COLLEGE OF ACCOUNTANCY

LEARNING MATERIALS IN CAS 11 (FINANCIAL MANAGEMENT)

Accounts Receivable Management

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Learning Outcomes:
After this lesson, students should have:
1. summarized the importance of managing receivables.
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Key Concepts:
RECEIVABLE are financial assets that represent a contractual right to receive cash or other financial assets
from another entity or customer. It includes the following:
a. Trade receivable – this is normally supported by a credit invoice issued by the company and has credit
terms. This is not supported by a promissory note.
b. Notes receivable - this is supported by a formal promise to pay in the form of a note.
c. Loans receivable - this is a receivable arising from the banks and other financial institution.

WHAT ARE THE ACCOUNTING ELEMENTS THAT AFFECT RECEIVABLES?

A. DISCOUNTS
1. TRADE DISCOUNT – a discount that is not recorded in the books of accounts. This is the discount
granted to a customer because of the bulk order that they made.
2. CASH DISCOUNT – this is the discount that is recorded in the books. This is the kind of discount that
you can see in your income statement in order for you to come up with net sales. This will encourage
our customers to pay on time because if they pay early or within the credit terms, they can avail of the
discount.
B. RETURNS
1. SALES RETURNS – these are the goods, which the customers have physically returned.
2. SALES ALLOWANCES – these are the goods, which were delivered to customers but defective. For
this reason, the company agrees to reduce the receivable account from these customers by granting a
sales allowance.
Accounts Receivable on the Statement of Financial Position:

• Net Realizable Value = balance of Accounts Receivable less balance of Allowance Account

RISK EVALUATION
There is always an inherent risk in granting credit to our customers. Normally, customers will grab an
opportunity of using the leverage in obtaining favorable response to their operating performance. We have to
do our part in order to minimize this inherent risk by exercising our best effort in the following:
1. Conduct a field investigation on the customers paying behavior. For this matter, we can ask from a third
party on how this customer behaves in settling his accounts with other suppliers.
2. Ask from the applicant/customer applying for credit facility, a financial report duly CPA, then prepare a
financial analysis.
RECEIVABLE ANALYSIS
 Accounts Receivable Turnover = total credit sales / average account receivable
 Number of Days in Receivables = 365 days / accounts receivable turnover

TWO METHODS IN THE ESTIMATION OF UNCOLLECTIBLE:

1. Percentage of sales – emphasis on Income Statement
2. Percentage of receivables - emphasis on Statement of Financial Position
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PERCENTAGE OF SALES BASIS
 Management estimates what percentage of credit sales will be uncollectible.
 Uses credit sales for the period to estimate bad debt expense for the period.
 Sometimes referred to as the income statement method.
 Expected bad debt losses are determined by applying the percentage to the sales base of the current period.
 If net credit sales for the year are P800,000, the estimated bad debts expense is P8,000 (1% X P800,000).
Debit Credit
December 31, 2017 Bad Debt Expense 8, 000
Allowance for Bad Debts 8, 000

PERCENTAGE OF RECEIVABLES BASIS

 Management estimates what percentage of receivables will result in losses from uncollectible accounts.
 Amount of the adjusting entry of difference between the required balance and the existing balance in the
allowance account
 Produces the better estimate of cash realizable value of receivables.
 Analyses the balance in Accounts Receivable to estimate the balance in the Allowance for Uncollectible
Accounts at the end of the period.
 Sometimes referred to as the Balance Sheet or Statement of Financial Position method.
 If the trial balance shows Allowance for Doubtful Accounts with a credit balance of P528, and the required
ending balance in the account is P2,228, an adjusting entry for P1,700 (P2,228 - P528) is necessary.

TWO METHODS OF ACCOUNTING FOR UNCOLLECTIBLE ACCOUNTS

1. Direct write-off method
 Bad debt losses are not anticipated and no allowance account is used – No entries are made for bad
debts until an account is determined to be uncollectible at which time the loss is charged to Bad Debts
Expense
 No matching
 No cash realizable value of accounts receivable on the balance sheet
 Not acceptable for financial reporting purposes
 This method violates the matching principle because it does not match revenues and expenses in the
same period.
 This method records uncollectible accounts expense in the period when the customer’s account is
determined to be uncollectible. The entry to write-off is:
Bad Debts Expense xx

Accounts Receivable xx

2. Allowance method
 Required when bad debts are deemed to be material in amount.
 Uncollectible accounts are estimated - expense for the uncollectible accounts is matched against sales
in the same accounting period in which the sales occurred.
 The allowance method follows the matching principle by recording the uncollectible accounts expense
in the same period as the related revenue. The account receivable is still written off in the period it is
determined to be uncollectible.
 The allowance account functions as a bridge between these two transactions, being credited when the
expense is recorded and debited when the uncollectible account is identified.
 The Allowance Method takes its name from the Allowance for Uncollectible Account that is used to
properly value accounts receivable until the uncollectible account receivable can be written-off.
 The allowance method debits bad debts expense in the period when the sale is recorded and credits a
contra-asset account, Allowance for Uncollectible Accounts.
Bad Debts Expense xx

Allowance for Uncollectible Accounts xx

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  In the period in which a specific account is determined to be uncollectible, the Allowance is debited and
Accounts Receivable is credited.
Allowance for Uncollectible Accounts xx

Accounts Receivable xx

Uncollectible Accounts Expense is reported on the Income Statement. The Allowance for Uncollectible
(Doubtful) Accounts is a contra-asset account and is reported on the Statement of Financial Position as a
deduction from Accounts Receivable.

Sometimes a customer will pay the accounts receivable after it was written off. Recording the receipt of cash is
always a two-step process: first, the accounts receivable is reinstated (added back into the general ledger)
and second, the cash is recorded and accounts receivable is reduced for the payment.

Accounts Receivable xx

Allowance for Uncollectible Accounts xx

Cash xx

Accounts Receivable xx

WHO HANDLES THE RECEIVABLES?

1. Credit and Investigation Personnel
2. Sales Representative
3. Collectors
4. Cashiers
5. Bookkeepers
6. Auditor

HOW TO CONVERT YOUR RECEIVABLE FASTER?

1. Pledging - Pledging accounts receivable is essentially the same as using any asset as collateral for a loan.
Cash is obtained from a lender by promising to repay. If the loan is not repaid, the collateral will be
converted to cash and the cash used to retire the debt. The receivables can be either an identified set of
notes and accounts or a general group in which new ones can be added and old ones retired. The
collection of a pledged receivable has no impact on the loan balance. The pledging agreement usually
calls for the substitution of another receivable for the one collected.

2. Assignment - a lender pays a borrower in exchange for the borrower assigning certain of its
receivable accounts to the lender. If the borrower does not repay the loan, the lender has the right
to collect the assigned receivables. The receivables are not actually sold to the lender, which means
that the borrower retains the risk of not collecting payments from customers. The amount loaned is
usually a percentage of the outstanding receivables in the accounts assigned to the lender. The exact
terms may vary - for example, the lender may require that all receivables be assigned to it. Under
this arrangement, the borrower pays interest on the loaned funds, as well as a service charge. In
essence, the assigned receivables act as collateral for the loan. The borrower may choose to
separately classify assigned receivables in a different asset account, to clarify the extent of the
arrangement with the lender. This type of financing is expensive, and so is only considered by
entities that have failed to obtain less expensive forms of financing. It is typically used when a
company is not sufficiently capitalized or is growing rapidly, and so does not have enough cash on
hand to fund its operations.

3. Factoring - under this method, the company is actually selling its accounts receivable to a factor
(lender). factoring could either be:
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a. Casual - is a casual selling of assets wherein the difference between the selling price and the
book value of the assets sold represents gain or loss.
b. As a continuing agreement - this arrangement would mean that the factor assumes the credit
function as well as the collection function of the company. So, the seller can receive the cash
and use it immediately in its operation.

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Inventory Management
Learning Outcomes:
After engaging in this lesson, you should be able to:
1. identify the components of inventory and its related terms;
2. identify the various forms and documents used to evidence an inventory account;
3. check the importance of human resources who handle the inventory;
4. methods of costing an inventory; and
5. describe the EOQ model.

Key Concepts

It’s all started with cash. The operating cycle says that the moment the company has cash; ordinarily they
have to convert it to inventory and when they have the inventory, they are going to sell and convert the
inventory into a receivable and then they will collect the account to eventually convert it back to cash.

DIFFERENT TYPES OF INVENTORY ACCOUNTS

The Philippine Accounting Standards 2 defined inventories as assets, which are held for sale in the ordinary
course of business, in the process of production for such sale or in the form of materials or supplies to be
consumed in the production process or in the rendering of services. Let us have a short review of this types
and forms of business organization.

Forms of Business Organization:

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 1. Sole Proprietorship – owned by one person only and owner is called proprietor or proprietress (in
case of a female owner)
2. Partnership – owned by two or more persons and the name of the owners are partners.
3. Corporation – owned by five or more persons and the owner is called corporator. If the corporation is
a stock corporation – the owner is called stockholder or shareholder. If the corporation is a non-stock
corporation, the owner is called a member.

Types of Business Organization

1. Service concern – those that render services to earn income.
2. Trading/Merchandising concern – those that sell merchandise to earn income.
3. Manufacturing concern – those that convert raw materials into finish products.

Each of these types of business organization requires a unique set of inventories to hold, control and direct.
For example – for service concern, the inventory account will only be for the supplies- the control mechanism
is quite simple and easy to operate. All we have to do is buy, record it in our books of accounts and post
correspondingly in the stock card and when issued do the same thing. The difference between what the
company received and what the company has issued is the unused portion of the supplies.

As we proceed to trading concern business enterprise, we have increased the number of accounts that we
have to hold, control and direct.
1. Supplies (the same control mechanism with that of the service concern)
2. Merchandise inventory- those items that the company purchased and intended for sale to its customers
Along with the merchandise inventory is the method of costing this inventory account. A little bit
complicated because for financial reporting, we have to abide with the benchmark first-in-first-out and
weighted-average method of inventory costing. This is the generally accepted accounting principle as
against the industry practice.

Finally, we now proceed to the last type of business organization and this is the manufacturing business
enterprise. Under this type, there are three more inventory accounts that will be added aside from the normal
supplies and merchandise inventory account and these are:
1. Raw materials inventory – these are the materials, which the company purchased and is for use in the
production.
2. Work-in process inventory – these are the partially finished products at the end of the month.
3. Finished goods inventory – these are products already finished, ready to be sold to customers.
Regardless of the inventory account, one has to bear in mind that when it comes to financial statements, we
have to go back to what is the benchmark because that is the generally accepted accounting principles. The
company might be using the other costing method but this should be converted to what is generally accepted
for fair presentation of the financial statement.

WHY DO WE HAVE TO MANAGE INVENTORY?

Management should warrant a good inventory system because the effects of mismanagement of inventory
could result in the following:
1. Under-stocking – this is a serious problem as this can result in the following:
a. Missed deliveries
b. Lost sales
c. Unsatisfied customers
d. Production bottlenecks and worst, work stoppage
2. Overstocking – these are the possible effect of this:
a. Holding cost might be too high
b. Funds could have been used for a more productive venture thus improving operating performance
With these possible effects, inventory should be taken with utmost care and must address two major
concerns:
1. Timing of order
2. Size of order
To effectively manage the inventory, one must have the following:
1. A system to keep track of the inventory on hand and or order
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 2. A reliable forecast of demand
3. Knowledge of lead time
4. Reasonable estimates of inventory holding cost, ordering cost and shortage cost
5. Classification system for inventory items

BEGINNING INVENTORY
The beginning inventory must be enough until the next delivery of the raw materials. Estimate the lead time.
The lead time must be based on the past experience of the company relating to traffic condition, supplier’s
culture, and distance of supplier’s warehouse to the company’s warehouse and of course the company’s
processing procedures and policies.

PURCHASES
The accredited supplier of choice must be objectively selected by a committee so that quality raw materials
can be easily procured. In some companies, there is no committee to handle and there are accredited
suppliers chosen by the company. In this case, the audit department should be energized so as to protect the
interest of the company. Protection would mean that the quality materials should be procured with the least
price per unit otherwise, the company might be able to purchase quality materials with high prices or
substandard raw materials with low prices. Also, it is important to consider the terms of contract with regards
to transportation.

TOTAL GOODS AVAILABLE FOR SALE

The total goods available for sale is your beginning inventory plus your net purchases. This account must be
controlled well because too much goods in the warehouse might result in over investment in inventory. Over-
investment in inventory would result to losses on the part of the company because that investment in
inventory could have been invested in other productive activity of the company like time deposit, etc.
The total goods available for sale must be well coordinated with the marketing department’s capabilities to
dispose of the inventory. Related to this, is the account receivable. Because of the marketing department’s
desire to dispose of the inventory, they might be able to dispose it to the wrong customer- a customer who
might not be able to pay its obligation to the company. For this matter, as you analyze your total available for
sale you also have to see to your accounts receivable on probability of uncollected accounts.

Also, there is a way by which you can analyze the movement of your inventory and this includes the following
formula:
1. Merchandise Inventory Turnover
= Cost of goods sold / Average Merchandise Inventory [(Beginning + Ending Inventory) / 2]
Suggests the number of times average inventory was disposed of during the accounting period. It also
signifies the over or under investment of the firm in their inventories.
2. Number of days in inventory = 365 days or 360 days / Inventory Turnover
Indicate the number of days by which inventories are used or sold. Implies the firm’s efficiency in
consuming or selling inventories.

MERCHANDISE INVENTORY, END

The merchandise that was left unsold at the end of the year and this is reflected in the Statement of Financial
Position of the company. It is important to know that the merchandise inventory should be reported to the BIR
30 days after the end of the company’s accounting period. This is reported to BIR to avoid using the account
as an adjustment account to the final net income of the company.

COST OF GOODS SOLD

The following are the factors that affect the cost of goods sold:
1. Merchandise inventory beginning – this is the merchandise inventory, end of the last accounting
period and at the same time the merchandise inventory beginning for this period.
2. Purchases
3. Freight-in – this the freight charges or transportation cost incurred by the company in purchasing
inventories.
4. Purchase discount – this is the discount availed by the company in paying early.

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 5. Purchase returns and allowances – this is the account for our purchases which we have returned
to our supplier for whatever reason.

WHO HANDLES INVENTORY

Now that we already have learned about the various types of inventories, we will now proceed on learning the
various personnel in the organization that has specific functions to do in relation to inventory. Just like with the
duties and responsibilities discussed in fund management, inventory should also be handled with care.
Remember that inventory is money in merchandise form and therefore should also be managed well.
Here are some personnel handling the inventory account:
1. Purchaser – This is the staff that procures the inventory. The job of the purchaser is to purchase
quality inventory at the cheapest price so that the company can offer also cheaper but quality
merchandise to its customers.
2. Warehouseman – This is the staff that received the merchandise and safekeeping it at the
warehouse, and issues to the store whenever there is a need or when the customer is ordering it.
3. Stock card clerk – This is the staff, usually an accounting clerk, who records the receipt and
issuances made by the warehouseman. The recording is on a per item basis or in other words this is
the subsidiary ledger of the bookkeeper’s control account. At the end of the period, the clerk’s total
inventory per item should equal with the bookkeeper’s merchandise inventory account in the general
ledger.
4. Bookkeeper – This is the staff that records the purchases made by the purchaser and as received by
the warehouseman. The recording is per supplier with no details because the details can only be seen
in the stock card. At the end of the period, the bookkeeper’s control account will equal the stock-card
clerk’s detailed inventory account.
5. Auditor – This is the staff that checks the inventory in the warehouse, the documents that supports
the purchases, the books where these transactions were recorded and later summarized in the financial
statement.
Each of them has a specific function to do to make the inventory handling safe and sound. Please notice that
their functions are interlocking. This means the internal control is active and in such a manner no man can
monopolize the transaction and therefore it is difficult to manipulate figures. This is essential in inventory
management so that errors can easily be detected and fraud can be minimized, if not totally detected.

DOCUMENTS AND FORMS USED TO EVIDENCE INVENTORY

Accounting forms are internal forms used by a business organization. These forms are intended in order to
have a consistent application of various transactions and in return can attain comparability of our financial
figures in the future.
1. Stock card – This form will be used as a subsidiary ledger for raw materials or direct materials and
even indirect materials. This business form is important because once filled up, it will show the proper
time to make an order so that the company is assured of a stable inventory of its materials and that at
any point in time, labor will not be disrupted because of shortage of raw materials. This will also
uncover efficiency in the request of raw materials. Frequent internal returns would mean that the
factory is not firm in its control of requisition or frequent external returns would mean that the
company is not efficient in choosing good material sources. Good material sources can promote good
product output or quality products.
2. Material Receiving Report (MRR) – This form is important because this will document the receipt
of materials received from the supplier. This will uncover the efficiency of the supplier in the delivery
of the raw materials. Accounting cannot record purchases unless it is covered by MMR. This form gives
confidence on the part of accounting that the materials are received in good order before payment is
made. From this form also, the company can check how fast the supplier delivers by comparing the
date of the purchase order with the date of MRR. This information is essential for the formulation of
the lead time for EOQ (economic order quantity computation) purposes. This will also uncover
suppliers, with frequent orders not delivered on time by comparing the purchase order and the MRR.
3. Material Issuance Slip (MIS) – This form will be used to document the issuance of raw materials to
various users together with the MRR; this will establish the warehousing responsibility of the

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 warehouseman. Issuance of raw materials without a corresponding MIS would mean a shortage of the
warehouseman.
a. Purchase order – This is the document used and serves as an authority of the purchaser to
purchase merchandise. This is based on the canvass sheet.
b. Canvass sheet – This is the survey of the prices of merchandise which the company would like to
purchase. This merchandise could either be for use in the office or for sale to the customers.
c. Bin card – This is the card maintained at the place where the merchandise was placed. This card
is maintained to monitor the physical movement of the merchandise. This is placed in the
warehouse.
HOW ARE THESE INVENTORY COST?
After learning the various types of inventories, the various personnel handling it, and the various forms and
documents used, we will now proceed to the next topic. We will discuss how these inventories will be cost.
The Accounting Standard Council has mentioned acceptable assumptions in costing this inventory.
1. Specific identification – the cost of units sold is identified as coming from specific purpose.

2. FIFO (First-In, First-Out) – this method is based on the assumptions that the first merchandise
acquired is the first merchandise sold.

3. Weighted average – the average unit cost is computed by dividing the total cost of goods available
for sale by the total number of goods available for sale. (Periodic Inventory System)

To illustrate, assume the following data:

Quantity Unit Cost Sales/unit
Beginning inventory 10 P 1,000
Purchase 1 100 1, 200
Sales 1 80 P 3, 000
Purchase 2 75 1, 150
Sales 2 95 3, 000
1. Specific identification
Assume that in sales 1, all were taken from purchase 1. In sales 2, 20 units were taken from purchase 1
and 75 units were taken from purchase 2.
a. The cost of goods sold is determined as follows:
Sales 1: From purchase 1 – (80 x P1, 200) P 96, 000
Sales 2: From purchase 1 – (20 x P1, 200) 24, 000
From purchase 2 – (75 x P1, 150) 86, 250
Cost of sales P 206, 250
b. The value of merchandise inventory end would be:
Merchandise inventory, end (10 x P1, 000) P 10, 000
c. The gross margin is computed as follows:
Sales (P3, 000 x 175) P 525, 000
Less: cost of goods sold (a) 206, 250
Gross profit P 318, 750

2. FIFO:
a. The cost of goods sold is determined as follows:
Sales 1: From beginning inventory (P1, 000 x 10) P 10, 000
From purchase 1 – (70 x P1, 200) 84, 000
Sales 2: From purchase 1 – (30 x P1, 200) 36, 000
From purchase 2 – (65 x P1, 150) 74, 750
Cost of sales P 204, 750

b. The value of merchandise end would be:

Beginning inventory (10 x P1, 000) P 10, 000
Purchase 1 (100 x P1, 200) 120, 000
Purchase 2 (75 x P1, 150) 86, 250
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 Total goods available for sale P 216, 250
Less: Cost of goods sold 204, 750
Merchandise inventory, end P 11, 500

c. The gross profit is computed as follows:

Sales (P3, 000 x 175) P 525, 000
Less: cost of goods sold (a) 204, 750
Gross profit P 320, 250

3. Weighted average:
Beginning inventory (10 x P1, 000) P 10, 000
Purchase 1 (100 x P1, 200) 120, 000
Purchase 2 (75 x P1, 150) 86, 250
Total goods available for sale P 216, 250
Divided by: Total goods available for sale 185
(units)
Weighted average cost per unit P 1, 168.92
Multiplied by: number of units unsold, end 10
Value of ending inventory – weighted average P 11, 689

a. The cost of goods sold is determined as follows:

Total cost of goods available for sale P 216, 250
Less: Cost of ending inventory 11, 689
Cost of goods sold P 204, 561

b. The gross profit is computed as follows:

Total sales P 525, 000
Less: Cost of goods sold 204, 561
Gross profit P 320, 439

MATERIALS QUANTITATIVE MODELS FOR PLANNING AND CONTROL

Inventory Models
Raw materials are not just purchased anytime. It is planned. Whether the product produced by the
company is a regular produce or a special produce, the company through its engineering department
should have the necessary designs, blueprints and specifications so that when the production starts, raw
materials are all ready for use. The following factors must be considered:
1. Forecast demand for the next month, quarter or year
2. Determine the lead time
3. Plan usage during the lead time
4. Establish quantity on hand
5. Place units on order
6. Safety stock requirement

ECONOMIC ORDER QUANTITY

The economic order quantity means the most economical order of raw materials that the company can
make.

The following formula is used to determine the economic order quantity (EOQ):

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Where,
 D = Demand per year
 Co = Cost per order
 Ch = Cost of holding per unit of inventory

EXAMPLE: Assuming that Covido Company have the following information relating to their purchasing of raw
materials: D = 5, 000; Co = P10.00/order; Ch = P0.80. To compute therefore the EOQ using the formula will
be:
EOQ = √ 2 (5 , 000 ) ( 10 )
0.80
= √ 100 , 000
0.80
= √ 125 , 000
= 353. 55 or 354 units
Now that we know the economic order quantity, we will now proceed with the question as to when to order
such economic order.

REORDER POINT
The reorder point will tell the manager when to place the order to initiate production in replenishing depleted
stocks. The computation of the reorder point is dependent on whether the raw materials are evenly or variably
used.
A. Constantly usage during lead time – This is based on the premise that raw materials are used
evenly or uniformly throughout the period. For this purpose, let us consider the following factors which
will affect your manner of computing the reorder point.
1. Economic order quantity (EOQ) – the most economical order
2. Lead time (LT) – this means the time the order was placed up to the time the order will be
received.
3. Average daily or weekly usage (ADU) – this means the average daily or weekly usage of the raw
materials based on their past experience.
Formula: ROP = (LT) (ADU)
Example: Assuming that the average daily usage of our above-mentioned example in EOQ is 15 units
and the lead time is 2 weeks. The reorder point will be:
ROP = (2) (15) = 30 units
This means that when the inventory balance reaches the level of 30 units, the company will place an
order for the replenishment of the depleted stocks.
B. Variable usage during the lead time
When the usage is variable as the usual case in actual situations, then safety stocks comes in. Safety
stocks (SS) is a buffer to prevent stock outs. It is an allowance made by the company depending on
the variability of the use of its raw materials. Let us consider our example above and include a safety
stock of 20 units.
Formula: ROP = (LT) (ADU) + SS
Example: Assuming that the average daily usage of our above-mentioned example in EOQ is 15 units
and the lead time is 2 weeks and a safety stock of 20 units.
The reorder point therefore will be:
ROP = (2) (15) + 20 = 50 units

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