accrued rent income, accrued royalties income and accrued interest on bond investment are usually classified as current assets. 8. 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. Customer’s credit balances Customer’s credit balances are credit balances in accounts receivable resulting from overpayments, returns and allowances, and advance payments from customers. These credit balances are classified as current liabilities and are not offset against the debit balances in other customers’ accounts, except when the same is not material in which case only the net accounts receivable may be presented. Initial measurement of receivables PFRS 9, paragraphs 5.11, provides that a financial asset shall be recognized initially 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 of financial asset is usually the transaction price, meaning, the fair value of the consideration given. Cash flows relating to short-term receivable are not discounted because the effect of discounting is usually immaterial. Thus, accounts receivable shall be measured initially at face value.

Accounts receivable Accounts receivable are open accounts arising from sale of merchandise or services in the ordinary course of business. Again , accounts receivable shall be measured initially at face value or original invoice amount. However, subsequently the accounts receivable shall be measured at net realized 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 recoverable from the customer. This is based on the established basic principle that “assets shall not be carried at above their recoverable amount”. 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 sale discount d. Allowance for doubtful accounts.

Terms of Sale Contract The terms of a sale contract are considered when determining, timing of transfer of control over the goods sold. The following are relevant contract terms: 1. FOB shipping point - Under FOB shipping point, ownership over the goods sold is transferred to the buyer upon shipment 2. FOB destination - UnderFOB destination, ownership is transferred only when the buyer receives the goods. *FOB stands for "free on board." Example: A seller ships goods on December 29, 20x1 and the customer receives them on January 2, 20x2. Scenario #1: FOB shipping point If the sales term is FOB shipping point, accounts receivable sales are recognized on December 29, 20x1 (i.e., date of shipment Consequently, the goods are excluded from the seller's year inventory) Scenario #2: FOB destination If the sales term is FOB destination, accounts receivable and are recognized only on January 2, 20x2 (i.e., date of receipt of delivery). Consequently, the goods in transit are included in the seller's Dec. 31, 20x1 inventory. Accounting for freight charges Another matter that should be addressed is the accounting for freight charges. Relevant terms follow: 1. Freight prepaid - The term “freight prepaid” means that freight charge on the goods shipped is already paid by the seller. 2. Freight collect - 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. • As a rule, the entity who owns the goods being shipped should pay for the shipping costs. No special accounting is necessary if the term of the sales contract is either "FOB shipping point, Freight collect” or “FOB destination, Freight prepaid” because the owner of the goods in transit is also the one who pays for the freight charges. Special accounting arises when the terms of the sale contract is either (a) “FOB shipping point,

Freight prepaid" or (b) "FOB destination, Freight collect." a. Under FOB shipping point, freight prepaid, the buyer owns the goods being shipped but the seller already paid the shipping costs. b. Under FOB destination freight collect, the seller owns the goods being shipped but the carrier will be collecting the shipping costs from the buyer.

Illustration: Goods in-transit On December 27, 20x1, ABC Co. received a sale order for a credit sale of goods with selling price of $1,000. ABC Co. shipped the goods on December 31, 20x1. The buyer received the goods on January 2, 20x2. The related shipping costs amounted to P10. ABC Co collected the receivable on January 5, 20x2. The pertinent entries in the books of ABC Co. under the d. terms of sale are as follows: a. FOB shipping point, freight collect December 27, 20x1

NO ENTRY

December 31, 20x1

(Dr) AR 1,000; (Cr) SALES 1,000

January 02, 20x2

NO ENTRY

January 05, 20x2

(Dr) CASH 1,000; (Cr) AR 1,000

B. FOB destination, freight prepaid December 31, 20x1

(Dr) Prepaid Freight 10; (Cr) CASH 10

January 02, 20x2

(Dr) AR 1,000; (Cr) SALES 1,000

January 02, 20x2

(Dr) Freight Out 10; (Cr) Prepaid Freight 10

January 05, 20x2

(Dr) CASH 1,000; (Cr) AR 1,000

Note: For proper matching of cost with revenue, the freight cost is deferred as Prepaid Freight and charged to expense as Freight Out when the related revenue is recognized C. FOB shipping point, freight prepaid December 31, 20x1

(Dr) AR 1,010; (Cr) SALES 1,000; Cash 10

January 02, 20x2

NO ENTRY

January 05, 20x2

(Dr) CASH 1,010; (Cr) AR 1,010

D. FOB destination, freight collect December 31, 20x1

NO ENTRY

January 02, 20x2

(Dr) AR 990; Freight Out 10; (Cr) SALES 1,000;

January 05, 20x2

(Dr) CASH 990; (Cr) AR 990

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. 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. Sale of merchandise for P100,000, terms 5/10,n/30. Accounts receivable

100,000

Sales

100,000

2. Assume collection is made within the discount period. Cash

95,000

Sales discount

5,000

Accounts receivable

100,000

3. Assume collection is made beyond the discount period. Cash

100,000 Accounts Receivable

100,000

Illustration- Net method 1. Sale of merchandise for P100,000, terms 5/10,n/30. Accounts receivable

95,000

Sales

95,000

2. Assume collection is made within the discount period. Cash

95,000 Accounts receivable

95,000

3. Assume collection is made beyond the discount period. Cash

100,000 Accounts receivable Sales discount forfeited

95,000 5,000

The sales discount forfeited account is classified as other income.

Allowance for sale discount If customers are granted cash discounts for prompt payment, then, conceptually estimates of cash discount on open accounts at the end of the period based on past experience shall be made. For example, of the accounts receivable of P1,000,000 at the end of the period, it is reliably

estimated that discounts to be taken will amount to P50,000 The adjustment to record the expected sales discount is: Sales discount

50,000

Allowance for sales discount

50,000

The adjustment may be reversed at the beginning of the next period in order that discounts can then be charged normally to sales discount accounts. Accounting for bad debts When an account becomes uncollectible, the entity has sustained a bad debt loss. This loss is simply one of the costs of doing business on credit. Two methods are followed in accounting for this bad debt loss, namely: 1. Allowance method 2. Direct writeoff method

Allowance method The allowance method requires recognition of a bad debt loss if the accounts are doubtful of collection. The journal entry to recognize the doubtful accounts is: Doubtful accounts

xx

Allowance for doubtful accounts

xx

The “allowance for doubtful accounts” is deduction from accounts receivable. If the doubtful accounts are subsequently found to be worthless or uncollectible, the accounts are written off as follows: Allowance for doubtful accounts Accounts receivable

xx xx

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.

Recoveries of accounts written off If a collection is made on an 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 received in full. The collection is then recorded normally by debiting cash and crediting accounts receivable. The recharging of the customer's account is usually followed because it is evidence of the attempt of the customer to reestablish his credit with the entity. Illustration- Allowance method 1. Accounts of P30,000 are considered doubtful of collection. Doubtful accounts

30,000

Allowance for doubtful accounts

30,000

2. The accounts are subsequently discovered to be worthless or uncollectible. Allowance for doubtful accounts

30,000

Accounts receivable

30,000

3. The same accounts that are previously written off are unexpectedly recovered or collected. Accounts receivable

30,000

Allowance for doubtful accounts Cash

30,000 30,000

Accounts receivable

30,000

Direct writeoff method The direct writeoff 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. However, the direct writeoff method violates the matching principle because the bad debt loss is often recognized in later accounting periods than the period in which the sales revenue was recognized.

Illustration- Direct writeoff method 1. Accounts of P30,000 are considered doubtful of collection. No entry necessary. 2. The accounts proved to be worthless. Bad debts

30,000

Accounts receivable

30,000

3. The same accounts that are previously written off as worthless are recovered or collected. Accounts receivable

30,000

Bad debts Cash

30,000 30,000

Accounts receivable

30,000

If the recovery is subsequent to the year of writeoff and the direct writeoff method is used, the recovery may simply be credited to other income.

Methods estimating doubtful accounts Doubtful accounts are recognized when the loss is probable and the amount can be estimated reliably. There are three methods of estimating doubtful accounts, namely: 1. Aging the accounts receivable or “statement of financial position approach” 2. Percent of accounts receivable or also statement of financial position approach 3. Percent of sales or “income statement approach” Aging of accounts receivable The aging of accounts receivable involves an analysis where the accounts are classified into not due or past due. a. Not due b. 1 to 30 days past due c. 31 to 60 days past due d. 61 to 90 days past due e. 91 to 120 days past due f.

121 to 180 days past due

g. 181 to 365 days past due

h. More than 1 year past due i.

Bankrupt or under litigation

Illustration The following data are summarized in aging the accounts receivable at the end of the period: (b) (a) Balance

(a x b)

Experience

Required

rate

allowance

Not due

500,000

1%

5,000

1 to 30 days past due

300,000

2%

6,000

31 to 60 days past due

200,000

4%

8,000

61 to 90 days past due

100,000

7%

7,000

91 to 180 days past due

50,000

10%

5,000

181 to 365 days past due

30,000

30%

9,000

More than 1 year past due

20,000

50%

10,000

1,200,000

50,000

The amount computed by aging of accounts receivable represents the required allowance for doubtful accounts at the end of the period. Thus, if the allowance for doubtful accounts has a credit balance of P10,000 before adjustment, the doubtful accounts expense is determined as follows: Required allowance

50,000

Less: Allowance balance before adjustment

10,000

Doubtful accounts expense

40,000

The journal entry to record the doubtful accounts expense is: Doubtful accounts Allowance for doubtful accounts

40,000 40,000

When is an account past due? The credit terms will determine whether an account is past due. For example, if the credit terms were 2/10, n/ 30, and the account is 45 days old, it is considered to be 15 days past

due. Therefore, the phase “past due” refers to the period beyond the maximum credit term. In the example, the credit term or credit period is 30 days. Percent of accounts receivable A certain rate is multiplied by the open accounts at the end of the period in order to get required allowance balance. The rate used is usually determined from past experience of the entity. Illustration 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 journal entry to record the doubtful account expense is: Doubtful accounts Allowance for doubtful accounts

50,000 50,000

Required allowance (3%x 2,000,000)

60,000

Less:credit balance in allowance

10,000

Doubtful accounts expense

50,000

Percent of sales 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 the “percent of sales” method is used in computing doubtful accounts, proper matching of cost against revenue is achieved. Illustration The following accounts are gathered from the ledger: Accounts receivable

1,000,000

Sales

5,050,000

Sales return

50,000

Allowance for doubtful accounts

20,000

If doubtful accounts are estimated at 1% of net sal...