Chapter 2 Receivables

Learning Objectives
1. Identify the proper presentation of receivables as either current or noncurrent assets.
2. State the timing of recognition and measurement of trade receivables.
3. Estimate the recoverable historical cost of trade receivables.
4. State the initial and subsequent measurements of notes receivable.
5. Compute for present value factors and apply them properly.
6. Prepare amortization tables.
7. Compute for the effective interest rate.
8. Derecognition of the receivable
9. Define the receivable financing

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 discount, also known as volume or quantity discount, are means of converting a catalog list
price to price is actually charged to the buyer. This may be used to make price differential among
different class of customer. trade discounts are not recognized for financial accounting purposes.
They are deducted from the list price prior to recording the account receivable arising from a credit
sales transaction.

Meanwhile, cash discounts or sales discount our reduction from the sales price as an inducement for
prompt payment of an account. They are expressed in terms which read as: 2/10, n/30 (2% discount
is granted if account is paid within 10 days from the invoice date, gross amount due in 30 days);
3/15, n/60 (3% discount is granted if account is paid within 15 days from the invoice date, gross
amount due in 60 days).

The timing of the recognition of the cash discount based on the method of accounting adopted by the
company for purchases and the related accounts payable. This method are as follows:
a. Gross Price Method
b. Net Method., and\
c. Allowance Method
Cash discounts are recognized(a) When taken using the gross price method, ( b) when are they can
use net price method and (C) when offered using allowance method.

Illustrative Problem

Assume on July 16, 2020, ABC manufacturing sells merchandise on hand with list price of Php
10,000 on account under credit terms of 20%, 10%, 2/10, n/30
 Gross Method Net Method Allowance Method

Sales on Account
Dr. AR 7,200* Dr. AR 7,056* Dr. AR 7,200
Cr. Sales 7,200 Cr. Sales 7,056 Cr. Sales 7,056
Cr. Allowance
(10,000 x 80% x 90%) (10,000 x 80% x 90% x 98%) For sales Discount 144

Assume Collection is made within the discount period

Dr. Cash 7,056 Dr. Cash 7,056 Dr. Cash 7,056
Cr. AR 7,200 Cr. AR 7,056 Dr. Allowance
Cr. Sales Discount 144* For sales Discount 144
Cr. AR 7,056
(10,000 x 80% x 90% x 2%)
Assume Collection is made beyond the discount period
Dr. Cash 7,200 Dr. Cash 7,200 Dr. Cash 7,200
Cr. AR 7,200 Cr. Sales Discount Dr. Allowance
Forfeited 144 For sales Discount 144
Cr. AR 7,056 Cr. Sales Discount
Forfeited 144
Cr. AR 7,200

Allowance Method of Accounting for Bad Debts

Some receivable will prove uncollectible and must be recognized as expense in a profit or loss.
This is called impairment loss, or more popularly called uncollectible accounts expense or bad debt
expense.

There are two methods of accounting for uncollectible accounts, the direct write-off method and the
allowance method.

The direct write off method recognition impairment loss or bad expense by directly crediting the
receivable accounts. The entry to recognize impairment on the receivable is

Bad Debt Expense xxx

Accounts Receivable xxx

Cash xxx
Accounts Receivable xxx
Some accounts, which have been previously written off are unexpectedly recovered or collected. In
such case, the entry to recover an account required its reinstatement and collection recorded in the
usual manner. Thus, to record recovery under direct write off method, the entries are

Accounts Receivable xxx

Bad Debt Recovery xxx

Cash xxx
Accounts Receivable xxx

On the other hand, the allowance method requires the use of valuation account for the receivables.
This method recognizes the impairment of receivable by a charge to bad debt expense and credit to
the allowance account.

Bad Debt Expense xxx

Allowance for Bad Debts xxx

When an account considered to be uncollectible written off, the entry is

Allowance for Bad Debts xxx

Accounts Receivable xxx

When an account previously written off is recovered, the account should be reinstated, and the
collection should be recorded. Thus, the entries should be

Accounts Receivable xxx

Allowance for Bad Debts xxx

Cash xxx
Accounts Receivable xxx

Estimating Doubtful Accounts

In the period of sale, the customer that eventually will not pay, the amount that will not
be paid and the period in which the customer’s account will become uncollectible cannot
be determined. Therefore, the uncollectible accounts expense must be estimated at the
end of each accounting period.

Bad debt expense is recognized when loss becomes probable and can be measured reliably. There are
three methods of estimating doubtful accounts, namely.
1. Percentage of net credit sales method
2. Percentage of ending receivable method
3. The aging of receivables method
Percentage of Net Credit Sales Method

The Percent of net credit sales method uses one income statement account, Sales, to estimate the
change in another income statement account, Bad Debt Expense, for the period. This is
the amount of the required adjusting entry. This method is typically used by businesses
with many customers with relatively uniform accounts receivable balances.

The balance in the Allowance account is the balance in the ledger before adjustment
plus, the adjusting entry for bad debt expense.

The bad debt expense for the period is calculated by multiplying the uncollectible
percentage times the credit sales in the period to determine the uncollectible accounts
expense for the period. This will be the amount of the adjusting entry.

Illustrative Problem

Gonzales Company provided the following information for the current year:

Allowance for doubtful accounts – January 1 180,000

Sales 9,500,000
Sales return and allowance 800,000
Sales discounts 200,000
Accounts written off as uncollectible 200,000

The entity provided for doubtful accounts expense at the rate of 3% of net sales. What is the
allowance of doubtful accounts at year-end?

Allowance for doubtful accounts – January 1 180,000

Doubtful accounts expense
(9,500,000 – 800,000 – 200,000 x 3%) 255,000
Total 435,000
Accounts written off (200,000)
Allowance for doubtful accounts – December 31 235,000

Under the percentage of sales method, the amount computed represents the doubtful accounts
expense.

Percentage of Ending Receivable Method

The percent of receivables method assumes a given percent of a company’s receivables is

uncollectible. The desired amount of the Allowance for Doubtful Accounts is calculated by
multiplying Accounts Receivable by this percent. The Allowance for Doubtful Accounts is this
adjusted so that it equals this desired amount.
Illustrative Problem

Example: The balance of Accounts Receivable is Php 100,000, and it is estimated that 5%
of accounts are uncollectible. The balance of the Allowance for Doubtful Accounts, before
adjustment, is Php 2,000 (credit). The desired balance of the Allowance for Doubtful Accounts
would be Php 5,000 (Php 100,000 * 5%). Since the balance of the Allowance for Doubtful Accounts
is now only Php 2,000, a Php 3,000 adjustment is required, as follows.

Bad Debts Expense 3,000

Allowance for Doubtful Accounts 3,000

The Aging of Receivables Method

Most companies have an aging of customers’ accounts receivable. In this aging report, each
customer balance is classified by how long it is past due. Based on this aging, experience is used to
estimate the percent of each aging total. Older past due receivables will be more likely uncollectible.
Once the total uncollectible amount is estimated, an adjusting entry is made to increase the
Allowance for Doubtful Accounts so that its balance equals the uncollectible estimate calculated by
using the aging report.

Illustrative Problem
On December 31, 2020, DEF show on the following letter balances:

Accounts Receivable 4,000,000

Allowance for Uncollectible Accounts 120,000

an aging of accounts receivable indicates the following:

Age Classification Balance Probability of Non-Collection

Less than 30 days 2,800,000 2%
31 - 90 days 700,000 10%
91 - 120 days 300,000 20%
more than 120 days 200,000 30%

After review of collectability, DEF determined that 20,000 of the accounts in the age category “more
than 120 days” are believed to be uncollectible and should be written off. The 30% provision for
non-collectability shall be applied on the remaining accounts in the same age category. Compute for
the bad debt expense.

2,800,000 x 2% = P 56,000
700,000 x 10% = 70,000
300,000 x 20% = 60,000
180,000 x 30% = 54,000
Required Allowance P 240,000
Existing Allowance 100,000
Additional Impairment 140,000
Note Receivables

A note receivable is a claim supported by a formal promise to pay a certain sum of money at a
specific future date usually in the form of a promissory note.

Notes Receivable can arise when the seller asks for a promissory note to replace an Accounts
Receivable when the customer requests additional time to pay a past-due account. A promissory
note is a written promise to pay a specific amount of money, usually including interest, at a
future date. The journal entries required are:
 Converting an accounts receivable to a note receivable
 Recording an adjusting entry for interest receivable at the end of the accounting period
 Recording receipt of note payment and interest when due
 Recording a dishonored note

Initial Measurement

• Receivables are initially recognized at fair value plus transaction costs that are directly
attributable to the acquisition, except trade receivables.

Summary of Measurements
Type of receivable Initial measurement Subsequent measurement

1. Short-term Face amount/ Present value/ Recoverable historical

Transaction price (for trade cost/Amortized cost/PFRS 15
receivables)
2. Long-term Face amount Recoverable historical cost
3. Long-term w/ zero interest Present value Amortized cost
4. Long-term w/ unreasonable Present value Amortized cost
interest

The fair value of the receivable at initial recognition may be measured in relation to the cash price
equivalent of the noncash asset given up in exchange for the receivable. In such case, the subsequent
measurement of the receivable is at amortized cost.

Time Value of Money

• FV of ₱1 vs. PV of ₱1
- The FV of ₱1 and PV of ₱1 are opposites.
- The FV of ₱1 answers the question “If I invest ₱100,000 today at 10% interest, how much
money do I have in three-years’ time?”
- FV of ₱1 = (1 + i)n = (1 + 10%)3 = 1.331
- Answer: (₱100,000 x 1.331 ) = ₱133,100
or (₱100,000 x 110% x 110% x 110%) = ₱133,100
 - The PV of ₱1 answers the question “If I want to have ₱133,100 in three-years’ time, how
much money do I have to invest today (at 10% interest)?
- PV of ₱1 = (1 + i)-n = (1 + 10%)-3 = 0.751315
- Answer: (₱133,100 x 0.751315 ) = ₱100,000

PV of ₱1
In the second example, the ₱133,100 to be received in 3-years’ time includes an unspecified
principal and unspecified interest. These elements can only be separated through present value
computations.

Therefore, assuming the ₱133,100 is a receivable, it should be recorded today only at ₱100,000 (the
present value) because the ₱33,100 is unearned interest. The interest will be recorded only when it
is earned, i.e., through passage of time.

PV of ₱1 is used when the cash flow is lump sum or when cash flows are non-uniform. PV of ₱1
= (1 + i)-n
PV of ordinary annuity ₱1 is used when the cash flows are in installments and the first installment
does not begin immediately.

PV of an annuity due of ₱1 is used when the cash flows are in installments and the first installment
begins immediately.

Effective Interest Method

PV of ₱1 amortization table

Date Interest income Unearned interest Present value

(a) = (c) x EIR (b) = previous bal. - (a) (c) = previous balance + (a)
1/1/x1
12/31/x1
PV of annuity amortization table
Interest Present
Date Collections income Amortization value
(d) = prev. bal.
(a) (b) = (d) x EIR (c) = (a) - (b) - (c)
1/1/x1

Illustrative Problem 1: Long-Term Interest-Bearing Note with Realistic Interest Rate

On January 1, 2020, ABC manufacturing sells an equipment costing 800,000 and with accumulated
depreciation of 450,000. The company receives a consideration 100,000 cash and a 15% interest
bearing note for 400,000 due on December 31, 2022. The interest on the note payable annually every
December 31. The prevailing rate of the interest for a note of this type is 15%.

The entries relative to the note for this entire 3-year term are as follows:

2020
Jan. 1 Cash 100,000
Notes Receivable 400,000
Accumulated Depreciation-Equipment 450,000
Equipment 800,000
Gain on Sale of Equipment 150,000

Sales price of equipment (100,000 + 400,000) 500,000

Carrying value of equipment (800,000 - 450,000) 350,000
Gain on sale of equipment 150,000

2020
Dec. 31 Cash 60,000
Interest Revenue 60,000
(15% x 400,000)

2021
Dec. 31 Cash 60,000
Interest Revenue 60,000

2022
Dec. 31 Cash 460,000
Notes Receivable 400,000
Interest Revenue 60,000
Collection of Notes and Interest Due

Illustrative Problem 2: Long-Term Non-Interest-Bearing Note with Realistic Interest Rate

On January 1, 2020, ABC manufacturing sells an equipment costing 800,000 and with accumulated
depreciation of 450,000. The company receives a consideration 100,000 cash and a non-interest-
bearing note for 400,000 due on December 31, 2022. The interest on the note payable annually every
December 31. The prevailing rate of the interest for a note of this type is 15%.

2020
Jan. 1 Cash 100,000
Notes Receivable 400,000
Accumulated Depreciation-Equipment 450,000
Equipment 800,000
Discount on Notes Receivable 137, 000
Gain on Sale of Equipment 13,000

Face Value of Note 400,000

Present Value of Note (0.6575 X 400,000) 263,000
Discount on Notes Receivable 137,000

Cash Received 100,000

Add Present Value of Note 263,000
Total Sales Price of Equipment 363,000
Carrying Value of Equipment (800,000 - 450,000) 350,000
Gain on Sale of Equipment 13,000

Date Interest Income Unearned Interest Carrying Value

January 01, 2020 137,000 263,000

December 31, 2020 39,450 97,550 302,450

December 31, 2021 45,368 52,183 347,818

December 31, 2022 52,183 - 400,000

2020
Dec. 31 Discount on Notes Receivable 39, 450
Interest Revenue 39, 450
Amortization Off Discount

2021
Dec. 31 Discount on Notes Receivable 45,368
Interest Revenue 45,368
Amortization Off Discount
2022
Dec. 31 Cash 400,000
Discounts a note receivable 52,183
Notes Receivable 400,000
Interest Revenue 52,183
Collection of Notes and Interest Due

Illustrative Problem 3: Long-Term Non-Interest-Bearing Installment Note

On January 1, 2020, ABC manufacturing sells an equipment costing 800,000 and with accumulated
depreciation of 450,000. The company receives a consideration 100,000 cash and a non-interest-
bearing note for 300,000 due in equal amount of 100,000. The interest on the note payable annually
every December 31. The prevailing rate of the interest for a note of this type is 15%.

2020
Jan. 1 Cash 100,000
Notes Receivable 300,000
Accumulated Depreciation-Equipment 450,000
Loss on Sale Of Equipment 21,680
Equipment 800,000
Discount on Notes Receivable 71,680

Face Value of Note 300,000

Present Value of Note (2.2832 X 100,000) 228,320
Discount on Notes Receivable 71,680

Cash Received 100,000

Add Present Value of Note 228,320
Total Sales Price of Equipment 328,320
Carrying Value of Equipment (800,000 - 450,000) 350,000
Loss on Sale of Equipment 21,680

Interest Unearned
Date Collections Present Value
Income Interest
January 01, 2020 71,680 228,320
December 31, 2020 100,000.00 34,248 65,752 162,568
December 31, 2021 100,000.00 24,385 75,615 86,953
December 31, 2022 100,000.00 13,043 86,953 -

2021
Dec. 31 Cash 100,000
Discount on Notes Receivable 34,248
Notes receivable 100,000
Interest Revenue 34,248
Amortization of discount and collection of installments
2021
Dec. 31 Cash 100,000
Discount on Notes Receivable 24,385
Notes receivable 100,000
Interest Revenue 24,385
Amortization of discount and collection of installments

2022
Dec. 31 Cash 100,000
Discounts a note receivable 13,043
Notes Receivable 100,000
Interest Revenue 13,043
Collection of Notes and Interest Due

Loan Receivables

Receivables are initially recognized at fair value plus transaction costs that are directly attributable
to the acquisition, except trade receivables.

 Direct origination costs are added to the carrying amount of a loan receivable. Indirect
origination costs are expensed when incurred.
 Origination fees are deducted from the carrying amount of a loan receivable.

Impairment
The expected credit loss model (ECL)
General approach

Derecognition Of Receivables

Financial assets are derecognized when:

a) the contractual rights to the cash flows from the financial asset expire; or
b) the financial assets are transferred, and the transfer qualifies for derecognition.

Derecognition (of a financial instrument) means the removal of a previously recognized financial
asset or financial liability from an entity’s statement of financial position.

Evaluation of Transfers of Receivables

If control over the receivable is:

• Substantially transferred, the receivable is derecognized.
• Substantially retained, the receivable is not derecognized but continued to be recognized.
Any cash received from the transfer is recognized as liability.
• Partially transferred and partially retained, the portion transferred is derecognized while the
portion retained is continued to be recognized.

Offsetting of Financial Assets and Financial Liabilities

A financial asset and a financial liability shall be offset, and the net amount presented in the
statement of financial position only when both of the following conditions are met:

a. The entity currently has a legally enforceable right to set off the recognized amounts; and
b. The entity intends either to settle on a net basis, or to realize the asset and settle the liability
simultaneously.
Receivable financing

1. Pledge (hypothecation)
Pledging refers to the use of receivables as collateral for a loan. It is otherwise known as
general assignment of accounts receivable, since all receivables are used as collateral for a
loan.

2. Assignment
Assignments it's a formal form of a pledge wherein the receivables are assigned or used as
collateral security for borrowing are specifically identified and stated in the loan contract.
a. Notification basis - Debtors whose receivables have been assigned are notified of the
assignment. Thereafter, the debtor will remit payments on the receivable not to the
assignor but to the assignee.
b. Non-notification basis - Debtors whose receivables have been assigned are not
notified of the assignment.

3. Factoring
Instead of borrowing money and pledging or assigning the receivable as collateral security,
entities will sometimes sell that receivable to a financial institution known as factor.

Factoring on a without recourse basis is an outright sale or are they not a sale of receivable.
this type of factoring is a transfer of financial asset that qualifies for the derecognition.

Factoring with recourse basis, The transferrer guarantees this payment of the factor in the
event The debtor fails to pay.

4. Discounting of notes receivable

a. NP = MV – D
b. MV = P + i
c. D = MV x Dr x Dp
d. Dr = Discount rate
e. Dp = Discount period (the unexpired term of the note)
Interest income = interest accrued on the expired term of the note

Video Reference
https://www.youtube.com/watch?v=YMw_9naWXNI
https://www.youtube.com/watch?v=NyitxKPGCjE
https://www.youtube.com/watch?v=hAwr3PbsacI